Abstract
The paper takes Chinese listed companies from 2010 to 2016 as samples, to examine the relationship between executive overconfidence and equity incen-tive. Results show that executive overconfidence has a significant weakening effect on equity compensation incentives (including stock options and re-stricted stocks), that is, compared with rational executives, the company will reduce the equity incentives for overconfident executives.
Highlights
Open AccessIn modern enterprises where ownership and control are separated, due to the inconsistency of the utility function and information asymmetry, there is inevitably a proxy conflict between the principal and the agent
This paper examines the relationship between executive overconfidence and equity compensation incentives by taking samples of Chinese listed companies from 2010 to 2016
Because overconfident executives have an upward bias toward the company’s prospects and equity compensation, lower-intensity equity compensation incentives are enough to encourage executives to work hard, so the company can take this into account when designing executive compensation contracts
Summary
In modern enterprises where ownership and control are separated, due to the inconsistency of the utility function and information asymmetry, there is inevitably a proxy conflict between the principal (shareholder) and the agent (the executive). Equity compensation has received extensive attention as an effective means for shareholders to motivate executives to take risks and mitigate agency conflicts (Jensen and Meckling, 1976) [2]. Roll (1986) [5] found that entrepreneurs generally have the irrational character of overconfidence Overconfident executives overestimate their own ability, overestimating the probability of successful of investment projects, and deviate from the decision-making under rational conditions. Over-confident executives are more inclined to invest in risky projects It raises the risk of the enterprise unconsciously. Goel and Thakor (2008) [7], in their theoretical derivation of its CEO selection model, found that the overconfidence of executives would inhibit the underinvestment caused by risk aversion. Because equity compensation and overconfidence can influence or motivate executives’ risk-taking, it can be expected that companies will adjust their compensation contracts in a timely manner according to the degree of overconfidence of executives so that executives’ risk-taking levels are optimal (Gervais, Heaton and Odean, 2011) [9]
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