CEO overconfidence and payout policy: The moderating power of governance mechanisms

This paper examines the moderating role of corporate governance in the relationship between Chief Executive Officer (CEO) overconfidence and corporate payout decisions. Using a panel dataset of 713 S&P 1500 firms from 2010 to 2019, we contribute to the behavioral corporate finance literature in several important ways. First, building on agency theory and upper echelons theory, we find that both external governance enhancements driven by the implementation of Dodd-Frank Act provisions, and internal governance mechanisms, including gender diversity and board independence mitigate the adverse effects of CEO overconfidence on cash dividends, while the moderating effects on share repurchases are less significant. For example, DF provisions attenuate the negative effect of overconfidence on dividend payouts by approximately one-third. Second, we uncover a context-dependent limitation: in innovative firms, governance mechanisms appear less effective in moderating overconfidence, suggesting that shareholders may tolerate or even encourage overconfident behavior to support risk-intensive innovation strategies. Lastly, our findings are robust across multiple measures of overconfidence and various estimation techniques, including instrumental variables, matching estimation, and staggered Difference-in-Differences. Overall, the results highlight the importance of tailoring governance frameworks to account for managerial behavioral traits, thereby enabling firms to harness the potential benefits of CEO overconfidence while safeguarding shareholder interests.