IDEAS home Printed from https://ideas.repec.org/a/eee/finlet/v54y2023ics1544612323001228.html
   My bibliography  Save this article

CEO overconfidence, lottery preference and the cross-section of stock returns

Author

Listed:
  • Lu, Jing
  • Ho, Keng-Yu
  • Ho, Po-Hsin
  • Ko, Kuan-Cheng

Abstract

Unlike existing studies that mostly focus on investors’ biased behavior in explaining the lottery-related anomaly, our study highlights the importance of CEO overconfidence for the anomaly. We propose that CEO overconfidence could enhance investors’ confidence in the stock's price even if the stock exhibits lottery-like payoffs. As a result, lottery stocks with overconfident CEOs are less prone to subsequent underperformance. Based on portfolio-based analyses and cross-sectional regressions, we provide robust evidence to confirm this hypothesis. Our study has important implications to the literature on both lottery-related anomaly and CEO overconfidence.

Suggested Citation

  • Lu, Jing & Ho, Keng-Yu & Ho, Po-Hsin & Ko, Kuan-Cheng, 2023. "CEO overconfidence, lottery preference and the cross-section of stock returns," Finance Research Letters, Elsevier, vol. 54(C).
    • Handle: RePEc:eee:finlet:v:54:y:2023:i:c:s1544612323001228
    DOI: 10.1016/j.frl.2023.103749
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S1544612323001228
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.frl.2023.103749?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Fama, Eugene F & French, Kenneth R, 1992. "The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-465, June.
    2. Scholes, Myron & Williams, Joseph, 1977. "Estimating betas from nonsynchronous data," Journal of Financial Economics, Elsevier, vol. 5(3), pages 309-327, December.
    3. Hall, Brian J. & Murphy, Kevin J., 2002. "Stock options for undiversified executives," Journal of Accounting and Economics, Elsevier, vol. 33(1), pages 3-42, February.
    4. Malmendier, Ulrike & Tate, Geoffrey, 2008. "Who makes acquisitions? CEO overconfidence and the market's reaction," Journal of Financial Economics, Elsevier, vol. 89(1), pages 20-43, July.
    5. Hung, Weifeng & Yang, J. Jimmy, 2018. "The MAX effect: Lottery stocks with price limits and limits to arbitrage," Journal of Financial Markets, Elsevier, vol. 41(C), pages 77-91.
    6. Ulrike Malmendier & Geoffrey Tate, 2005. "CEO Overconfidence and Corporate Investment," Journal of Finance, American Finance Association, vol. 60(6), pages 2661-2700, December.
    7. Deshmukh, Sanjay & Goel, Anand M. & Howe, Keith M., 2013. "CEO overconfidence and dividend policy," Journal of Financial Intermediation, Elsevier, vol. 22(3), pages 440-463.
    8. Ferris, Stephen P. & Jayaraman, Narayanan & Sabherwal, Sanjiv, 2013. "CEO Overconfidence and International Merger and Acquisition Activity," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 48(1), pages 137-164, February.
    9. Byun, Suk-Joon & Goh, Jihoon & Kim, Da-Hea, 2020. "The role of psychological barriers in lottery-related anomalies," Journal of Banking & Finance, Elsevier, vol. 114(C).
    10. Barinov, Alexander, 2018. "Stocks with extreme past returns: Lotteries or insurance?," Journal of Financial Economics, Elsevier, vol. 129(3), pages 458-478.
    11. Hwang, Yunji & Hun Han, Seung, 2022. "Terrorist attacks, CEO overconfidence, and CEO compensation," Finance Research Letters, Elsevier, vol. 46(PA).
    12. Bali, Turan G. & Cakici, Nusret & Whitelaw, Robert F., 2011. "Maxing out: Stocks as lotteries and the cross-section of expected returns," Journal of Financial Economics, Elsevier, vol. 99(2), pages 427-446, February.
    13. Ang, Andrew & Hodrick, Robert J. & Xing, Yuhang & Zhang, Xiaoyan, 2009. "High idiosyncratic volatility and low returns: International and further U.S. evidence," Journal of Financial Economics, Elsevier, vol. 91(1), pages 1-23, January.
