State-contingent overconfidence : application to bank loans

  • Sze Nam CHAN

Student thesis: MPhil Thesis (Lingnan)

Abstract

Overconfidence (arrogance or overestimation of one’s ability) has often been viewed in the finance literature as a character trait that is stable over time. This paper, however, provides a first attempt to show that overconfidence can be state-contingent, that is, the level of overconfidence among overconfident individuals could be influenced by an external shock such as a financial crisis and a change in regulation, for example, the adoption of Sarbanes-Oxley Act (SOX). Both our experimental (based on psychological approach on over-precision) and empirical results using more than 4500 manager-year observations through controlling different personal and firm characteristics show that individual self-confidence can be manipulated in psychological experiment and managerial overconfidence can be state-contingent. We apply our results to the credit market and show that since overconfident managers are excessive risk-takers, creditors could be offering inefficient amounts of bank loans to business firms in the absence of the knowledge about state-contingent overconfidence. However, during financial crisis and under stricter regulation, overconfident managers are still opportunity seekers that they would still look for profitable investment or else they would have exercised their options. Our results show that the firms under the control remaining overconfidence chief company officers during financial crisis and after implementation of SOX would have a significant larger loan amount than the others.
Date of Award8 Sep 2020
Original languageEnglish
Awarding Institution
  • Lingnan University
SupervisorJan Piaw Thomas VOON (Supervisor)

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