CEO Overconfidence and Financial Crisis

The chief executive officers (CEOs), as the top decision maker in the bank, are the primary influence on bank investment and financing decisions, CEO attitudes toward borrower prospects thus could affect their banks’ lending standards and leverage levels. An overly optimistic assessment of borrower prospects during a credit boom could make banks more vulnerable when a credit boom is followed by a crisis. Overconfident CEOs generally think they have more precise knowledge about future events than they actually have and that they are more likely to experience favorable future outcomes than they actually are. Such biased perceptions cause them overestimate their ability to generate higher returns on their investment projects, often resulting in overinvestment. During an economic upswing, an overconfident CEO who is more bullish than others on prospects for the economy could relax lending standards and increase bank leverage more than other banks while they take exposures believed to be the most profitable for current shareholders. Yet, by taking greater risk, overconfident CEOs make their banks more vulnerable to an external shock such as a financial crisis.

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