Overconfidence And Corporate Governance

Modern corporate governance theory is one of the most important parts of finance research. Since Berle-means(1932), corporate governance research has experienced from Berle-means mode to LLSV mode for 70 years. The core of research also changes from "dispersed ownership, separation of ownership and control " to the new agency problem, which is "concentrated ownership, separation of control right and cash flow right". But after the financial scandal of Enron and Worldcom, lots of scholars found that, corporate governance system based on rational assumption seems fail. Consideration on this problem prompts the development of corporate theory. Scholars like Langevoort(1998, 2000) point out, failure of corporate governance system is not because of the system itself, while because of the human under the system. The human is not as rational as traditional theory portrays. On the contrary, it is irrational frequently. Therefore, lots of scholars gradually bring the psychological factor and irrational behavior of human into the research on corporate governance(Morck, 2007). This new research direction is considered to offer a substituted thought to solve the agency problem between managers and stockholders (Gervais,Heaton and Odean, 2003). It prompts the new generation research on corporate governance, which is called behavioral corporate governance.In behavioral corporate governance, overconfidence is one of the most important tokens of irrational behaviors, so lots of behavioral corporate governance research focuses on managerial overconfidence and board overconfidence (Keiber, 2002,Paredes, 2004). But because it is hard to measure overconfidence, at present most of financial research on overconfidence and corporate governance is theoretical research, empirical evidence is still rare. And most research focuses on developed countries. Empirical research on developing countries is also rare. So under the special institutional background of China, are there overconfidence biases in the listed companies in China? Particularly, do the managers and board of the listed companies in China have overconfidence bias and does the overconfidence bias affect the efficiency of corporate governance system? The present literature lacks comprehensive and deep analysis on these problems. Through designing the proxy to measure managerial overconfidence and board overconfidence, the paper analyses and answers these problems, which provides meaningful evidence for the research of behavioral corporate governance.The paper begins with a literature review, followed by theoretical analyses, and the empirical research. It is divided into six chapters.Chapter one is introduction, which briefly introduces the issues, contents, and framework, as well as the contributions of the paper to research in this area.Chapter Two is literature review. This chapter firstly introduces the development of two generation corporate governance theory, then introduces Psychology theory foundation of behavior corporate governance. Finally, Reviewing the Psychology literature of overconfidence, this chapter introduces the effect of managerial overconfidence and board overconfidence on corporate governance, which provides the theory support to empirical research.Chapter three empirically analyses the effect of managerial overconfidence on top management team (TMT) pay gap. This chapter firstly reviews three kinds of theory explanation on TMT pay gap, then portrays the method to measure managerial overconfidence based on the listed company earning warning system of China. Using the sample of the listed companies which provides earning warning, the paper empirically analyses the effect of managerial overconfidence on (TMT) pay gap, and how to explain the empirical results from the view of behavioral corporate governance.Chapter four empirically analyses the effect of managerial overconfidence on managerial compensation performance sensitivity. The empirical research is divided to two parts, the first part analyses the effect of managerial overconfidence on managerial compensation performance sensitivity, the second part analyses the effect of managerial overconfidence on the risk attitude of managers, and the relationship between risk and compensation performance sensitivity.Chapter five empirically analyses the effect of board overconfidence on the performance of companies. Based on the special treatment (ST) system and the literature of manager turnover, the paper designs a proxy to measure board overconfidence . Then the paper empirically analyses the effect of board overconfidence on supervision efficiency of the board and the performance of companies.Chapter six is research conclusions and implications. The chapter concludes the research and point out the future areas of the research.The conclusions of this research are as follows.Firstly, managerial overconfidence behavior has significant influence on TMT pay gap. Then not matter TMT absolute pay gap and comparative pay gap is not related to future performance of the companies, which means TMT pay gap has not efficient incentive effect on managers.Secondly, managerial overconfidence behavior has significant influence on managerial compensation performance sensitivity. And this effect maybe roots in self-serving bias of managers. Then managerial overconfidence behavior has significant influence on the risk attitude of managers, and the relationship between risk and compensation performance sensitivity.Thirdly, board overconfidence behavior has negative effect on the performance of companies.The above research proves that managerial overconfidence and board overconfidence significantly affect the efficiency of corporate governance system. When designing corporate governance system, the irrational behavior of managers and board should be take into consideration. Transformation from institutional research to psychological factor research, from rational behavior to irrational behavior, from institutional corporate governance research to behavioral corporate governance research maybe the future research direction of corporate governance theory.