Managerial Overconfidence and Market Feedback Effects
65 Pages Posted: 21 Oct 2016 Last revised: 2 Nov 2020
Date Written: January 15, 2017
We show that managerial learning from stock prices can lead to feedback loop vulnerability: liquidity-induced trading can impose a negative externality on the firm's investment decisions, inducing liquidity unconstrained investors to sell their stock holdings. Interestingly, overconfident managers that dismiss stock price information may be less vulnerable to the price impact of liquidity-driven trades. Our empirical evidence strongly supports the model's underlying premises and predictions: First, investment decisions of overconfident CEOs are significantly less responsive to stock price fluctuations. Second, the price impact of liquidity shocks, e.g., mutual fund fire sales, is substantially smaller for firms with overconfident CEOs.
Keywords: Market feedback, CEO overconfidence, Fire sale
JEL Classification: G23, G32, G34
Suggested Citation: Suggested Citation