Hostname: page-component-76fb5796d-wq484 Total loading time: 0 Render date: 2024-04-25T11:23:50.865Z Has data issue: false hasContentIssue false
  • English
  • Français

Can Strong Boards and Trading Their Own Firm’s Stock Help CEOs Make Better Decisions? Evidence from Acquisitions by Overconfident CEOs

Published online by Cambridge University Press:  08 August 2013

Adam C. Kolasinski  and
Xu Li
Adam C. Kolasinski
Affiliation:
akolasinski@mays.tamu.edu, Mays School of Business, Texas A&M University, 4812 TAMU, College Station, TX 77843
Xu Li
Affiliation:
xuli1@hku.hk, School of Business, Faculty of Business and Economics, University of Hong Kong, Pokfulam Road, Hong Kong
Get access Rights & Permissions [Opens in a new window]

Abstract

Little evidence exists on whether boards help managers make better decisions. We provide evidence that strong and independent boards help overconfident chief executive officers (CEOs) avoid honest mistakes when they seek to acquire other companies. In addition, we find that once-overconfident CEOs make better acquisition decisions after they experience personal stock trading losses, providing evidence that a manager’s recent personal experience, and not just educational and early career experience, influences firm investment policy. Finally, we develop and validate a new CEO overconfidence measure that is easily constructed from machine-readable insider trading data, unlike previously used measures.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 48 , Issue 4 , August 2013 , pp. 1173 - 1206
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2013 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Adams, R., and Ferreira, D.. “A Theory of Friendly Boards.” Journal of Finance, 62 (2007), 217–250.Google Scholar
Adams, R.; Hermalin, B.; and Weisbach, M.. “The Role of Boards of Directors in Corporate Governance: A Conceptual Framework and Survey.” Journal of Economic Literature, 48 (2010), 58–107.Google Scholar
Agrawal, A., and Knoeber, C.. “Do Some Outside Directors Play a Political Role?” Journal of Law andEconomics, 64 (2001), 179–198.Google Scholar
Ai, C., and Norton, E.. “Interaction Terms in Logit and Probit Models.” Economics Letters, 80 (2003), 123–129.Google Scholar
Akerlof, G. “Procrastination and Obedience.” American Economics Review Papers and Proceedings, 81 (1991), 1–19.Google Scholar
Andrade, G.; Mitchell, M.; and Stafford, E.. “New Evidence and Perspectives on Mergers.” Journal of Economic Perspectives, 15 (2001), 103–120.Google Scholar
Baker, M., and Gompers, P.. “The Determinants of Board Structure at the Initial Public Offering.” Journal of Law and Economics, 46 (2003), 569–598.CrossRefGoogle Scholar
Bebchuk, L.; Cohen, A.; and Ferrell, A.. “What Matters in Corporate Governance?” Review of Financial Studies, 22 (2009), 783–827.Google Scholar
Bertrand, M., and Schoar, A.. “Managing with Style: The Effect of Managers on Firm Policies.” Quarterly Journal of Economics, 118 (2003), 1169–1208.Google Scholar
Billett, M., and Qian, Y.. “Are Overconfident CEOs Born or Made? Evidence of Self-Attribution Bias from Frequent Acquirers.” Management Science, 54 (2008), 1037–1051.Google Scholar
Boone, A.; Field, L.; Karpoff, J.; and Raheja, C.. “The Determinants of Corporate Board Size and Composition: An Empirical Analysis.” Journal of Financial Economics, 85 (2007), 66–101.Google Scholar
Booth, J., and Deli, D.. “On Executives of Financial Institutions as Outside Directors.” Journal of Corporate Finance, 5 (1996), 227–250.Google Scholar
Business Mexico. “Hawkish CEOs Have the Urge to Merge.” Business Mexico (March 1, 2004),38–39.Google Scholar
Campbell, T. C.; Gallmeyer, M.; Johnson, S. A.; Rutherford, J.; and Stanley, B. W.. “CEO Optimism and Forced Turnover.” Journal of Financial Economics, 101 (2011), 695–712.CrossRefGoogle Scholar
Cheng, S.; Nagar, V.; and Rajan, M.. “Insider Trades and Private Information: The Special Case of Delayed-Disclosure Trades.” Review of Financial Studies, 20 (2007), 1833–1864.Google Scholar
Choi, J.; Laibson, D.; and Madrian, B.. “Reducing the Complexity Costs of 401K Participation and Enrollment.” NBER Working Paper #11979 (2006).Google Scholar
