The Effect of Overconfident Managers on Pay-for-Performance Sensitivity

Abstract

This study examines how overconfident managers influence their pay-for-performance sensitivity in South Korea. We use a sample of 14,012 firm-year observations from 2011 to 2020 listed in KOSPI and KOSDAQ. This study uses regression analysis to analyze the data, with firm size as a robustness check. We find a negative and significant relationship between managerial overconfidence and pay-for-performance sensitivity, suggesting that overconfident managers can play a significant role in deteriorating efficient compensation contracts. This result is consistent with prior studies’ findings that managerial overconfidence can increase the agency costs between shareholders and managers. In addition, we find that the effect of managerial overconfidence on pay-for-performance sensitivity is more pronounced when overconfident managers are in large-sized firms. This paper contributes to prior studies in the following ways. First, this study confirms the relationship between managerial overconfidence and pay-for-performance sensitivity. Second, it expands prior studies related to pay-for-performance sensitivity and managerial overconfidence. Third, the effect of managerial overconfidence on pay-for-performance sensitivity affected by firm size should be carefully considered. Lastly, the results of this study indicate that managerial overconfidence should be managed effectively to create compensation contracts that are related to a firm’s performance.