Managerial Overconfidence and Self-Reported Success

Nikolaj Kirkeby Niebuhr ()
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Nikolaj Kirkeby Niebuhr: Department of Economics and Business Economics, Aarhus University, Postal: Department of Economics and Business Economics, Aarhus University, Fuglesangs Alle 4, DK-8210 Aarhus V

Economics Working Papers from Department of Economics and Business Economics, Aarhus University

Abstract: I consider the optimal contract for an overconfident manager in a principal-agent model with moral hazard where the contract is written on the earnings of the firm. Overconfidence causes the manager to overestimate his ability to affect the outcome of the firm. Overconfidence first reduces cost of agency, and if the level of overconfidence is significant enough, it causes the manager to wager on his wrong beliefs. The accounting system obscures the outcome of the manager's effort, which attenuates the effect of significant overconfidence and decreases the principal's profit. Inducing the manager to truthfully communicate his self-observed success allows the principal to directly contract on the cause of disagreement, the manager's effect on firm outcome. This reduces the risk premium for a slightly overconfident manager and emphasizes the wager effect for a significantly overconfident manager. The value of communication is first decreasing in overconfidence for a slightly overconfident manager and then increasing in overconfidence for a significantly overconfident manager.

Keywords: Overconfidence; Moral hazard; Communication; Disclosure (search for similar items in EconPapers)
JEL-codes: D83 D86 D91 M41 (search for similar items in EconPapers)
Pages: 47
Date: 2020-01-10
New Economics Papers: this item is included in nep-bec, nep-cta, nep-hrm, nep-mic and nep-ore
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