Choi, J.; Laibson, D.; Madrian, B.; and Metrick, A.. “For Better or For Worse: Default Effects and 401(k) Savings Behavior.” In Perspectives in the Economics of Aging, Wise, D., ed. Chicago: University of Chicago Press (2004), 81–121.Google Scholar
Coles, J.; Daniel, N.; and Naveen, L.. “Boards: Does One Size Fit All?” Journal of Financial Economics, 87 (2008), 329–356.Google Scholar
Core, J., and Guay, W.. “Estimating the Value of Employee Stock Option Portfolios and Their Sensitivities to Price and Volatility.” Journal of Accounting Research, 40 (2002), 613–630.Google Scholar
Cornett, M.; Marcus, A.; and Tehranian, H.. “Corporate Governance and Pay-for-Performance: The Impact of Earnings Management.” Journal of Financial Economics, 87 (2008), 357–373.Google Scholar
Deshmukh, S.; Goel, A. M.; and Howe, K. M.. “CEO Overconfidence and Dividend Policy: Theory and Evidence.” Journal of Financial Intermediation, 22 (2013), 440–463.CrossRefGoogle Scholar
Eisenberg, T.; Sundgren, S.; and Wells, M. T.. “Larger Board Size and Decreasing Firm Value in Small Firms.” Journal of Financial Economics, 48 (1998), 35–54.Google Scholar
Fich, E., and Shivdasani, A.. “Are Busy Boards Effective Monitors?” Journal of Finance, 61 (2006), 689–724.Google Scholar
Frankel, R., and Li, X.. “Characteristics of a Firm’s Information Environment and the Information Asymmetry between Insiders and Outsiders.” Journal of Accounting and Economics, 37 (2004), 229–259.Google Scholar
Givoly, D., and Palmon, D.. “Insider Trading and the Exploitation of Inside Information: Some Empirical Evidence.” Journal of Business, 58 (1985), 69–87.Google Scholar
Goel, A. M., and Thakor, A.. “Overconfidence, CEO Selection, and Corporate Governance.” Journal of Finance, 63 (2008), 2737–2784.CrossRefGoogle Scholar
Gompers, P.; Ishii, J. L.; and Metrick, A.. “Corporate Governance and Equity Prices.” Quarterly Journal of Economics, 118 (2003), 107–155.Google Scholar
Gorton, G.; Kahl, M.; and Rosen, R.. “Eat or Be Eaten: A Theory of Mergers and Firm Size.” Journal of Finance, 64 (2009), 1291–1344.Google Scholar
Graham, J.; Hazarika, S.; and Narasimhan, K.. “Corporate Governance, Debt, and Investment Policy During the Great Depression.” Management Science, 57 (2011), 2083–2100.Google Scholar
Graham, J., and Narasimhan, K.. “Corporate Survival and Managerial Experiences During the Great Depression.” Working Paper, Duke University (2004).Google Scholar
Hackbarth, D. “Managerial Traits and Capital Structure Decisions.” Journal of Financial and Quantitative Analysis, 43 (2008), 843–882.Google Scholar
Hackman, R. J. Groups That Work. San Francisco: Jossey-Bass (1990).Google Scholar
Harford, J. “Corporate Cash Reserves and Acquisitions.” Journal of Finance, 54 (1999), 1969–1997.Google Scholar
Harford, J. “What Drives Merger Waves?” Journal of Financial Economics, 77 (2005), 529–560.Google Scholar
Harris, M., and Raviv, A.. “A Theory of Board Control and Size.” Review of Financial Studies, 21 (2006), 1797–1831.Google Scholar
Heaton, J. B. “Managerial Optimism and Corporate Finance.” Financial Management, 31 (2002), 33–45.Google Scholar
Helland, E., and Sykuta, S.. “Regulation and the Evolution of Corporate Boards: Monitoring, Advising, or Window Dressing.” Journal of Law and Economics, 74 (2004), 167–192.Google Scholar
Hermalin, B., and Weisbach, M.. “Endogenously Chosen Boards of Directors and Their Monitoring of the CEO.” American Economic Review, 88 (1998), 96–118.Google Scholar
Hermalin, B., and Weisbach, M.. “Boards of Directors as an Endogenously Determined Institution: A Survey of the Economic Literature.” Federal Reserve Bank of New York Economic Policy Review (April 2003), 7–26.Google Scholar
Hietala, P.; Kaplan, S.; and Robinson, D.. “What Is the Price of Hubris? Using Takeover Battles to Infer Overpayments and Synergies.” NBER Working Paper #W9264 (2002).Google Scholar
Hirshleifer, D.; Low, A.; and Teoh, S. H.. “Are Overconfident CEOs Better Innovators?” Journal of Finance, 67 (2012), 1457–1498.Google Scholar
Hribar, P., and Yang, H.. “Does CEO Overconfidence Affect Management Forecasting and Subsequent Earnings Announcements? Working Paper, University of Iowa (2010).Google Scholar
