CEO Overconfidence and Dominance in Bank Financial Decisions: The US Evidence

Abstract

This thesis empirically investigates financial and investment decisions of banks and bank holding companies in a managerial behavioural approach with a view to ascertaining to what extent managerial psychology is as important as managerial incentive a determinant affecting the process of instituting an efficient bank governance mechanism. A large sample of US banks and bank holding companies over 1996-2006 is examined for the effects of irrational and powerful bank Chief Executive Officers (CEOs). Integrating the analyses of both corporate governance and corporate finance, the thesis uncovers evidence that overconfident, dominating and overconfident-dominating bank CEOs have negative impact on bank financial decisions, such as M&As, payout policy and risk taking as they tend to overestimate their ability and underestimate possible risks of invested projects. Cognitive failures of this origin would have the worst fallout effects when the overconfident CEOs are also dominating the boards. Deploying Holder 67 and CEO-Chair as proxies for overconfidence and dominance factors respectively, the study shows that overconfident, dominating and overconfident-dominating CEOs are more likely to perform mergers with dubious quality, particularly in activity and geography diversifying mergers. The one- and two-year negative post-merger performance of banks ran by overconfident, dominating and overconfident-dominating CEOs bolsters the argument that mergers undertaken by these CEOs are economically undesirable. For the effects of psychological and cognitive biases on bank payout policy, results show that overconfident and overconfident-dominating CEOs are negatively related to the dividend payout ratio and total payout ratio. The negative association becomes stronger when the banks under examination have a higher degree of information asymmetry or with less growth opportunity. Evidence also confirms that CEO overconfidence, dominance and especially overconfidence-dominance have negative effects on bank risk control. CEOs with these attributes have a higher propensity for taking some bank-related risks, such as market-based risk, earnings volatility, credit risk and default risk. Overall, findings of this research suggest the essentiality of taking account of managerial psychological biases in reforming the existing bank governance mechanism, especially in designing appropriate compensation packages for executives and the desirable board composition for banks with overconfident-dominating CEOs.