Hostname: page-component-586b7cd67f-g8jcs Total loading time: 0 Render date: 2024-11-25T07:13:16.707Z Has data issue: false hasContentIssue false
  • English
  • Français

Executive Overconfidence and Securities Class Actions

Published online by Cambridge University Press:  08 October 2018

Suman Banerjee ,
Mark Humphery-Jenner ,
Vikram Nanda  and
Mandy Tham
Get access Rights & Permissions [Opens in a new window]

Abstract

Overconfident CEOs/senior executives tend to have excessively positive views of their own skills and their company’s future performance. We hypothesize that overconfident managers are more likely to engage in reckless or intentional actions/disclosures that give rise to securities class actions (SCAs). Empirical evidence is supportive: Overconfident CEOs/senior executives increase SCA likelihood, though litigation risk is ameliorated through improved governance, such as following the Sarbanes–Oxley Act of 2002. Post-SCA, companies are less likely to hire an overconfident CEO. Following an SCA, overconfident CEOs appear to moderate behavior and to reduce their litigation risk.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 53 , Issue 6 , December 2018 , pp. 2685 - 2719
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2018 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

1

We thank the seminar participants at the Australian National University, Chinese University of Hong Kong, Nanyang Technological University, University of Adelaide, University of Auckland, University of Hong Kong, University of Otago, Queensland University of Technology, University of New South Wales Learn@Lunch, University of Texas–Dallas, Utah State University, University of Washington, University of Wyoming, and Victoria University of Wellington. We also benefited from comments received at the 2014 Forum on Global Financial Stability and Prosperity, the 2014 Conference on Asia-Pacific Financial Markets, the 2014 Australasian Finance and Banking Conference, the 2015 American Law and Economics Association Annual Meeting, the 2015 Conference on Empirical Legal Studies, the 2015 Financial Management Association (FMA) Asian Meeting and Annual Meeting, the 2015 University of Technology Sydney (UTS) Summer Accounting Symposium, and the 2015 New Zealand Finance Colloquium. This paper additionally benefited from comments by Murillo Campello, Jean Canil, Ansley Chua, Raymond Da Silva Rosa, Jefferson Duarte, Jon Karpoff, Andy Kim, Taejin Kim, Chen Lin, Stephan Siegel, Eric Talley, Robert Tumarkin, Cong Wang, Alfred Yawson, Bohui Zhang, and Jian Zhang. Humphery-Jenner acknowledges the financial support of Australian Research Council (ARC) for Discovery Early Career Researcher Award (DECRA) Grant DE150100895.

