IDEAS home Printed from https://ideas.repec.org/a/bla/stratm/v44y2023i4p1084-1110.html
   My bibliography  Save this article

A cognitive perspective on real options investment: CEO overconfidence

Author

Listed:
  • Joon Mahn Lee
  • Jung Chul Park
  • Guoli Chen

Abstract

Research Summary While real options theory has been applied with the optimality assumption, actual real options investments are made by managers, who are subject to cognitive biases, especially under uncertainty. In this article, we focus on one important type of cognitive bias, overconfidence, to provide new insights on real options literature. We argue that overconfident CEOs will invest less in real options than non‐overconfident CEOs. We also predict that the relationship between overconfident CEOs and firms' real options intensity will be strengthened when market uncertainty is higher. In a study of U.S. public firms, we find strong support across various tests that use multiple measures of overconfidence in CEOs and real options investments, and control for potential selection issues and other endogeneity concerns. Managerial Summary This article studies how a CEO's cognitive bias, overconfidence, may shape a firm's real option investments, which could result in a different level of strategic flexibility. We argue that overconfident CEOs have overly high expectations of their performance under uncertainty and/or underestimate the level of uncertainty in their strategic decision‐making, which leads to lower investments in the firms' real options relative to non‐overconfident CEOs. We study a sample of U.S. public firms and find strong evidence that an overconfident CEO is positively related to the real options investments at the firm level. We also find that this overconfidence effect becomes more pronounced in markets with greater uncertainty.

Suggested Citation

  • Joon Mahn Lee & Jung Chul Park & Guoli Chen, 2023. "A cognitive perspective on real options investment: CEO overconfidence," Strategic Management Journal, Wiley Blackwell, vol. 44(4), pages 1084-1110, April.
  • Handle: RePEc:bla:stratm:v:44:y:2023:i:4:p:1084-1110
    DOI: 10.1002/smj.3469
    as

