We explore behavioral explanations for sub-optimal corporate investment decisions. Focusing on the sensitivity of investment to cash flow, we argue that personal characteristics of chief executive officers, in particular overconfidence, can account for this widespread and persistent investment distortion. Overconfident CEOs overestimate the quality of their investment projects and view external finance as unduly costly. As a result, they invest more when they have internal funds at their disposal. We test the overconfidence hypothesis, using data on personal portfolio and corporate investment decisions of CEOs in Forbes 500 companies. We classify CEOs as overconfident if they repeatedly fail to exercise options that are highly in the money, or if they habitually acquire stock of their own company. The main result is that investment is significantly more responsive to cash flow if the CEO displays overconfidence. In addition, we identify personal characteristics other than overconfidence (education, employment background, cohort, military service, and status in the company) that strongly affect the correlation between investment and cash flow. We are indebted to Brian Hall and David Yermack for providing us with the data. We are very grateful to Jeremy Stein for his invaluable support and comments. We also would like to thank Philippe Aghion, George

Does CEO overconfidence help to explain merger decisions? Overconfident CEOs overestimate their ability to generate returns. As a result, they overpay for target companies and undertake value-destroying mergers. The effects are strongest if they have access to internal financing. We test these predictions using two proxies for overconfidence: CEOs' personal overinvestment in their company and their press portrayal. We find that the odds of making an acquisition are 65 % higher if the CEO is classified as overconfident. The effect is largest if the merger is diversifying and does not require external financing. The market reaction at merger announcement (–90 basis points) is significantly more negative than for non-overconfident CEOs (–12 basis points). We consider alternative interpretations including inside information, signaling, and risk tolerance.

This article argues that (a) ego, or self, is an organization of knowledge, (b) ego is characterized by cognitive biases strikingly analogous to totalitarian information-control strategies, and (c) these totalitarian-ego biases junction to preserve organization in cognitive structures. Ego's cognitive biases are egocentricity (self as the focus of knowledge), "beneffectance" (perception of responsibility for desired, but not undesired, outcomes), and cognitive conservatism (resistance to cognitive change). In addition to being pervasively evident in recent studies of normal human cognition, these three biases are found in actively functioning, higher level organizations of knowledge, perhaps best exemplified by theoretical paradigms in science. The thesis that egocentricity, beneffectance, and

The theory outlined in the present chapter adopts a cognitive approach to motivation. In the pages that follow we describe a research program premised on the notion that the cognitive treatment affords conceptual and methodological advantages enabling new insights into problems of motivated action, self-regulation and self-control. We begin by placing our work in the broader historical context of social psychological theorizing about motivation and cognition. We then present our theoretical notions and trace their implications for a variety of psychological issues including activity-experience, goal-commitment, choice, and substitution. The gist of the chapter that follows describes our empirical research concerning a broad range of phenomena informed by the goal-systemic analysis. Motivation Versus Cognition, or Motivation as Cognition Motivation versus cognition: the “separatist program. ” Social psychological theories have often treated motivation as separate from cognition, and have often approached it in a somewhat static manner. The separatism of the “motivation versus cognition ” approach was manifest in several major formulations and debates. Thus, for example, the dissonance versus self-perception debate (Bem, 1972) pitted against each other motivational (i.e., dissonance) versus cognitive (i.e., self-perception) explanations of attitude change phenomena. A similar subsequent controversy pertained to the question of whether a motivational explanation of biased causal attributions in terms of ego-defensive tendencies (cf. Kelley, 1972) is valid, given the alternative possibility of a purely cognitive explanation (Miller & Ross, 1975). The separatism of the “motivation versus cognition ” approach assigned distinct functions to motivational and cognitive variables. This is apparent in major social psychological notions of persuasion, judgment or impression formation. For instance, in the popular dual-mode theories of

We examine changes in the stock trading behavior and investment performance of 1,607 investors who switch from phone based to online trading during the period 1992 to 1995. We document that young men who are active traders with high incomes and a preference for investing in small growth stocks with high market risk are more likely to switch to online trading. We also find that those who switch to online trading experience unusually strong performance prior to going online, beating the market by more than two percent annually. After going online, they trade more actively, more speculatively, and less profitably than before-- lagging the market by more than three percent annually. A rational response to reductions in market frictions (lower trading costs, improved execution speed, and greater ease of access) does not explain these findings. The increase in trading and reduction in performance of online investors can be explained by overconfidence augmented by self-attribution bias, the illusion of knowledge, and the illusion of control.

Human cognition is often biased, from judgments of the time of impact of approaching objects all the way through to estimations of social outcomes in the future. We propose these effects and a host of others may all be understood from an evolutionary psychological perspective. In this article, we elaborate error management theory (EMT; Haselton & Buss, 2000). EMT predicts that if judgments are made under uncertainty, and the costs of false positive and false negative errors have been asymmetric over evolutionary history, selection should have favored a bias toward making the least costly error. This perspective integrates a diverse array of effects under a single explanatory umbrella, and it yields new content-specific predictions. Better safe than sorry. (folk wisdom) Nothing ventured, nothing gained. (contradictory folk wisdom) These two wisdoms seem contradictory. The first urges caution, whereas the second reminds us that we have nothing to lose and should throw caution to the

The question that this volume poses—What can social psychology tell us about the Holocaust?—is a difficult and complex one to answer. Perhaps it is fair to begin by saying that the Holocaust has influenced our understanding of social psychology more than the other way around. Early work in the field was directly motivated by the devastation and tragedies that took place between 1933-1945 (e.g., on the Holocaust, see Hilberg, 1973; on Jewish persecution from 1933-39, see Friedländer, 1997; on the Third Reich, see Shirer, 1998). Central topics in social psychology such as attribution, social influence, and intergroup processes all have their roots in the works of thinkers who had the events of the 1930s and 40s seared in their minds, many of whom had to flee their homelands to escape the specter of Nazism. In the 1960s and early 70s, seminal work in the field, such as Milgram's (1974) research on obedience to authority and the Stanford Prison experiment by Zimbardo and his colleagues (Zimbardo, Banks, Haney, & Jaffe, 1973), continued to be motivated by a need to understand the perpetrators of the Holocaust and other acts of collective violence. To this day, these studies represent social psychology's most salient demonstrations of situationism—a core tenet of the field that emphasizes the power of the situational forces over human behavior (see Ross &

∗This paper is an updated version of a previous working paper, “The Positive Role of Overconfidence and

We argue that individual characteristics of managers can explain capital structure decisions like debt conservatism and pecking-order financing choices. Moreover, they can explain cross-sectional variation in these decisions despite identical firm characteristics. We link the reluctance of (some) managers to access external capital markets, and in particular equity markets, to managerial overconfidence. Overconfident managers believe that their company is undervalued. They view external financing, and especially equity financing, as overpriced. We test the overconfidence hypothesis, using several measures of managerial overconfidence. We classify CEOs as overconfident if they persistently fail to reduce their personal exposure to company-specific risk. We also classify CEOs based on their characterization in the business press. We find that overconfident CEOs are significantly less likely than other CEOs to issue equity, conditional on tapping public securities markets. Likewise, they issue roughly 30 cents more debt to cover an additional dollar of external financing deficit than their peers. Finally, overconfident CEOs access all external capital markets (including debt markets) more conservatively.

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