CEO Overconfidence and Bank Failure

Abstract

This study examines the impacts of overconfidence on bank performance during the 2008 financial crisis. I find three significant results related to overconfidence: (1) The number of bank chief executive officers (CEO) who were overconfident grew significantly in the run-up to the crisis (increased 55% between 2000 and 2006); (2) measures of overconfidence (especially vested in-the-money options) were the highest in 2006 – a year preceding the crisis, and (3) overly-optimistic tendencies cut across diverse sectors in the financial industry prior to the crisis. The implication is that a bank with an overconfident CEO was more likely to fail or receive a financial bailout Trouble Asset Relief Program (TARP) fund. Overall, the results demonstrate that the value-destroying investment decisions of an overconfident CEO can extend beyond the firm, and contribute to a global credit crisis.