Overconfidence, corporate governance structure and risk management initiatives

Abstract

This research will investigate the influence of managerial overconfidence on decisions related to Enterprise Risk Management (ERM). The basic hypothesis to be theoretically modeled and empirically tested is that firms managed by overconfident CEOs engage in less ERM initiatives, since these managers would show a greater sense of control about corporate outcomes, thus perceiving less benefit from costly risk management initiatives. This has not been proposed nor tested in the literature and constitutes the main planned contribution. In addition, this research will also investigate the role of corporate governance structure, particularly Board of Directors, in mitigating the effectiveness of biased decisions by overconfident managers. Besides traditional measures of corporate governance, it will investigate two collective biases that may affect the decision making of Boards: groupthink and social cascades. This has not been empirically tested in the literature and constitutes another relevant potential contribution of this research. We'll employ different proxies for managerial overconfidence, such as the managers status as an entrepreneur or not and the pattern of ownership of firm's shares held by the main executive. The idea is to test such propositions in a cross-country setting, with data from nine markets: Large developing countries (Brazil, India), Continental Europe countries or insider systems (France, Belgium, Germany), Anglo-Saxon countries or outsider systems (US, UK), and Asian economies (Korea, Japan). Overall, this research contributes to the behavioral corporate finance literature, an emergent line of research outside traditional corporate finance theories that proposes a new and complementary understanding about corporate decision making. It will also fit in the risk management literature, a particularly relevant topic after the emergence of the 2008 global financial crisis. (AU)