Momentum,Reversals, and Fund Manager Overconfidence

This paper examines the role of investor overconfidence and self‐attribution bias in explaining the momentum effect. We develop a novel measure of overconfidence based on characteristics and trading patterns of US equity mutual fund managers. Stocks held by more overconfident managers experience greater momentum profits and stronger return reversals than stocks held by less overconfident managers. The difference in momentum profits is not compensation for risk nor is it attributable to stock characteristics that influence momentum. Our results are consistent with Daniel, Hirshleifer, and Subrahmanyam (1998) who argue that momentum results from delayed overreaction caused by overconfidence and biased self‐attribution.     

National Culture and Takeover Contest Outcomes

We examine the effects of cultural differences on the outcome of takeover contests. Our main focus is on individuality, which we posit to have an effect on firm behavior in international takeover contests. In a sample of international acquisitions with bidders from multiple countries, we find that individuality positively relates to the probability of placing the winning bid. We further find that takeover contest winners with high individuality scores experience lower announcement returns. Our results are consistent with the literature that links individuality to overconfidence. Our evidence suggests that firms should control culture‐related behavioral biases in their mergers and acquisitions activity.     

Endogenous overconfidence in managerial forecasts

We examine whether attribution bias leads managers who have experienced short-term forecasting success to become overconfident in their ability to forecast future earnings. Importantly, this form of overconfidence is endogenous and dynamic. We also examine the effect of this cognitive bias on the managerial credibility. Consistent with the existence of dynamic overconfidence, managers who have predicted earnings accurately in the previous four quarters are less accurate in their subsequent earnings predictions. These managers also display greater divergence from the analyst consensus and are more precise. Lastly, investors and analysts react less strongly to forecasts issued by overconfident managers.     

CEO Overconfidence and Corporate Investment

We argue that managerial overconfidence can account for corporate investment distortions. Overconfident managers overestimate the returns to their investment projects and view external funds as unduly costly. Thus, they overinvest when they have abundant internal funds, but curtail investment when they require external financing. We test the overconfidence hypothesis, using panel data on personal portfolio and corporate investment decisions of Forbes 500 CEOs. We classify CEOs as overconfident if they persistently fail to reduce their personal exposure to company‐specific risk. We find that investment of overconfident CEOs is significantly more responsive to cash flow, particularly in equity‐dependent firms.     

Managerial Overconfidence,Self-Attribution Bias,and Downwardly Sticky Investment: Evidence from Korea

The extant literature on behavioral corporate finance has explored the effects of overconfidence on investment–cash flow sensitivity (ICS) to explain overinvestment, yet it has overlooked the asymmetric behavior of investments in relation to changes in cash flow levels. This study examines whether investments behave asymmetrically responding to changes in cash flows and, if so, how managerial overconfidence affects asymmetric ICS. Using a sample of KOSPI and KOSDAQ firms in Korea, we find the incidence of downwardly sticky ICS in unconstrained firms. We then find that overconfident managers encourage ICS to be stickier than their rational peers do in unconstrained firms. Finally, we find that managerial overconfidence intensified by self-attribution bias induces ICS to get even stickier, suggesting more explicit evidence of corporate investment distortions. The results of alternative tests using the asymmetric models of Homburg and Nasev (2008) are qualitatively consistent with prior results. Overall, our findings imply a higher incidence of excessive investment commitments driven by overconfident managers.     

CEO Overconfidence and Earnings Management: Evidence from Property-Liability Insurers' Loss Reserves

This study investigates the relation between managerial overconfidence and loss-reserving practices in the U.S. property-liability insurance industry. We find robust evidence that CEO overconfidence is significantly associated with relatively low loss reserves, resulting in relatively high reported earnings. This finding is consistent with the theoretical predication that overconfident managers overestimate the returns on their investment projects and underestimate losses. Our result contributes to the literature linking CEOs' personality traits and firms' accounting policy as well as to the literature on insurer loss-reserving practices.     

