Article ID: | iaor201112095 |
Volume: | 66 |
Issue: | 5 |
Start Page Number: | 1735 |
End Page Number: | 1777 |
Publication Date: | Oct 2011 |
Journal: | The Journal of Finance |
Authors: | Odean Terrance, Gervais Simon, Heaton J B |
Keywords: | management |
A risk‐averse manager’s overconfidence makes him less conservative. As a result, it is cheaper for firms to motivate him to pursue valuable risky projects. When compensation endogenously adjusts to reflect outside opportunities, moderate levels of overconfidence lead firms to offer the manager flatter compensation contracts that make him better off. Overconfident managers are also more attractive to firms than their rational counterparts because overconfidence commits them to exert effort to learn about projects. Still, too much overconfidence is detrimental to the manager since it leads him to accept highly convex compensation contracts that expose him to excessive risk.