CEO Overconfidence and Incentive Compensation

• In Event: Management Accounting 2

Abstract

We examine the impact of CEO overconfidence on compensation. For an overconfident CEO, existing theory suggests the purpose of an option-intensive compensation contract is to take advantage of the CEO’s overly-optimistic view of future profitability (the exploitation hypothesis). Premised on the need to provide incentives, we provide an alternative and show theoretically that it can be optimal to compensate overconfident CEOs with more incentive-based pay (the strong-incentive hypothesis). Empirically, we find the evidence is more consistent with the strong-incentive hypothesis. We also find overconfidence impacts non-CEO executive compensation in a similar manner to which it impacts CEO compensation. Our results indicate boards write compensation contracts that reflect individual behavioral traits such as overconfidence.

Authors

• Ling Lisic, George Mason University

• Mark Laurence Humphery-Jenner, University of New South Wales

• Vikram Nanda, Rutgers University

• Dino Silveri, Binghamton University