Effects of managerial overconfidence and ability on going-concern decisions and auditor turnover

I examine how the appearance of managerial overconfidence and managerial ability affect 1) auditors' decisions to issue a going concern opinion and 2) auditor dismissal rates after issuing a going concern opinion. Managerial attributes are likely to have an influence on auditors' decisions because auditors obtain and evaluate information about client management's remedy plans when there is substantial doubt about the entity's ability to continue as a going concern. While prior literature on managerial overconfidence classifies all managers who demonstrate overconfident behaviors in one group, I argue that the literature needs to take managerial ability into consideration when measuring overconfidence. I find that auditors are more likely to issue a going concern opinion to clients with seemingly overconfident managers only when the management who appears overconfident is also incompetent. I also find that auditors are more likely to be dismissed after issuance of a going concern opinion when the client company has seemingly overconfident management. Finally, I find that the association between managerial overconfidence and auditor dismissal subsequent to issuance of a going concern opinion is stronger when management is relatively more powerful than the company's audit committee.     

The effect of bidder conservatism on M&A decisions: Text-based evidence from US 10-K filings

This paper examines whether and how bidders' conservative tone in 10-K filings influences the subsequent mergers and acquisitions (M&A) investment decisions of these US firms from 1996 to 2013. Based on 39,260 firm-year observations, we find, consistent with behavioural consistency theory, that conservative bidders are less likely to engage in M&A deals. Further, those that decide to engage in M&As are likely to acquire public targets and within-industry firms. These bidders are inclined to employ more stock acquisitions than cash acquisitions. Our results also indicate that conservative bidders experience abnormally poor stock returns around the announcements of M&A investments. This provides new insights on the mechanism through which bidders' sentiments influence shareholders' wealth. Overall, these findings highlight the implications of the textual sentiment of corporate disclosure for the forecasting of corporate investment and financing decisions. Our results have practical implications, since they shed light on the value relevance of the information content of major Securities Exchange Commission (SEC)-mandated 10-K filings.     

Multiple Bids, Management Opposition, and the Market for Corporate Control

We use regression analysis to disentangle the wealth effect for acquired firm shareholders of management opposition and multiple bids (e.g., multiple bidders and bid revisions). Although multiple bidders and bid revisions occur more frequently for opposed acquisitions, opposition is not associated with incremental acquisition returns for acquisitions with multiple bidders. We also find that management opposition has no significant incremental effect on single bidder acquisitions unless the acquiring firm revises its initial bid. These findings indicate that rather than amplifying acqiuisition returns directly, management opposition instead serves as a negotiating tool to solicit additional bids.     

Managerial rights,use of investment banks,and the wealth effects for acquiring firms’ shareholders

We examine the relation between managerial rights in acquiring firms and the decision to use an investment bank in merger and acquisition deals, and explore whether this relation impacts the wealth effects for acquiring firms’ shareholders. We find that acquiring firms whose managers have relatively strong rights are more likely to use investment banks to facilitate deals and are more likely to use reputable banks. The wealth effects to acquiring firms are inversely related to the use of investment banks when managerial rights are relatively strong. However, the wealth loss is mitigated when acquiring firms use reputable investment banks.     

Why do private acquirers pay so little compared to public acquirers?

Using the longest event window, we find that public target shareholders receive a 63% (14%) higher premium when the acquirer is a public firm rather than a private equity firm (private operating firm). The premium difference holds with the usual controls for deal and target characteristics, and it is highest (lowest) when acquisitions by private bidders are compared to acquisitions by public companies with low (high) managerial ownership. Further, the premium paid by public bidders (not private bidders) increases with target managerial and institutional ownership.     

