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CEO overconfidence and the level of short-selling activity

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Abstract

This study examines the impact of CEO overconfidence on the level of short-selling activity, as proxied by the short interest ratio. This research employs 19,300 listed firm-year observations from the US market for the period 1998–2017. After controlling for firm and institutional characteristics, empirical results show that short interest is positively associated with CEO overconfidence. The findings further reveal that this positive correlation is more pronounced when the product market competition is high and when the firm is more financially constrained. This study is the first of its kind in that it comprehensively investigates the correlation between CEO overconfidence and short interest. The findings serve as valuable references for corporate governors with insights into the overconfidence effect of management. Likewise, investors benefit from information on the overconfidence effect as it allows them to better identify firms that match or do not match their financial goals and directions.

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Notes

  1. In the psychology literature, overconfidence sometimes refers to the overestimation of the accuracy of one’s belief. Nevertheless, consistent with Kim et al. (2015), the overestimation of accuracy can also be classified as a positive illusion since it concerns one’s judgment.

  2. Malmendier and Tate (2005) require the overconfident CEOs to hold options that are more than 67% in the money at least twice during the sample period.

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Authors and Affiliations

  1. School of Hospitality Management, Macao Institute for Tourism Studies, Macau, China

    Jieqi Guan & Ching Chi Lam

  2. Division of Business and Management, BNU-HKBU United International College, Zhuhai, China

    Brian M. Lam

  3. Faculty of Business Administration, University of Macau, Macau, China

    Ming Liu

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  1. Jieqi Guan
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  2. Brian M. Lam
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  3. Ching Chi Lam
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  4. Ming Liu
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Correspondence to Brian M. Lam.

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Appendix: Variable definitions

Appendix: Variable definitions

Variable

Definition

Short interest ratio

The number of shares sold short divided by the total shares outstanding at fiscal year-end

Short interest ratio (Adj)

The number of shares sold short with adjustments divided by the total shares outstanding at fiscal year-end

CEO overconfidence

One if a CEO holds options that are at least 100% in-the-money at least twice a fiscal year

CEO overconfidence (Alt)

One if a CEO holds options that are at least 100% in-the-money at least once a fiscal year

Overconfidence (SZ2012)

One if the firm meets at least two of the following five criteria and zero otherwise: (1) Investment is above the median of firms within industry–years; (2) Net acquisitions from the statement of cash flows are above the median of firms within industry–years; (3) The debt-to-equity ratio is above the median of firms within industry–years; (4) Either convertible debt or preferred stock is greater than zero

Log (Dist. To Canada)

An instrument variable for social capital as proxied by taking the natural logarithm of the shortest straight-line geographic distance (in 1000 km) between a firm’s headquarter and the US–Canada border

CEO overconfidence (Estimated)

A predicted value of social capital from the first stage of the 2SLS approach

Beta

An estimation by regressing the daily individual stock returns over the fiscal year on the contemporaneous CRSP value-weighted market returns, correcting for nonsynchronous trading following Scholes and Williams (1977)

Idiosyncratic risk

The annualized standard deviation of the residuals from regressing daily individual stock returns over the fiscal year on the contemporaneous CRSP value-weighted market returns, correcting for nonsynchronous trading following Scholes and Williams (1977)

Log(Market value of equity)

Natural logarithm of the fiscal year-end market value of equity

Book-to-market

Book value to market value of equity

Book leverage

The sum of the book value of long-term debt and the book value of debt in current liabilities divided by the book value of assets

Momentum

The stock return over the fiscal year

Analyst forecast dispersion

Natural logarithm of the forecast dispersion defined as the coefficient of variation of one-period-ahead I/B/E/S earnings forecasts

Long-term growth rate

I/B/E/S analyst long-term growth in earnings forecasts

Return on assets

Income before extraordinary items divided by the beginning-of-year book value of assets

HHI

The Herfindahl–Hirschman Index is calculated by summing the squares of an individual company’s market share in an industry based on the two-digit Standard Industry Classification

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Guan, J., Lam, B.M., Lam, C.C. et al. CEO overconfidence and the level of short-selling activity. Rev Quant Finan Acc 58, 685–708 (2022). https://doi.org/10.1007/s11156-021-01006-y

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