This chapter analyzes the determinants of overconfident CEO appointments and the effect these appointments on competitor stock performance during managerial turnover within the firm. It also analyzes the turnovers that take place in S&P 500 firms and find that an overconfident successor appointed to the firm pertains to a significant positive impact on competitor's stock price. The author also finds that when the outgoing CEO is overconfident it is more likely for the firm to have an overconfident successor.
Top1. Introduction
Recent behavioral studies show that overconfident managers engage in overinvestment and make value destroying acquisitions, consequently, the appointment of an overconfident CEO pertains to a significant negative impact on firm’s stock price whereas others argue that it might be desirable for a firm to hire an overconfident manager as he can result in greater innovative success of the firm.1Yet, we do not know much about the determinants of having an overconfident CEO in the firm and how the competitors of the firm are affected by the appointment of an overconfident CEO. Since a CEO plays a crucial role in setting and implementing the strategy and actions of a firm, and most firms do not operate in monopolistic markets, understanding the determinants of CEO overconfidence and its effect on competitor stock prices would also appear to be an important issue for investigation.
We study the turnover sample of CEOs employed by S&P 500 firms from 1996 to 2006 as in Mazzeo and Yilmaz (2014). Mazzeo and Yilmaz (2014) find that when an overconfident CEO is appointed to the firm there is a significant negative impact on firm’s stock price. The proxy for overconfidence is from Malmendier and Tate (2005) who use CEO option holdings data to measure CEO overconfidence and consider overconfidence as the persistent failure of the manager to reduce his exposure to company-specific risk. Using an event study methodology to calculate turnover abnormal returns of the competitor, we identify interesting findings. First, we find that successor overconfidence has a significant impact; when an overconfident CEO is appointed to the firm the abnormal return on the immediate competitor stock increases at the time of the succession announcement. Next, we examine the determinants of having an overconfident CEO appointed to the firm and find that the outgoing CEO being overconfident increases the likelihood, whereas, the outgoing CEO having an MBA degree pertains to a lower probability of having an overconfident successor.
The findings of this paper contribute to the growing behavioral corporate finance literature. Beginning with Roll (1986), studies examine the role of managerial irrationality in corporate finance. In general findings suggest that overconfident managers may be detrimental to firm value (e.g., Ben-David et al., 2007; Malmendier and Tate, 2008) and the market reacts negatively to the appointment of an overconfident CEO (Mazzeo and Yilmaz, 2014).However, some studies argue that it might be desirable for a firm to hire an overconfident manager as he can increase firm value (e.g., Englmaier, 2004; Gervais et al., 2011;Hirshleifer et al., 2012). This study complements the literature by measuring the biased managerial beliefs and examining the determinants of overconfident CEOs appointed to the firm.
The results of this paper also contribute to the research on product market competition. While several studies focus on the effect of competition on managerial turnover, this paper focuses on the consequences of CEO turnover on competitors by examining the repercussions of CEO overconfidence on competitor’s abnormal stock return when a turnover takes place within the firm.2