    14. David Hirshleifer & Angie Low & Siew Hong Teoh, 2012. "Are Overconfident CEOs Better Innovators?," Journal of Finance, American Finance Association, vol. 67(4), pages 1457-1498, August.
    15. Aktas, Nihat & Louca, Christodoulos & Petmezas, Dimitris, 2019. "CEO overconfidence and the value of corporate cash holdings," Journal of Corporate Finance, Elsevier, vol. 54(C), pages 85-106.
    16. Anand M. Goel & Anjan V. Thakor, 2008. "Overconfidence, CEO Selection, and Corporate Governance," Journal of Finance, American Finance Association, vol. 63(6), pages 2737-2784, December.
    17. Bharati, Rakesh & Doellman, Thomas & Fu, Xudong, 2016. "CEO confidence and stock returns," Journal of Contemporary Accounting and Economics, Elsevier, vol. 12(1), pages 89-110.
    18. Zhong, Angel & Gray, Philip, 2016. "The MAX effect: An exploration of risk and mispricing explanations," Journal of Banking & Finance, Elsevier, vol. 65(C), pages 76-90.
    19. Jegadeesh, Narasimhan, 1990. "Evidence of Predictable Behavior of Security Returns," Journal of Finance, American Finance Association, vol. 45(3), pages 881-898, July.
    20. Lo, Andrew W & MacKinlay, A Craig, 1990. "When Are Contrarian Profits Due to Stock Market Overreaction?," The Review of Financial Studies, Society for Financial Studies, vol. 3(2), pages 175-205.
    21. Pastor, Lubos & Stambaugh, Robert F., 2003. "Liquidity Risk and Expected Stock Returns," Journal of Political Economy, University of Chicago Press, vol. 111(3), pages 642-685, June.
    22. Tien-Shih Hsieh & Jean C. Bedard & Karla M. Johnstone, 2014. "CEO Overconfidence and Earnings Management During Shifting Regulatory Regimes," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 41(9-10), pages 1243-1268, November.
    23. James A. Chyz & Fabio B. Gaertner & Asad Kausar & Luke Watson, 2019. "Overconfidence and Corporate Tax Policy," Review of Accounting Studies, Springer, vol. 24(3), pages 1114-1145, September.
    24. Paul Hribar & Holly Yang, 2016. "CEO Overconfidence and Management Forecasting," Contemporary Accounting Research, John Wiley & Sons, vol. 33(1), pages 204-227, March.
    25. Fong, Wai Mun & Toh, Benjamin, 2014. "Investor sentiment and the MAX effect," Journal of Banking & Finance, Elsevier, vol. 46(C), pages 190-201.
    26. Simon Gervais & J. B. Heaton & Terrance Odean, 2011. "Overconfidence, Compensation Contracts, and Capital Budgeting," Journal of Finance, American Finance Association, vol. 66(5), pages 1735-1777, October.
    27. Humphery-Jenner, Mark & Lisic, Ling Lei & Nanda, Vikram & Silveri, Sabatino Dino, 2016. "Executive overconfidence and compensation structure," Journal of Financial Economics, Elsevier, vol. 119(3), pages 533-558.
    28. Garrett, Thomas A. & Sobel, Russell S., 1999. "Gamblers favor skewness, not risk: Further evidence from United States' lottery games," Economics Letters, Elsevier, vol. 63(1), pages 85-90, April.
    29. Kang, Yong Joo & Lee, Ho-Young & Park, Hyun-Young & Park, Ju Hyoung, 2022. "Social ties, managerial overconfidence, and investment efficiency," Finance Research Letters, Elsevier, vol. 46(PA).
    30. Amihud, Yakov, 2002. "Illiquidity and stock returns: cross-section and time-series effects," Journal of Financial Markets, Elsevier, vol. 5(1), pages 31-56, January.
    31. Fama, Eugene F. & French, Kenneth R., 2015. "A five-factor asset pricing model," Journal of Financial Economics, Elsevier, vol. 116(1), pages 1-22.
    32. Andrew Ang & Robert J. Hodrick & Yuhang Xing & Xiaoyan Zhang, 2006. "The Cross‐Section of Volatility and Expected Returns," Journal of Finance, American Finance Association, vol. 61(1), pages 259-299, February.