Is the M&A announcement effect different across Europe? More evidences from continental Europe and the UK

The United Kingdom (UK) and Continental Europe are two of the most dynamic markets for mergers and acquisitions in the world. Using a sample of 2823 European acquisitions announced between 2002 and 2010, we investigate the effect of M&A announcements on stock returns of acquiring companies located in Continental Europe and the UK. The analysis is based on characteristics of takeover transactions such as method of payment, listing status of the target company, geographic scope (cross-border vs. domestic), industry relatedness of the bidding and the target company, amongst other factors. We find that European bidders earn positive abnormal returns both in cross-border and domestic acquisitions, and there is a significant difference between the abnormal returns of stock and cash deals, and between acquisitions of listed and unlisted target companies. However, the cross-border wealth effects are not significantly different between the UK and Continental Europe. We find that bidding firm’s shareholders gain more in equity than in cash offers if they are located in the UK and if they acquire unlisted targets. Cash bids for listed targets are associated with higher abnormal returns for bidders located in Continental Europe. We do not find supportive evidence that industry diversification destroys value for shareholders of both Continental European and the UK bidders.     

A new method for measuring CEO overconfidence: Evidence from acquisitions

This study proposes a new direct method of measuring managerial overconfidence using an acquisition setting. CEOs with significantly higher synergies forecast error (SFE), measured as the deviation between acquisition forecasted operating synergies and actual realized operating synergies, are more likely to exhibit traits of overconfidence. In support of this view, we find that synergies forecast error is positively related to takeover premium and negatively related to acquirer returns. Additionally, validation tests confirm that high SFE firms conduct more diversifying acquisitions. Reflecting, as well, the ex-ante power of the overconfidence measure in other settings, high SFE firms have a positive relation with capital expenditures, leverage, and innovation, and negative relation with equity issues.     

CEO Overconfidence and Earnings Management During Shifting Regulatory Regimes

This study examines the relationship of CEO overconfidence with accrual‐based earnings management, real activities‐based earnings management, and targeting to meet or just beat analyst forecasts. Following, we measure “overconfidence” based on the CEO's tendency to hold in‐the‐money stock options, as rational expected utility maximizers should exercise early to avoid overexposure to company idiosyncratic risks. The results show that before the Sarbanes Oxley Act of 2002 (SOX), companies of overconfident CEOs were more likely than other CEOs to engage in managing earnings through accelerating the timing of cash flow from operations and achieving analyst forecast benchmarks. After SOX, we find that overconfident CEOs are more likely to have income‐increasing discretionary accruals. They remain more likely to engage in real activities management through abnormally high cash flows, and also have abnormally low discretionary expenses. These results are consistent with overconfident CEOs feeling less constrained by SOX, and suggest that this individual characteristic works against regulators’ attempts to constrain earnings management by corporate executives. In contrast, we find that the tendency of overconfident CEOs to manage to targets decreases after SOX, perhaps due to changes in investor behavior in the new regulatory environment.     

Investment decisions and internal capital markets: Evidence from acquisitions

In this paper, we examine the workings of internal capital markets in diversified firms that engage in related and unrelated corporate acquisitions. Our evidence indicates that bidders invest outside their core business (diversify) when the cash flows of their core business fall behind those of their non-core lines of business. However, bidders invest inside their core business (i.e., undertake non-diversifying investments) when their core business experiences superior cash flows. We also find that bidders whose core business are in industries with low growth prospects engage in diversifying acquisitions while bidders whose core business are in high growth industries undertake non-diversifying acquisitions. The pre-acquisition evidence, then, suggests that firms tend to diversify when the cash flows and the growth opportunities of their core business are considerably lower than those of their non-core business. Subsequent to acquisitions we find that diversifying bidders continue to allocate financial resources from less profitable business segments (i.e., core business) to more profitable business segments (i.e., non-core business). Given the low profitability of diversifying bidders’ core business, this capital resource allocation suggests that diversification increases do not result in capital allocation inefficiencies. The evidence for non-diversifying bidders, however, supports the existence of “corporate socialism” in the sense that there is transfer of funds from the profitable (core) to the less profitable (non-core) business segments in multi-segment bidders. We find that the capital expenditures of bidders’ non-core business segments rely on both core and non-core cash flows.     

