CFO Overconfidence

A recent NBER paper:

We test whether top corporate executives are miscalibrated, and whether their miscalibration impacts investment behavior. Over six years, we collect a unique panel of nearly 7,000 observations of probability distributions provided by top financial executives regarding the stock market. Financial executives are miscalibrated: realized market returns are within the executives’ 80% confidence intervals only 38% of the time. We show that companies with overconfident CFOs use lower discount rates to value cash flows, and that they invest more, use more debt, are less likely to pay dividends, are more likely to repurchase shares, and they use proportionally more long-term, as opposed to short-term, debt.

It would be relatively easy to measure overconfidence in CFO candidates, and choose less overconfident ones.  Since this doesn’t happen, I suspect that CEOs, like bosses of software managers, prefer overconfident CFOs.

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  • CEO or CFO? It seems like there should be a huge difference in the effects of overconfidence.

  • Cyan

    I hypothesize that the problem is that the prediction is doing double duty. Its stated purpose is forecasting; its unstated purpose is as a signal of the predictor’s commitment to achieving the goal.

  • Silas

    Anyone know if this research has been connected to the value-stock premium? It would seem that poor performance would correlate with overconfidence which would correlate with not throwing off dividends which would be correlated with “growth stock” status.

  • The author of this paper does not understand that a share repurchase is equivalent to a dividend. (Both are ways of returning capital to investors.) A share repurchase is often preferred because it is more tax efficient. This has nothing to do with overconfidence.
    Also, the paper implies that 38% is low, or at least lower than average. I don’t think this is correct.

  • The point is that 38% is lower than 80%.

  • Richard, there is no reason to assume that any of the candidates achieved 80%. It might be that the least overconfident person was selected from a pool of overconfident candidates.

  • Benquo, thanks – made the correction.

    Cyan, yes that is plausible.

  • Tim Tyler

    The viral video “Impossible is Nothing” illustrates the overconfidence effect:

    “you must believe beyond any reasonable doubt that you will achieve your goals … failure cannot be considered an option”