    Download full text from publisher

    File URL: https://doi.org/10.1002/smj.3469
    Download Restriction: no

    File URL: https://libkey.io/10.1002/smj.3469?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. Rodolphe Durand & Robert M. Grant & Tammy L. Madsen & Lenos Trigeorgis & Jeffrey J. Reuer, 2017. "Real options theory in strategic management," Strategic Management Journal, Wiley Blackwell, vol. 38(1), pages 42-63, January.
    2. Moore, Don A. & Cain, Daylian M., 2007. "Overconfidence and underconfidence: When and why people underestimate (and overestimate) the competition," Organizational Behavior and Human Decision Processes, Elsevier, vol. 103(2), pages 197-213, July.
    3. Aabo, Tom & Pantzalis, Christos & Park, Jung Chul, 2016. "Multinationality as real option facilitator — Illusion or reality?," Journal of Corporate Finance, Elsevier, vol. 38(C), pages 1-17.
    4. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-1054, July.
    5. Christian Schumacher & Steffen Keck & Wenjie Tang, 2020. "Biased interpretation of performance feedback: The role of CEO overconfidence," Strategic Management Journal, Wiley Blackwell, vol. 41(6), pages 1139-1165, June.
    6. Malmendier, Ulrike & Tate, Geoffrey, 2008. "Who makes acquisitions? CEO overconfidence and the market's reaction," Journal of Financial Economics, Elsevier, vol. 89(1), pages 20-43, July.
    7. Manuel Ammann & Philipp Horsch & David Oesch, 2016. "Competing with Superstars," Management Science, INFORMS, vol. 62(10), pages 2842-2858, October.
    8. Arkadiy V. Sakhartov & Timothy B. Folta, 2014. "Resource relatedness, redeployability, and firm value," Strategic Management Journal, Wiley Blackwell, vol. 35(12), pages 1781-1797, December.
    9. Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, number 5474.
    10. Ulrike Malmendier & Geoffrey Tate, 2005. "CEO Overconfidence and Corporate Investment," Journal of Finance, American Finance Association, vol. 60(6), pages 2661-2700, December.
    11. Lihua Wang & Edward J. Zajac, 2007. "Alliance or acquisition? a dyadic perspective on interfirm resource combinations," Strategic Management Journal, Wiley Blackwell, vol. 28(13), pages 1291-1317, December.
    12. Timothy J. Quigley & Craig Crossland & Robert J. Campbell, 2017. "Shareholder perceptions of the changing impact of CEOs: Market reactions to unexpected CEO deaths, 1950–2009," Strategic Management Journal, Wiley Blackwell, vol. 38(4), pages 939-949, April.
    13. Mark Grinblatt & Matti Keloharju, 2009. "Sensation Seeking, Overconfidence, and Trading Activity," Journal of Finance, American Finance Association, vol. 64(2), pages 549-578, April.
    14. David Hirshleifer & Angie Low & Siew Hong Teoh, 2012. "Are Overconfident CEOs Better Innovators?," Journal of Finance, American Finance Association, vol. 67(4), pages 1457-1498, August.
    15. Robert McDonald & Daniel Siegel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 101(4), pages 707-727.
    16. Li, Feng & Minnis, Michael & Nagar, Venky & Rajan, Madhav, 2014. "Knowledge, compensation, and firm value: An empirical analysis of firm communication," Journal of Accounting and Economics, Elsevier, vol. 58(1), pages 96-116.
    17. Itzhak Ben-David & John R. Graham, 2013. "Managerial Miscalibration," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 128(4), pages 1547-1584.
    18. Joon Mahn Lee & Byoung‐Hyoun Hwang & Hailiang Chen, 2017. "Are founder CEOs more overconfident than professional CEOs? Evidence from S&P 1500 companies," Strategic Management Journal, Wiley Blackwell, vol. 38(3), pages 751-769, March.
    19. Tailan Chi, 2000. "Option to acquire or divest a joint venture," Strategic Management Journal, Wiley Blackwell, vol. 21(6), pages 665-687, June.
    20. Guoli Chen & Craig Crossland & Shuqing Luo, 2015. "Making the same mistake all over again: CEO overconfidence and corporate resistance to corrective feedback," Strategic Management Journal, Wiley Blackwell, vol. 36(10), pages 1513-1535, October.
    21. Schrand, Catherine M. & Zechman, Sarah L.C., 2012. "Executive overconfidence and the slippery slope to financial misreporting," Journal of Accounting and Economics, Elsevier, vol. 53(1), pages 311-329.