References

Adams, R. B., and Ragunathan, V.. “Lehman Sisters.” Available at https://ssrn.com/abstract=3046451 (2017).Google Scholar
Ahmed, A. S., and Duellman, S.. “Managerial Overconfidence and Accounting Conservatism.” Journal of Accounting Research, 51 (2013), 1–30.Google Scholar
Ai, C., and Norton, E. C.. “Interaction Terms in Logit and Probit Models.” Economics Letters, 80 (2003), 123–129.Google Scholar
Altman, E. I.“Financial Ratios, Discriminant Analysis, and the Prediction of Corporate Bankruptcy.” Journal of Finance, 23 (1968), 589–609.Google Scholar
Arena, M., and Julio, B.. “The Effects of Securities Class Action Litigation on Corporate Liquidity and Investment Policy.” Journal of Financial and Quantitative Analysis, 50 (2015), 251–275.Google Scholar
Arping, S., and Sautner, Z.. “Did SOX Section 404 Make Firms Less Opaque? Evidence from Cross-Listed Firms.” Contemporary Accounting Research, 30 (2013), 1133–1165.Google Scholar
Autore, D. M.; Hutton, I.; Peterson, D. R.; and Smith, A. H.. “The Effect of Securities Litigation on External Financing.” Journal of Corporate Finance, 27 (2014), 231–250.Google Scholar
Ayers, B. C.; Jiang, J.; and Yeung, P. E.. “Discretionary Accruals and Earnings Management: An Analysis of Pseudo Earnings Targets.” Accounting Review, 81 (2006), 617–652.Google Scholar
Basic Inc. v. Levinson, 485 U.S. 224 (1988).Google Scholar
Banerjee, S.; Humphery-Jenner, M.; and Nanda, V.. “Restraining Overconfident CEOs through Improved Governance: Evidence from the Sarbanes-Oxley Act.” Review of Financial Studies, 28 (2015), 2812–2858.Google Scholar
Bebchuk, L.; Cohen, A.; and Ferrell, A.. “What Matters in Corporate Governance?” Review of Financial Studies, 22 (2009), 783–827.Google Scholar
Ben-David, I.; Graham, J. R.; and Harvey, C. R.. “Managerial Miscalibration.” Quarterly Journal of Economics, 128 (2013), 1547–1584.Google Scholar
Bernile, G.; Bhagwat, V.; and Rau, P. R.. “What Doesn’t Kill You Will Only Make You More Risk-Loving: Early-Life Disasters and CEO Behavior.” Journal of Finance, 72 (2017), 167–206.Google Scholar
Bertrand, M., and Mullainathan, S.. “Enjoying the Quiet Life? Corporate Governance and Managerial Preferences.” Journal of Political Economy, 111 (2003), 1043–1075.Google Scholar
Billings, M. B., and Cedergren, M. C.. “Strategic Silence, Insider Selling and Litigation Risk.” Journal of Accounting and Economics, 59 (2015), 119–142.Google Scholar
Black, F., and Scholes, M.. “The Pricing of Options and Corporate Liabilities.” Journal of Political Economy, 81 (1973), 637–654.Google Scholar
Blau, B. M., and Tew, P. L.. “Short Sales and Class-Action Lawsuits.” Journal of Financial Markets, 20 (2014), 79–100.Google Scholar
Bolger, J. P.“Recklessness and the Rule 10b-5 Scienter Standard after Hochfelder.” Fordham Law Review, 48 (1980), 817–837.Google Scholar
Bouwman, C. H. S.“Managerial Optimism and Earnings Smoothing.” Journal of Banking & Finance, 41 (2014), 283–303.Google Scholar
Bucciol, A., and Zarri, L.. “Financial Risk Aversion and Personal Life History.” Technical Report, Netspar (2013).Google Scholar
Cameron, L., and Shah, M.. “Risk-Taking Behavior in the Wake of Natural Disasters.” Journal of Human Resources, 50 (2015), 484–515.Google Scholar
Campbell, T. C.; Gallmeyer, M. A.; Johnson, S. A.; Rutherford, J.; and Stanley, B. W.. “CEO Optimism and Forced Turnover.” Journal of Financial Economics, 101 (2011), 695–712.Google Scholar
Cassar, A.; Healy, A.; and von Kessler, C.. “Trust, Risk, and Time Preferences after a Natural Disaster: Experimental Evidence from Thailand.” World Development, 94 (2017), 90–105.Google Scholar
Cesarini, D.; Johannesson, M.; Lichtenstein, P.; and Wallace, B.. “Heritability of Overconfidence.” Journal of the European Economic Association, 7 (2009), 617–622.Google Scholar
Chapple, L.; Clout, V. J.; and Tan, D.. “Corporate Governance and Securities Class Actions.” Australian Journal of Management, 39 (2014), 525–547.Google Scholar
