Managerial Overconfidence and Corporate Risk-Taking in Pakistani Firms

Abstract

The behavioral characteristics of managers have become a growing focus of corporate finance studies and especially of why managers fail to act in accordance with the classic rational decision making models. Out of these characteristics, one has stood out as a decisive element in the policies and strategy of companies, namely managerial overconfidence. This paper focuses on the connection between managerial overconfidence and risk-taking behavior in Pakistani corporations which is an emerging market with institutional limitations, lack of information and economic fluctuations. Using behavioral finance theory and the upper echelons theory, the paper states that overconfident managers are overly optimistic in their abilities and the accuracy of the information they have, which results in an increase in risk taking in corporate investment, finance and operational decisions. The research tries to test the empirical relationship between managerial overconfidence and corporate risk-taking in a developing economy setting using firm level data of Pakistani listed companies. It is hoped that the findings will add to the emerging behavioral corporate finance scholarship as it offers both the evidence of Pakistan and offers practical implications of corporate governance, regulatory oversight, and accountability within managers.