Valuation Effects of Overconfident CEOs on Corporate Diversification and Refocusing Decisions

Andreou, Panayiotis C.; Doukas, John A.; Koursaros, Demetris; Louca, Christodoulos

Abstract

This study presents a theoretical model that links chief executive officer (CEO) overconfidence to the value loss of corporate diversification. Consistent with the model's prediction, the findings show that diversified firms run by overconfident CEOs experience value loss compared to diversified firms run by their rational counterparts. Empirically, the value loss is economically significant and ranges between 12.5% and 14.1%. In addition, the model predicts heightened corporate refocusing activity by overconfident CEOs who pursued diversified investments in the past once realized returns fail to match initial expectations. The empirical odds of corporate refocusing decisions are 67% to 98% higher when past diversifications are undertaken by overconfident rather than rational CEOs. Another prediction of the model is that overconfident CEOs exhibit preference for diversified investments, especially in the presence of ample internal funds. This prediction is also strongly supported by the data. Overall, this study proposes CEO overconfidence as a unified and consistent explanation of why firms pursue value-destructive corporate diversification policies and later adopt refocusing policies aiming to restore value.

Citation

Andreou, P. C., Doukas, J. A., Koursaros, D., & Louca, C. (2019). Valuation Effects of Overconfident CEOs on Corporate Diversification and Refocusing Decisions. Journal of Banking and Finance, 100, 182-204. https://doi.org/10.1016/j.jbankfin.2019.01.009

• Journal Article Type: Article
• Acceptance Date: Jan 11, 2019
• Online Publication Date: Jan 17, 2019
• Publication Date: Mar 31, 2019
• Deposit Date: Jan 14, 2019
• Publicly Available Date: Jul 17, 2020
• Journal: Journal of Banking and Finance
• Print ISSN: 0378-4266
• Publisher: Elsevier
• Peer Reviewed: Peer Reviewed
• Volume: 100
• Pages: 182-204
• DOI: https://doi.org/10.1016/j.jbankfin.2019.01.009
• Public URL: https://durham-repository.worktribe.com/output/1309919