Chen, G.; Crossland, C.; and Luo, S.. “Making the Same Mistake All Over Again: CEO Overconfidence and Corporate Resistance to Corrective Feedback.” Strategic Management Journal, 36 (2015), 1513–1535.Google Scholar
Choi, J. J.; Li, Y.; and Zhang, J.. “Can Monitoring by Non-CEO Executives Reduce the Likelihood of Corporate Fraud?” Working Paper, Temple University (2013).Google Scholar
Choi, S. J.“Do the Merits Matter Less after the Private Securities Litigation Reform Act?” Journal of Law, Economics, and Organization, 23 (2006), 598–626.Google Scholar
Choi, S. J.; Johnson-Skinner, D. T.; and Pritchard, A. C.. “The Price of Pay to Play in Securities Class Actions.” Journal of Empirical Legal Studies, 8 (2011), 650–681.Google Scholar
Choi, S. J.; Nelson, K. K.; and Pritchard, A. C.. “The Screening Effect of the Private Securities Litigation Reform Act.” Journal of Empirical Legal Studies, 6 (2009), 35–68.Google Scholar
Clarke v. United States, 132 F.2d 538, 540-41 (9th Cir. 1943).Google Scholar
Cronqvist, H.; Münkel, F.; and Siegel, S.. “Genetics, Homeownership, and Home Location Choice.” Journal of Real Estate Finance and Economics, 48 (2014), 79–111.Google Scholar
Cronqvist, H., and Siegel, S.. “The Genetics of Investment Biases.” Journal of Financial Economics, 113 (2014), 215–234.Google Scholar
Dimmock, S. G., and Gerken, W. C.. “Regulatory Oversight and Return Misreporting by Hedge Funds.” Review of Finance, 20 (2015), 795–821.Google Scholar
Donelson, D. C., and Prentice, R. A.. “Scienter Pleading and Rule 10b-5: Empirical Analysis and Behavioral Implications.” Case Western Reserve Law Review, 63 (2012), 441–509.Google Scholar
Duarte, J.; Kong, K.; Young, L. A.; and Siegel, S.. “The Impact of the Sarbanes–Oxley Act on Shareholders and Managers of Foreign Firms.” Review of Finance, 18 (2014), 417–455.Google Scholar
Edmans, A.; Gabaix, X.; and Landier, A.. “A Multiplicative Model of Optimal CEO Incentives in Market Equilibrium.” Review of Financial Studies, 22 (2009), 4881–4917.Google Scholar
Erica P. John Fund, Inc. v. Halliburton, 563 U.S. 804 (2011).Google Scholar
Ernst & Ernst v. Hochfelder, 425 U.S. 185 at 193 (1976).Google Scholar
Field, L.; Lowry, M.; and Shu, S.. “Does Disclosure Deter or Trigger Litigation?” Journal of Accounting and Economics, 39 (2005), 487–507.Google Scholar
Fitzpatrick, B. T.“The End of Class Actions?” Arizona Law Review, 57 (2015), 161–199.Google Scholar
Gande, A., and Lewis, C. M.. “Shareholder-Initiated Class Action Lawsuits: Shareholder Wealth Effects and Industry Spillovers.” Journal of Financial and Quantitative Analysis, 44 (2009), 823–850.Google Scholar
Gompers, P.; Ishii, J.; and Metrick, A.. “Corporate Governance and Equity Prices.” Quarterly Journal of Economics, 118 (2003), 107–155.Google Scholar
Greene, W.“The Behavior of the Maximum Likelihood Estimator of Limited Dependent Variable Models in the Presence of Fixed Effects.” Econometrics Journal, 7 (2004), 98–119.Google Scholar
Herman & MacLean v. Huddleston, 459 U.S. 375, 390 n.30 (1983).Google Scholar
Hirshleifer, D.; Low, A.; and Teoh, S. H.. “Are Overconfident CEOs Better Innovators?” Journal of Finance, 67 (2012), 1457–1498.Google Scholar
Hoberg, G., and Phillips, G.. “Text-Based Network Industries and Endogenous Product Differentiation.” Journal of Political Economy, 124 (2016), 1423–1465.Google Scholar
Johnson, W. C.; Xie, W.; and Yi, S.. “Corporate Fraud and the Value of Reputations in the Product Market.” Journal of Corporate Finance, 25 (2014), 16–39.Google Scholar
Jones, C. L., and Weingram, S. E.. “The Effects of Insider Trading, Seasoned Equity Offerings, Corporate Announcements, Accounting Restatements, and SEC Enforcement Actions on 10b-5 Litigation Risk.” Working Paper, Stanford University (1996).Google Scholar
Jones, J.“Earnings Management during Import Relief Investigations.” Journal of Accounting Research, 29 (1991), 193–228.Google Scholar
Karpoff, J. M.; Lee, D. S.; and Martin, G. S.. “The Cost to Firms of Cooking the Books.” Journal of Financial and Quantitative Analysis, 43 (2008), 581–612.Google Scholar