    33. Suman Banerjee & Mark Humphery-Jenner & Vikram Nanda, 2015. "Restraining Overconfident CEOs through Improved Governance: Evidence from the Sarbanes-Oxley Act," The Review of Financial Studies, Society for Financial Studies, vol. 28(10), pages 2812-2858.
    34. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Russian Presidential Academy of National Economy and Public Administration (RANEPA), vol. 33(1), pages 125-132.
    35. Smith, Daniel R., 2007. "Conditional coskewness and asset pricing," Journal of Empirical Finance, Elsevier, vol. 14(1), pages 91-119, January.
    36. Dimson, Elroy, 1979. "Risk measurement when shares are subject to infrequent trading," Journal of Financial Economics, Elsevier, vol. 7(2), pages 197-226, June.
    37. Todd Mitton & Keith Vorkink, 2007. "Equilibrium Underdiversification and the Preference for Skewness," The Review of Financial Studies, Society for Financial Studies, vol. 20(4), pages 1255-1288.
    38. Alok Kumar, 2009. "Who Gambles in the Stock Market?," Journal of Finance, American Finance Association, vol. 64(4), pages 1889-1933, August.
    39. Alberto Galasso & Timothy S. Simcoe, 2011. "CEO Overconfidence and Innovation," Management Science, INFORMS, vol. 57(8), pages 1469-1484, August.
    40. Ji, Qiong & Quan, Xiaofeng & Yin, Hongying & Yuan, Qingbo, 2021. "Gambling preferences and stock price crash risk: Evidence from China," Journal of Banking & Finance, Elsevier, vol. 128(C).
    41. Chen, Yao & Kumar, Alok & Zhang, Chendi, 2021. "Searching for Gambles: Gambling Sentiment and Stock Market Outcomes," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 56(6), pages 2010-2038, September.
    42. Campbell R. Harvey & Akhtar Siddique, 2000. "Conditional Skewness in Asset Pricing Tests," Journal of Finance, American Finance Association, vol. 55(3), pages 1263-1295, June.
    43. Kraus, Alan & Litzenberger, Robert H, 1976. "Skewness Preference and the Valuation of Risk Assets," Journal of Finance, American Finance Association, vol. 31(4), pages 1085-1100, September.
    44. Nguyen, Hung T. & Truong, Cameron, 2018. "When are extreme daily returns not lottery? At earnings announcements!," Journal of Financial Markets, Elsevier, vol. 41(C), pages 92-116.
    45. Campbell, T. Colin & Gallmeyer, Michael & Johnson, Shane A. & Rutherford, Jessica & Stanley, Brooke W., 2011. "CEO optimism and forced turnover," Journal of Financial Economics, Elsevier, vol. 101(3), pages 695-712, September.
    46. Chen, Yenn-Ru & Ho, Keng-Yu & Yeh, Chia-Wei, 2020. "CEO overconfidence and corporate cash holdings," Journal of Corporate Finance, Elsevier, vol. 62(C).
    47. Jeong†Bon Kim & Zheng Wang & Liandong Zhang, 2016. "CEO Overconfidence and Stock Price Crash Risk," Contemporary Accounting Research, John Wiley & Sons, vol. 33(4), pages 1720-1749, December.
    48. Li An & Huijun Wang & Jian Wang & Jianfeng Yu, 2020. "Lottery-Related Anomalies: The Role of Reference-Dependent Preferences," Management Science, INFORMS, vol. 66(1), pages 473-501, January.
    49. Jegadeesh, Narasimhan & Titman, Sheridan, 1993. "Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency," Journal of Finance, American Finance Association, vol. 48(1), pages 65-91, March.
    50. Ulrike Malmendier & Geoffrey Tate & Jon Yan, 2011. "Overconfidence and Early‐Life Experiences: The Effect of Managerial Traits on Corporate Financial Policies," Journal of Finance, American Finance Association, vol. 66(5), pages 1687-1733, October.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Melisa Ozdamar & Levent Akdeniz & Ahmet Sensoy, 2021. "Lottery-like preferences and the MAX effect in the cryptocurrency market," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 7(1), pages 1-27, December.
    2. Zhong, Angel & Gray, Philip, 2016. "The MAX effect: An exploration of risk and mispricing explanations," Journal of Banking & Finance, Elsevier, vol. 65(C), pages 76-90.
