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The effect of CEO power on overinvestment

Author

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  • Huai-Chun Lo

    (Yuan Ze University)

  • Shin-Rong Shiah-Hou

    (Yuan Ze University)

Abstract

Studies on CEO power show that more powerful CEOs have more incentive to use their managerial control to make decisions that are beneficial to themselves rather than shareholders. Research also finds that CEOs can obtain personal benefits through overinvestment. The question that arises is whether CEOs with stronger decision-making power overinvest. We refer to three views on the effect of CEO power on overinvestment. Under the discretion effect, CEO power is positively associated with overinvestment, as powerful CEOs have more discretion and may use overinvestment decisions to generate more personal benefits. Under the risk aversion effect, CEO power is negatively associated with overinvestment, as powerful CEOs are more risk-averse. Under the ability effect, powerful CEOs with better managerial ability can make investment decisions efficiently and then are less likely to overinvest. We construct a composite index for CEO power by combining seven CEO characteristics. Our evidence indicates that the negative relationship between CEO power and overinvestment can be attributed to the risk aversion effect and the ability effect prevailing over the discretion effect.

Suggested Citation

  • Huai-Chun Lo & Shin-Rong Shiah-Hou, 2022. "The effect of CEO power on overinvestment," Review of Quantitative Finance and Accounting, Springer, vol. 59(1), pages 23-63, July.
    • Handle: RePEc:kap:rqfnac:v:59:y:2022:i:1:d:10.1007_s11156-022-01060-0
    DOI: 10.1007/s11156-022-01060-0
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    Keywords

    Overinvestment; CEO power; Investment inefficiency;
    All these keywords.

    JEL classification:

    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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