Hulbert, M. “Measuring CEOs on the Hubris Index.” New York Times (May 22, 2005).Google Scholar
Jensen, M. C. “The Modern Industrial Revolution, Exit, and the Failure of Internal Control Systems.” Journal of Finance, 48 (1993), 831–880.Google Scholar
Jovanovic, B., and Rousseau, P.. “The Q Theory of Mergers.” American Economic Review, 92 (2002), 198–204.CrossRefGoogle Scholar
Khorana, A.; Tufano, P.; and Wedge, L.. “Board Structure, Mergers, and Shareholder Wealth: A Study of the Mutual Fund Industry.” Journal of Financial Economics, 85 (2007), 572–598.Google Scholar
Kolasinski, A., and Li, X.. “Are Corporate Managers Savvy About Their Stock Price? Evidence from Insider Trading after Earnings Announcements.” Journal of Accounting and Public Policy, 29 (2010), 27–44.Google Scholar
Kolasinski, A., and Siegel, A.. “On the Economic Meaning of Interaction Terms in Logit and Probit Models.” Working Paper, University of Washington (2010).Google Scholar
Lakonishok, J., and Lee, I.. “Are Insider Trades Informative?” Review of Financial Studies, 14 (2001), 79–111.Google Scholar
Linck, J.; Netter, S.; and Yang, T.. “The Determinants of Board Structure.” Journal of Financial Economics, 87 (2008), 308–328.Google Scholar
Madrian, B. C., and Shea, D.. “The Power of Suggestion: Inertia in 401 Participation and Savings Behavior.” Quarterly Journal of Economics, 66 (2001), 1149–1188.Google Scholar
Malmendier, U., and Tate, G.. “CEO Overconfidence and Corporate Investment.” Journal of Finance, 60 (2005a), 2661–2700.Google Scholar
Malmendier, U., and Tate, G.. “Does CEO Overconfidence Affect Corporate Investment? CEO Overconfidence Measures Revisited.” European Financial Management, 11 (2005b), 649–659.Google Scholar
Malmendier, U., and Tate, G.. “Who Makes Acquisitions? CEO Overconfidence and the Market’s Reaction.” Journal of Financial Economics, 89 (2008), 20–43.Google Scholar
Malmendier, U.; Tate, G.; and Yan, J.. “Corporate Financial Policies with Overconfident Managers.” NBER Working Paper #W13570 (2007).Google Scholar
Meehan, C. “Bullish Executives May Harm Companies.” Financial News (Feb. 22, 2004).Google Scholar
Moeller, S. B.; Schlingemann, F. P.; and Stulz, R. M.. “Firm Size and the Gains from Acquisitions.” Journal of Financial Economics, 73 (2004), 201–228.Google Scholar
Morck, R.; Shleifer, A.; and Vishny, R.. “Do Managerial Objectives Drive Bad Acquisitions?” Journal of Finance, 45 (1990), 31–48.CrossRefGoogle Scholar
Paul, D. “Board Composition and Corrective Action: Evidence from Corporate Responses to Bad Acquisition Bids.” Journal of Financial and Quantitative Analysis, 42 (2007), 759–784.Google Scholar
Raheja, C. “Determinants of Board Size and Composition: A Theory of Corporate Boards.” Journal of Financial and Quantitative Analysis, 40 (2005), 283–305.Google Scholar
Rhodes-Kropf, M.; Robinson, D.; and Viswanathan, S.. “Valuation Waves and Merger Activity: The Empirical Evidence.” Journal of Financial Economics, 77 (2005), 561–603.Google Scholar
Roll, R. “The Hubris Hypothesis of Corporate Takeovers.” Journal of Business, 59 (1986), 197–216.Google Scholar
Schoar, A. “The Effects of Diversification on Productivity.” Journal of Finance, 57 (2002), 2379–2403.CrossRefGoogle Scholar
Seyhun, N. “The Information Content of Aggregate Insider Trading.” Journal of Business, 61 (1988), 1–24.Google Scholar
Seyhun, N. “Overreaction or Fundamentals: Some Lessons from Insiders’ Response to the Market Crash of 1987.” Journal of Finance, 45 (1990), 1363–1368.Google Scholar
Song, F., and Thakor, A.. “Information Control, Career Concerns, and Corporate Governance.” Journal of Finance, 61 (2006), 1845–1896.Google Scholar
Steiner, I. D. Group Process and Productivity. New York: Academic Press (1972).Google Scholar
Varian, H. “What Can We Learn From How a Manager Invests His Own Money?” New York Times (Dec. 15, 2005).Google Scholar
Xuan, Y. H. “Empire Building or Bridge-Building? Evidence from New CEOs’ Internal Capital Market Allocation Decisions.” Review of Financial Studies, 22 (2009), 4919–4948.Google Scholar
Yermack, D. “Higher Market Valuation of Companies with a Small Board of Directors.” Journal of Financial Economics, 40 (1996), 185–211.Google Scholar