    3. Bali, Turan G. & Cakici, Nusret & Whitelaw, Robert F., 2011. "Maxing out: Stocks as lotteries and the cross-section of expected returns," Journal of Financial Economics, Elsevier, vol. 99(2), pages 427-446, February.
    4. Lin, Chaonan & Chen, Hong-Yi & Ko, Kuan-Cheng & Yang, Nien-Tzu, 2021. "Time-dependent lottery preference and the cross-section of stock returns," Journal of Empirical Finance, Elsevier, vol. 64(C), pages 272-294.
    5. Zhao, Xiaojuan & Wang, Ye & Liu, Weiyi, 2024. "Someone like you: Lottery-like preference and the cross-section of expected returns in the cryptocurrency market," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 91(C).
    6. Killins, Robert & Ngo, Thanh & Wang, Hongxia, 2021. "Goodwill impairment and CEO overconfidence," Journal of Behavioral and Experimental Finance, Elsevier, vol. 29(C).
    7. Nguyen, Hung T. & Truong, Cameron, 2018. "When are extreme daily returns not lottery? At earnings announcements!," Journal of Financial Markets, Elsevier, vol. 41(C), pages 92-116.
    8. Lin, Mei-Chen & Lin, Yu-Ling, 2021. "Idiosyncratic skewness and cross-section of stock returns: Evidence from Taiwan," International Review of Financial Analysis, Elsevier, vol. 77(C).
    9. Theophilus Lartey & Albert Danso, 2022. "CEO overconfidence and debt covenant violations," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 45(1), pages 162-199, March.
    10. Gao, Ya & Bradrania, Reza, 2024. "Property crime and lottery-related anomalies," Global Finance Journal, Elsevier, vol. 59(C).
    11. Adam Zaremba & Jacob Koby Shemer, 2018. "Price-Based Investment Strategies," Springer Books, Springer, number 978-3-319-91530-2, June.
    12. Bradrania, Reza & Gao, Ya, 2024. "Lottery demand, weather and the cross-section of stock returns," Journal of Behavioral and Experimental Finance, Elsevier, vol. 42(C).
    13. Baars, Maren & Mohrschladt, Hannes, 2021. "An alternative behavioral explanation for the MAX effect," Journal of Economic Behavior & Organization, Elsevier, vol. 191(C), pages 868-886.
    14. Annaert, Jan & De Ceuster, Marc & Verstegen, Kurt, 2013. "Are extreme returns priced in the stock market? European evidence," Journal of Banking & Finance, Elsevier, vol. 37(9), pages 3401-3411.
    15. Lai, Shaojie & Li, Xiaorong & Chan, Kam C., 2021. "CEO overconfidence and labor investment efficiency," The North American Journal of Economics and Finance, Elsevier, vol. 55(C).
    16. Gao, Ya & Han, Xing & Xiong, Xiong, 2021. "Loss from the chasing of MAX stocks: Evidence from China," The North American Journal of Economics and Finance, Elsevier, vol. 58(C).
    17. Turan G. Bali & Nusret Cakici & Robert F. Whitelaw, 2009. "Maxing Out: Stocks as Lotteries and the Cross-Section of Expected Returns," NBER Working Papers 14804, National Bureau of Economic Research, Inc.
    18. Yao, Shouyu & Wang, Chunfeng & Fang, Zhenming & Chiao, Chaoshin, 2021. "MAX is not the max under the interference of daily price limits: Evidence from China," International Review of Economics & Finance, Elsevier, vol. 73(C), pages 348-369.
    19. Jennifer Kunz & Lara Sonnenholzner, 2023. "Managerial overconfidence: promoter of or obstacle to organizational resilience?," Review of Managerial Science, Springer, vol. 17(1), pages 67-128, January.
    20. Xu, Zhongxiang & Chevapatrakul, Thanaset & Li, Xiafei, 2019. "Return asymmetry and the cross section of stock returns," Journal of International Money and Finance, Elsevier, vol. 97(C), pages 93-110.

    More about this item

    Keywords

    CEO overconfidence; Lottery preference; Maximum daily returns; Stock returns;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:finlet:v:54:y:2023:i:c:s1544612323001228. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/frl .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.