Managerial overconfidence and corporate cash holdings: Evidence from primary and secondary data

The corporate finance literature argues that overconfident managers tend to hold less cash, and this leads to a significant deviation from optimal cash levels. We analyse the impact of executive overconfidence on the corporate cash holdings of listed Vietnamese firms. To quantify managerial overconfidence, a novel core measure used in our analyses is voice pitch, which is obtained from interviews with top-line managers. Other measures of managerial overconfidence are also used to support the results and confirm the validity of the voice pitch measure. Our empirical evidence, with economically significant results, reveals that higher levels of overconfidence amongst managers are associated with lower cash holdings. Surprisingly, the findings show that overconfident managers tend to be associated with a low level of deviation from optimal cash holding levels. In addition, our findings also provide evidence that managerial overconfidence can increase cash levels and deviations from target cash holdings for overinvesting firms.     

Time-varying managerial overconfidence and pecking order preference

This paper examines whether managerial overconfidence enhances or weakens pecking order preference. We construct time-varying managerial words-based (i.e. tone of Chairman’s Statement) and action-based (i.e. firm investment and directors’ trading) overconfidence measures. Both optimistic tone and industry-adjusted investment have significant and negative impacts on the pecking order coefficient in the Shyam-Sunder and Myers (J Financ Econ 51:219–244, 1999) regression framework. Overconfident managers tend to use more equity than debt to finance deficits. This new evidence is consistent with the proposition that overconfident managers who underestimate the riskiness of future earnings believe that their debt (equity) is undervalued (overvalued) and therefore prefer equity to debt financing. Thus, managerial overconfidence can lead to a reverse pecking order preference. We also find that managerial overconfidence significantly weakens pecking order preference especially in firms with high earnings volatility and small firms.     

Do firms have leverage targets? Evidence from acquisitions

In the context of large acquisitions, we provide evidence on whether firms have target capital structures. We examine how deviations from these targets affect how bidders choose to finance acquisitions and how they adjust their capital structure following the acquisitions. We show that when a bidder's leverage is over its target level, it is less likely to finance the acquisition with debt and more likely to finance the acquisition with equity. Also, we find a positive association between the merger-induced changes in target and actual leverage, and we show that bidders incorporate more than two-thirds of the change to the merged firm's new target leverage. Following debt-financed acquisitions, managers actively move the firm back to its target leverage, reversing more than 75% of the acquisition's leverage effect within five years. Overall, our results are consistent with a model of capital structure that includes a target level and adjustment costs.     

Managerial Overconfidence and Accounting Conservatism

Overconfident managers overestimate future returns from their firms’ investments. Thus, we predict that overconfident managers will tend to delay loss recognition and generally use less conservative accounting. Furthermore, we test whether external monitoring helps to mitigate this effect. Using measures of both conditional and unconditional conservatism respectively, we find robust evidence of a negative relation between CEO overconfidence and accounting conservatism. We further find that external monitoring does not appear to mitigate this effect. Our findings add to the growing literature on overconfidence and complement the findings by Schrand and Zechman [2011] that overconfidence affects financial reporting behavior.     

Shareholder Wealth Effects of European Domestic and Cross‐border Takeover Bids

This paper analyses the short‐term wealth effects of large intra‐European takeover bids. We find announcement effects of 9% for the target firms compared to a statistically significant announcement effect of only 0.7% for the bidders. The type of takeover bid has a large impact on the short‐term wealth effects with hostile takeovers triggering substantially larger price reactions than friendly operations. When a UK firm is involved, the abnormal returns are higher than those of bids involving both a Continental European target and bidder. There is strong evidence that the means of payment in an offer has an impact on the share price. A high market‐to‐book ratio of the target leads to a higher bid premium, but triggers a negative price reaction for the bidding firm. We also investigate whether the predominant reason for takeovers is synergies, agency problems or managerial hubris. Our results suggest that synergies are the prime motivation for bids and that targets and bidders share the wealth gains.