Overconfidence and bailouts

Arbeitspapier

Empirical evidence suggests that managerial overconfidence and government guarantees contribute substantially to excessive risk-taking in the banking industry. This paper incorporates managerial overconfidence and limited bank liability into a principal-agent model, where the bank manager unobservably chooses effort and risk. An overconfident manager overestimates the returns to effort and risk. We find that managerial overconfidence necessitates an intervention into banker pay. This is due to the bank's exploitation of the manager's overvaluation of bonuses, which causes excessive risk-taking in equilibrium. Moreover, we show that the optimal bonus tax rises in overconfidence, if risk-shifting incentives are sufficiently large. Finally, the model indicates that overconfident managers are more likely to be found in banks with large government guarantees, low bonus taxes, and lax capital requirements.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: Discussion Paper ; No. 132

Classification and Topics

• Classification: Wirtschaft ; Taxation, Subsidies, and Revenue: General ; Fiscal Policies and Behavior of Economic Agents: General ; Financial Institutions and Services: Government Policy and Regulation ; Behavioral Finance: Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets‡
• Subject: Overconfidence ; Bailouts ; Banking Regulation ; Bonus Taxes

Contributors, Location and Time

• Event: Geistige Schöpfung
• (who): Gietl, Daniel
• Event: Veröffentlichung
• (who): Ludwig-Maximilians-Universität München und Humboldt-Universität zu Berlin, Collaborative Research Center Transregio 190 - Rationality and Competition
• (where): München und Berlin
• (when): 2018

Further information

• Handle: http://hdl.handle.net/10419/194028
• Last update: 20.09.2024, 8:24 AM CEST