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Overconfidence in a Career-Concerns Setting

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  • Leonidas Enrique De La Rosa

Abstract

We study the effects of overconfidence in a two-period investment-decision agency setting. Under common priors, agent risk aversion implies inefficiently low first-period investment. In our model, principal and agent disagree about the profitability of the investment decision conditional on a given public signal. An overconfident agent believes that the principal will update her beliefs upwards more often than not. As a consequence, the agent overestimates the benefits of learning from first-period investment. This implies that agent overconfidence mitigates the agency problems arising from the agent’s career concerns, even though an overconfident agent bears more project and reputational risk in equilibrium.

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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 2405.

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Date of creation: 2008
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Handle: RePEc:ces:ceswps:_2405

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Related research

Keywords: overconfidence; heterogenous beliefs; career concerns;

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  1. Robert Gibbons & Kevin J. Murphy, 1991. "Optimal Incentive Contracts in the Presence of Career Concerns: Theory and Evidence," NBER Working Papers 3792, National Bureau of Economic Research, Inc.
  2. Gervais, Simon & Odean, Terrance, 2001. "Learning to be Overconfident," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 14(1), pages 1-27.
  3. Mark Westerfield & Tobias Adrian, 2007. "Disagreement and Learning in a Dynamic Contracting Model," 2007 Meeting Papers, Society for Economic Dynamics 270, Society for Economic Dynamics.
  4. Benjamin Hermalin., 1991. "Managerial Preferences Concerning Risky Projects," Economics Working Papers, University of California at Berkeley 91-168, University of California at Berkeley.
  5. Luís Santos-Pinto, 2008. "Positive Self-image and Incentives in Organisations," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 118(531), pages 1315-1332, 08.
  6. Pinto, Luis Santos, 2007. "Positive Self-Image and Incentives in Organizations," FEUNL Working Paper Series wp509, Universidade Nova de Lisboa, Faculdade de Economia.
  7. Simon Gervais & Itay Goldstein, 2007. "The Positive Effects of Biased Self-Perceptions in Firms," Review of Finance, European Finance Association, European Finance Association, vol. 11(3), pages 453-496.
  8. Eyster, Erik & Rabin, Matthew, 2002. "Cursed Equilibrium," Department of Economics, Working Paper Series, Department of Economics, Institute for Business and Economic Research, UC Berkeley qt7p2911dn, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  9. Bengt Holmstrom & I. Ricard & Joan Costa, 1984. "Managerial Incentives and Capital Management," Cowles Foundation Discussion Papers, Cowles Foundation for Research in Economics, Yale University 729, Cowles Foundation for Research in Economics, Yale University.
  10. Morris, Stephen, 1995. "The Common Prior Assumption in Economic Theory," Economics and Philosophy, Cambridge University Press, vol. 11(02), pages 227-253, October.
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