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Corporate risk: CEO overconfidence and incentive compensation

Tom Aabo (Aarhus University, Aarhus C, Denmark)
Nicholai Theodor Hvistendahl (Unifeeder A/S, Aarhus N, Denmark)
Jacob Kring (Deloitte, Aarhus, Denmark)

Managerial Finance

ISSN: 0307-4358

Article publication date: 8 September 2020

Issue publication date: 28 January 2021

1519

Abstract

Purpose

The purpose of this study is to investigate the association between corporate risk and the interaction between CEO incentive compensation and CEO overconfidence.

Design/methodology/approach

This empirical study performs random and fixed effect (FE) regression analysis. It uses option-implied measures of CEO overconfidence.

Findings

The authors contribute to the existing literature by showing (1) that the positive association between high CEO incentive compensation and corporate risk only exists in the sphere of overconfident CEOs and (2) that the positive association between overconfident CEOs and corporate risk only exists in the sphere of high CEO incentive compensation. The authors show that the combination of high CEO incentive compensation and CEO overconfidence is associated with an increase in corporate risk of approximately 6% while the individual effects are for all practical reasons negligible. The results imply that only the combination of high CEO incentive compensation and CEO overconfidence is associated with a significantly elevated level of corporate risk.

Research limitations/implications

The findings are based on S&P 1500 non-financial firms in the period 2007–2016.

Practical implications

The findings have important implications in terms of CEO selection and compensation.

Originality/value

This study provides empirical evidence on the importance of the dual presence of high CEO incentive compensation and CEO overconfidence for corporate risk. The previous literature has primarily investigated these phenomena in isolation.

Keywords

Acknowledgements

We thank Mikkel Als, Niklas Vestergaard Andersen, Søren Christian Ilvig, Kasper Jensen, Alex Lønstrup Kristensen, Jeppe Garder Kristiansen, Jonas Bejer Kristoffersen, Henrik Hansen Købke, Laurits Lærke, Rune Petersen, Steffan Petersen, Matthias Elkjær Schrøder, Sune Lund Simonsen, Lars Thomsen, participants at the Financial Management Association European Conference 2019 and the Financial Management Association Annual Meeting 2019, and seminar participants at Aarhus University, Cardiff Business School, ESADE, and University of South Florida for helpful comments and suggestions. We bear sole responsibility for all remaining errors and omissions.

Citation

Aabo, T., Hvistendahl, N.T. and Kring, J. (2021), "Corporate risk: CEO overconfidence and incentive compensation", Managerial Finance, Vol. 47 No. 2, pp. 244-265. https://doi.org/10.1108/MF-05-2020-0278

Publisher

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Emerald Publishing Limited

Copyright © 2020, Emerald Publishing Limited

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