“CEO Overconfidence and Repurchases” by Mark Humphery-Jenner
University of New South Wales
Nanyang Technological University
Georgia Institute of Technology
This paper analyzes how CEO overconfidence influences repurchase-decisions, dividend-repurchase substitution, and the market's reaction to repurchases. Overconfident CEOs tend to over-estimate the value of investments and under-estimate their risk. We show that overconfident CEOs prefer repurchases to dividends as they represent less of a drain on future cash flows, reflecting overconfident CEOs' positive beliefs about future projects and the need for cash to support them. This manifests in a substitution from dividends to repurchases. Further, consistent with the idea that an overconfident CEO believes their company to be under-valued, overconfident CEOs are even more likely to substitute CAPEX for repurchases. Overconfident CEOs are also more sensitive to a stock market decline than are other CEOs and are less sensitive to the company's cash/cash-flow decision when making repurchases. Overconfident CEOs who are more insulated from internal or external discipline are more likley to act on these behavioral biases. We also find that overconfident CEOs' excessive optimism results in repurchases conveying a weaker signal about the firm's quality, leading the market to react less strongly to overconfident CEOs' repurchases.