Too Much Pay, Too Much Deference: Behavioral Corporate Finance, CEOs, and Corporate Governance

Abstract

In this Article, Professor Paredes considers the implications of behavioral corporate finance, and of CEO overconfidence especially, for corporate governance. To date, corporate governance has focused on solving conflicts of interest and on motivating managers to work hard—in other words, on traditional agency problems. Corporate governance has not emphasized the need to remedy the kind of “good-faith mismanagement” that results when CEOs are overconfident, although well-intentioned and hard-working. In addition to detailing the effects of CEO overconfidence, Professor Paredes theorizes that CEO overconfidence is actually a product of corporate governance. First, Professor Paredes explains that high executive compensation gives positive feedback to a CEO and signals that the chief executive is a success. Studies show that positive feedback and recent success can result in overconfidence. Indeed, the very process of winning the tournament to become the top executive probably makes a CEO more confident. Stressing the possible link between CEO pay and CEO overconfidence offers a new behavioral approach to executive compensation that emphasizes the impact of executive pay on managerial psychology and decisionmaking. Second, a CEO-centric model of corporate governance is predominant in the United States as boards, subordinate officers, gatekeepers, judges, and shareholders defer to the chief executive, even in the post-Sarbanes-Oxley era. Professor Paredes suggests that CEOs can become overconfident as a result of the extensive corporate control concentrated in their hands and the fact that they are rarely seri-