    22. J. P. Eggers & Sarah Kaplan, 2009. "Cognition and Renewal: Comparing CEO and Organizational Effects on Incumbent Adaptation to Technical Change," Organization Science, INFORMS, vol. 20(2), pages 461-477, April.
    23. Alberto Galasso & Timothy S. Simcoe, 2011. "CEO Overconfidence and Innovation," Management Science, INFORMS, vol. 57(8), pages 1469-1484, August.
    24. Matthew T. Billett & Yiming Qian, 2008. "Are Overconfident CEOs Born or Made? Evidence of Self-Attribution Bias from Frequent Acquirers," Management Science, INFORMS, vol. 54(6), pages 1037-1051, June.
    25. Nittai K. Bergman & Sugata Roychowdhury, 2008. "Investor Sentiment and Corporate Disclosure," Journal of Accounting Research, Wiley Blackwell, vol. 46(5), pages 1057-1083, December.
    26. Hill, Aaron D. & Kern, David A. & White, Margaret A., 2014. "Are we overconfident in executive overconfidence research? An examination of the convergent and content validity of extant unobtrusive measures," Journal of Business Research, Elsevier, vol. 67(7), pages 1414-1420.
    27. Yi Tang & Cuili Qian & Guoli Chen & Rui Shen, 2015. "How CEO hubris affects corporate social (ir)responsibility," Strategic Management Journal, Wiley Blackwell, vol. 36(9), pages 1338-1357, September.
    28. Dirk Martignoni & Anoop Menon & Nicolaj Siggelkow, 2016. "Consequences of misspecified mental models: Contrasting effects and the role of cognitive fit," Strategic Management Journal, Wiley Blackwell, vol. 37(13), pages 2545-2568, December.
    29. Paul Hribar & Holly Yang, 2016. "CEO Overconfidence and Management Forecasting," Contemporary Accounting Research, John Wiley & Sons, vol. 33(1), pages 204-227, March.
    30. Bruce Kogut, 1991. "Joint Ventures and the Option to Expand and Acquire," Management Science, INFORMS, vol. 37(1), pages 19-33, January.
    31. Tony W Tong & Jeffrey J Reuer, 2007. "Real options in multinational corporations: organizational challenges and risk implications," Journal of International Business Studies, Palgrave Macmillan;Academy of International Business, vol. 38(2), pages 215-230, March.
    32. Stevo Pavićević & Thomas Keil, 2021. "The role of procedural rationality in debiasing acquisition decisions of overconfident CEOs," Strategic Management Journal, Wiley Blackwell, vol. 42(9), pages 1696-1715, September.
    33. Campbell, T. Colin & Gallmeyer, Michael & Johnson, Shane A. & Rutherford, Jessica & Stanley, Brooke W., 2011. "CEO optimism and forced turnover," Journal of Financial Economics, Elsevier, vol. 101(3), pages 695-712, September.
    34. Gustavo Grullon & Evgeny Lyandres & Alexei Zhdanov, 2012. "Real Options, Volatility, and Stock Returns," Journal of Finance, American Finance Association, vol. 67(4), pages 1499-1537, August.
    35. Wei Shi & Yan Zhang & Robert E. Hoskisson, 2017. "Ripple Effects of CEO Awards: Investigating the Acquisition Activities of Superstar CEOs' Competitors," Strategic Management Journal, Wiley Blackwell, vol. 38(10), pages 2080-2102, October.
    36. Dan Lovallo & Colin Camerer, 1999. "Overconfidence and Excess Entry: An Experimental Approach," American Economic Review, American Economic Association, vol. 89(1), pages 306-318, March.
    37. Constance E. Helfat & Margaret A. Peteraf, 2015. "Managerial cognitive capabilities and the microfoundations of dynamic capabilities," Strategic Management Journal, Wiley Blackwell, vol. 36(6), pages 831-850, June.
    38. Karel Cool & Dan Schendel, 1988. "Performance differences among strategic group members," Strategic Management Journal, Wiley Blackwell, vol. 9(3), pages 207-223, May.
    39. Engle, Robert F, 1982. "Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation," Econometrica, Econometric Society, vol. 50(4), pages 987-1007, July.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Juwon Jang & Eunju Lee, 2024. "CEO confidence matters: the real effects of short sale constraints revisited," Review of Quantitative Finance and Accounting, Springer, vol. 62(2), pages 603-636, February.
    2. Lai, Shaojie & Liu, Shiang & Wang, Qing Sophie, 2023. "Déjà Vu: CEO overconfidence and bank mortgage lending in the post-financial crisis period," Journal of Behavioral and Experimental Finance, Elsevier, vol. 39(C).

