Consequences of CEO Overconfidence

Abstract

We test the impact of CEO overconfidence on the cost of debt and the impact of SOX on overconfidence via CEO selection. Our CEO overconfidence measure is based on the degree of optimism in management earnings forecasts, and the measure for the cost of debt is bond yield spreads. Our evidence supports that the market discounts CEO overconfidence by increasing the cost of borrowing. Moreover, we find that the financial market also incorporates past CEO overconfidence into bond pricing. We document that the board prefers to appoint a more rational CEO over an overconfident CEO. Our findings are consistent with Banerjee et al.’s (2015) argument that an independent board mitigates the costs of CEO overconfidence in terms of investment and risk exposure.