Date: 08 November 2019, Friday
Place: Faculty of Business Administration,
Ümit Berkman Seminar Room (MA-330)
“Relative Performance Evaluation of Overconfident CEOs”
Abstract: This paper offers one of the first empirical tests of the relationship between performance evaluation mechanisms and risk-taking by biased chief executive officers (“CEO”s). The literature on CEO overconfidence exclusively focused on the perception of their abilities or an irrational belief in the positive outcomes. We show that overconfidence is not prevalent only in self-assessment, but also in the relative assessment. We compare the change in the overall risk levels of firms with overconfident CEOs with those with unbiased CEOs upon the introduction of explicit relative performance evaluation (“RPE”) contracts. Using an options-based measure of CEO overconfidence, we demonstrate that the use of RPE multiplies excessive risk-taking by biased CEOs. Finally, the size of the RPE peer set also increases risk-taking due to increased ambiguity in performance comparison. We propose that CEO biases are a critical determinant of the effects of incentive contracts and performance evaluation schemes.