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Johannes Brunzel, 2021. "Overconfidence and narcissism among the upper echelons: a systematic literature review," Management Review Quarterly, Springer, vol. 71(3), pages 585-623, July.
    2. Tuck Siong Chung & Angie Low & Roland T. Rust, 2023. "Executive confidence and myopic marketing management," Journal of the Academy of Marketing Science, Springer, vol. 51(5), pages 1118-1142, September.
    3. Aabo, Tom & Pantzalis, Christos & Park, Jung Chul & Trigeorgis, Lenos & Wulff, Jesper N., 2024. "CEO personality traits, strategic flexibility, and firm dynamics," Journal of Corporate Finance, Elsevier, vol. 84(C).
    4. Christian Schumacher & Steffen Keck & Wenjie Tang, 2020. "Biased interpretation of performance feedback: The role of CEO overconfidence," Strategic Management Journal, Wiley Blackwell, vol. 41(6), pages 1139-1165, June.
    5. Jennifer Kunz & Lara Sonnenholzner, 2023. "Managerial overconfidence: promoter of or obstacle to organizational resilience?," Review of Managerial Science, Springer, vol. 17(1), pages 67-128, January.
    6. Juwon Jang & Eunju Lee, 2024. "CEO confidence matters: the real effects of short sale constraints revisited," Review of Quantitative Finance and Accounting, Springer, vol. 62(2), pages 603-636, February.
    7. Killins, Robert & Ngo, Thanh & Wang, Hongxia, 2021. "Goodwill impairment and CEO overconfidence," Journal of Behavioral and Experimental Finance, Elsevier, vol. 29(C).
    8. Caleb Rawson, 2022. "Manager perception and proprietary investment disclosure," Review of Accounting Studies, Springer, vol. 27(4), pages 1493-1525, December.
    9. Stevo Pavićević & Thomas Keil, 2021. "The role of procedural rationality in debiasing acquisition decisions of overconfident CEOs," Strategic Management Journal, Wiley Blackwell, vol. 42(9), pages 1696-1715, September.
    10. Sanaz Aghazadeh & Lili Sun & Qian Wang & Rong Yang, 2018. "Investors’ perception of CEO overconfidence: evidence from the cost of equity capital," Review of Quantitative Finance and Accounting, Springer, vol. 51(4), pages 1129-1150, November.
    11. Fang, Yiwei & Hasan, Iftekhar & Lin, Chih-Yung & Sun, Jiong, 2022. "The impact of overconfident customers on supplier firm risks," Journal of Economic Behavior & Organization, Elsevier, vol. 197(C), pages 115-133.
    12. Lin Li & Wilson H. S. Tong, 2022. "Who shall succeed? An examination of manager overconfidence and CEO selection," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 49(9-10), pages 1736-1783, October.
    13. Prokudina, Elena & Renneboog, Luc & Tobler, Philippe, 2015. "Does Confidence Predict Out-of-Domain Effort?," Discussion Paper 2015-055, Tilburg University, Center for Economic Research.
    14. Jieqi Guan & Brian M. Lam & Ching Chi Lam & Ming Liu, 2022. "CEO overconfidence and the level of short-selling activity," Review of Quantitative Finance and Accounting, Springer, vol. 58(2), pages 685-708, February.
    15. Chen, Sheng-Syan & Lin, Chih-Yen & Tsai, Yun-Ching, 2018. "New product strategies and firm performance: CEO optimism," International Review of Economics & Finance, Elsevier, vol. 55(C), pages 37-53.
    16. Gurdgiev, Constantin & Ni, Qiuxin, 2023. "Board diversity: Moderating effects of CEO overconfidence on firm financing decisions," Journal of Behavioral and Experimental Finance, Elsevier, vol. 37(C).
    17. Yungu Kang & David H. Zhu & Yan Anthea Zhang, 2021. "Being extraordinary: How CEOS' uncommon names explain strategic distinctiveness," Strategic Management Journal, Wiley Blackwell, vol. 42(2), pages 462-488, February.
    18. Pikulina, Elena & Renneboog, Luc & Tobler, Philippe N., 2018. "Do confident individuals generally work harder?," Journal of Multinational Financial Management, Elsevier, vol. 44(C), pages 51-60.
    19. Rong Gong, 2023. "CEO overconfidence and the tone of press release," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 63(2), pages 2081-2108, June.
    20. Kim, Mindy (Hyo Jung), 2021. "Effects of managerial overconfidence and ability on going-concern decisions and auditor turnover," Advances in accounting, Elsevier, vol. 54(C).

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bla:stratm:v:44:y:2023:i:4:p:1084-1110. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Wiley Content Delivery (email available below). General contact details of provider: http://onlinelibrary.wiley.com/journal/10.1111/0143-2095 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.