Publications

Journal Article

Research Summary: while real options theory has been applied with the optimality assumption, actual real options investments are made by managers, who are subject to cognitive biases, especially under uncertainty. In this paper, the authors focus on one important type of cognitive bias, overconfidence, to provide new insights on real options literature. The authors argue that overconfident CEOs will invest less in real options than non-overconfident CEOs. The authors also predict that the relationship between overconfident CEOs and firms’ real options intensity will be strengthened when market uncertainty is higher. In a study of U.S. public firms, the authors find strong support across various tests that use multiple measures of overconfidence in CEOs and real options investments, and control for potential selection issues and other endogeneity concerns.

Managerial Summary: this paper studies how a CEO's cognitive bias, overconfidence, may shape a firm's real option investments, which could result in a different level of strategic flexibility. The authors argue that overconfident CEOs have overly high expectations of their performance under uncertainty and/or underestimate the level of uncertainty in their strategic decision-making, which leads to lower investments in the firms’ real options relative to non-overconfident CEOs. The authors study a sample of U.S. public firms and find strong evidence that an overconfident CEO is positively related to the real options investments at the firm level. The authors also find that this overconfidence effect becomes more pronounced in markets with greater uncertainty.