Executive Overconfidence and Compensation Structure

Abstract

We examine the impact of overconfidence on compensation structure. We test alternative hypotheses, drawing upon and extending existing theories. Our findings support the exploitation hypothesis: firms offer incentive-heavy compensation contracts to overconfident CEOs to exploit their positively-biased views of firm prospects. Overconfident CEOs receive more option-intensive compensation and this relation increases with CEO bargaining power. Exogenous shocks (SOX and FAS 123R) provide additional support for the findings. Overconfident non-CEO executives also receive more incentive-based pay, independent of CEO overconfidence, buttressing the notion that firms tailor compensation contracts to individual behavioral traits such as overconfidence.