CEO Overconfidence and Corporate Tax Strategy

Abstract

Literature in accounting, economics, and corporate finance explores how top corporate executives’ personal traits and psychological biases affect firm decisions. This study focuses on one specific dimension of CEO personality: overconfidence and examines how CEO overconfidence influences corporate tax strategies. Overconfident executives tend to expect good outcomes due to optimistic bias or overestimation of their ability to bring about success. Therefore, they tend to overestimate the returns on investment projects and overinvest. We postulate that overconfident CEOs are inclined to seek risky tax planning activities to generate additional cash streams to make up for those projects not producing as much cash flow as originally expected. We find our three measures of overconfidence to be positively correlated with the book-tax difference (BTD). Our main overconfidence measure, proxied by CEOs delaying exercising their stock options, is negatively correlated with the cash effective tax rate (CETR), consistent with our prediction that overconfident CEOs exhibit more tax aggressiveness to preserve cash. Additionally, we test whether corporate governance affects corporate tax strategies and show that overconfident CEOs continue to have a negative effect on cash-effective tax rates regardless of the strength of board governance.