Khanna, V.; Kim, E. H.; and Lu, Y.. “CEO Connectedness and Corporate Fraud.” Journal of Finance, 70 (2015), 1203–1252.Google Scholar
Kim, I., and Skinner, D. J.. “Measuring Securities Litigation Risk.” Journal of Accounting and Economics, 53 (2012), 290–310.Google Scholar
Kim, S.“The Acquisitiveness of Youth: CEO Age and Acquisition Behavior.” Journal of Financial Economics, 108 (2013), 250–273.Google Scholar
Klasa, S.; Maxwell, W. F.; and Ortiz-Molina, H.. “The Strategic Use of Corporate Cash Holdings in Collective Bargaining with Labor Unions.” Journal of Financial Economics, 92 (2009), 421–442.Google Scholar
Kolasinski, A. C., and Li, X.. “Do Strong Boards and Trading in Their Own Firm’s Stock Help CEOs Make Better Decisions? Evidence from Corporate Acquisitions by Overconfident CEOs.” Journal of Financial and Quantitative Analysis, 48 (2013), 1173–1206.Google Scholar
Laux, V., and Stocken, P. C.. “Managerial Reporting, Overoptimism, and Litigation Risk.” Journal of Accounting and Economics, 53 (2012), 577–591.Google Scholar
Levi, M.; Li, K.; and Zhang, F.. “Director Gender and Mergers and Acquisitions.” Journal of Corporate Finance, 28 (2014), 185–200.Google Scholar
Loughran, T., and Ritter, J.. “Why Has IPO Underpricing Changed Over Time?” Financial Management, 33 (2004), 5–37.Google Scholar
Malm, J., and Mobbs, S.. “Independent Directors and Corporate Litigation.” Working Paper, University of Alabama (2014).Google Scholar
Malmendier, U., and Tate, G.. “CEO Overconfidence and Corporate Investment.” Journal of Financial Economics, 60 (2005), 2661–2700.Google Scholar
Malmendier, U., and Tate, G.. “Who Makes Acquisitions? CEO Overconfidence and the Market’s Reaction.” Journal of Financial Economics, 89 (2008), 20–43.Google Scholar
Malmendier, U.; Tate, G.; and Yan, J.. “Overconfidence and Early-Life Experiences: The Effect of Managerial Traits on Corporate Financial Policies.” Journal of Finance, 66 (2011), 1687–1733.Google Scholar
McTier, B. C., and Wald, J. K.. “The Causes and Consequences of Securities Class Action Litigation.” Journal of Corporate Finance, 17 (2011), 649–665.Google Scholar
Niehaus, G., and Roth, G.. “Insider Trading, Equity Issues, and CEO Turnover in Firms Subject to Securities Class Action.” Financial Management, 28 (1999), 52–72.Google Scholar
Peng, L., and Röell, A.. “Executive Pay and Shareholder Litigation.” Review of Finance, 12 (2008), 141–184.Google Scholar
Perino, M.“Institutional Activism Through Litigation: An Empirical Analysis of Public Pension Fund Participation in Securities Class Actions.” Journal of Empirical Legal Studies, 9 (2012), 368–392.Google Scholar
Perino, M.“Have Institutional Fiduciaries Improved Securities Class Actions? A Review of the Empirical Literature on the PSLRA’s Lead Plaintiff.” In Cambridge Handbook of Institutional Investment and Fiduciary Duty, Hawley, J. P., Hoepner, A. G. F., Johnson, K. L., Sandberg, J., and Waitzer, E. J., eds. Cambridge, UK: Cambridge University Press (2014), 146–158.Google Scholar
Reeb, D. M., and Zhao, W.. “Director Capital and Corporate Disclosure Quality.” Journal of Accounting and Public Policy, 32 (2013), 191–212.Google Scholar
Schrand, C. M., and Zechman, S. L. C.. “Executive Overconfidence and the Slippery Slope to Financial Misreporting.” Journal of Accounting and Economics, 53 (2012), 311–329.Google Scholar
Serfling, M. A.“CEO Age and the Riskiness of Corporate Policies.” Journal of Corporate Finance, 25 (2014), 251–273.Google Scholar
Walker, R. H., and Seymour, J. G.. “Recent Judicial and Legislative Developments Affecting the Private Securities Fraud Class Action.” Arizona Law Review, 40 (1998), 1003–1037.Google Scholar
Wang, T., and Winton, A.. “Product Market Interactions and Corporate Fraud.” Working Paper, University of Minnesota–Twin Cities (2014).Google Scholar
Wang, T.; Winton, A.; and Yu, X.. “Corporate Fraud and Business Conditions: Evidence from IPOs.” Journal of Finance, 65 (2010), 2255–2292.Google Scholar