CEO Overconfidence Corporate Investment Activity and Performance Evidence

‘CEO Overconfidence, Corporate Investment Activity, and Performance: Evidence from REITs ’ Prof. Dr. Piet Eichholtz Erkan Yönder Maastricht University ERES 2011 Eindhoven, the Netherlands

Behavioral Biases in Finance Theory …not sufficiently investigated on professional managers § Overconfidence is one of the behavioral biases that has been documented mainly on individual investors. (Benos, 1998, Hirshleifer and Luo, 2001, etc. ) § But not sufficiently on professional managers. The few exceptions include most notably the empirical work by Malmendier and Tate (2005), Crane and Hartzell (2010). § In this project, we aim to investigate overconfidence of professional managers using a (Real Estate Investment Trusts) REIT sample. 2

CEO Overconfidence …a behavioral bias § Overconfident people believe that they are «better-than-average» . (Miller and Ross, 1975) § They are too optimistic about their decisions. They overestimate the returns to their investment projects. q They underestimate the risks associated with their decisions. (Hirshleifer and Luo, 2001) q § Overconfident managers overinvest… q Malmendier and Tate (2005) propose 3 overconfidence measures. (Holder 67, Long Holder and Net Buyer) 3

Net Buyer of Own Company’s Stocks …good vs. bad performance An overconfident CEO is a «net buyer» of own company’s stocks throughout the sample period. Net buyer of own company’s stock Positive private information Overconfidence Suboptimal investment activity Good performance Bad performance 4

Why REITs? …better observable investment activity § Investment decisions can easily be identified. § Easy to observe how much a firm spent when investing in a project. § Accurate investment frequency can be determined at corporate level. § Only largest investment decisions can be observed with M&A. § Different from M&A, selling activity can be observed. REITs offer a unique labarotary environment to test the effect of overconfidence on professional managers’ investment decisions and performance. 5

Data & Model § Sample q q q 161 U. S. REITs Annual data from 2003 -2008 Collected from SEC Reports, SNL, Worldscope § Investment Activity (Brounen, Eichholtz, and Ling, 2007) (1) Purchasing Activity = f(net buyer dummy, financial determinants, property type, time dummies, u) (2) Sales Activity = g(net buyer dummy, financial determinants, property type, time dummies, u) 6

Investment Activity and Overconfidence …overconfident CEOs purchase more VARIABLES (1) Purchasing (USD value) Net Buyer 0. 094*** [0. 023] ln(Size) 0. 019** [0. 008] Age -0. 003*** [0. 001] Debt Ratio(t-1) -0. 103* [0. 055] Cash(t-1) 0. 126 [0. 165] M/B(t-1) 0. 052** [0. 026] Constant -0. 111 [0. 120] (2) Purchasing (# of properties) 0. 074** [0. 031] -0. 005 [0. 012] -0. 002** [0. 001] -0. 162** [0. 066] 1. 258*** [0. 191] 0. 112*** [0. 034] 0. 160 [0. 175] (3) Sales (USD value) -0. 021** [0. 010] 0. 006 [0. 004] 0. 000 [0. 000] 0. 028 [0. 023] -0. 005 [0. 068] -0. 013 [0. 011] -0. 053 [0. 054] (4) Sales (# of properties) -0. 024* [0. 013] 0. 006 [0. 005] 0. 001 [0. 000] 0. 043 [0. 028] -0. 035 [0. 081] -0. 024* [0. 014] -0. 029 [0. 072] Property Type Year Dummy Yes 496 133 0. 21 Yes 538 143 0. 10 Yes 496 133 0. 09 Observations # of REITs R-squared Yes 538 143 0. 17 7

Performance Regressions …overconfident CEOs underperform VARIABLES Net Buyer Debt Ratio ln(Size) ln(FFO) Constant Property Type Year Dummy Observations Number of REITs R-squared Chi-Squared Prob. (1) ALPHA -0. 011* [0. 006] -0. 036** [0. 018] 0. 015 [0. 010] Yes 637 154 (2) ALPHA -0. 006 [0. 007] -0. 047** [0. 020] 0. 003 [0. 007] 0. 001 [0. 007] -0. 044 [0. 041] Yes 572 147 28. 20 0. 0017 32. 63 0. 0011 (3) TOBIN’S Q -0. 186*** [0. 039] -0. 350*** [0. 079] -0. 117*** [0. 018] 0. 077*** [0. 013] 2. 419*** [0. 205] Yes 577 154 0. 39 (4) ROA -0. 823** [0. 353] -5. 305*** [0. 916] -1. 690*** [0. 223] 1. 704*** [0. 187] 13. 300*** [2. 088] Yes 577 154 0. 32 (5) ROE -6. 265** [2. 704] 11. 660* [6. 845] -6. 621*** [1. 647] 5. 551*** [1. 360] 36. 115** [15. 825] Yes 577 154 0. 12 8

Extended Overconfidence Measure …only underperforming net buyers purchase more VARIABLES (1) (2) (3) (4) (5) Purchasing Purchasing (USD value) (USD value) Net Buyer*Low ROA 0. 120*** [0. 023] Net Buyer*Low ROE 0. 135*** [0. 023] Net Buyer*Low Alpha(t+1) 0. 053** [0. 022] Net Buyer*High ROA -0. 024 [0. 029] Net Buyer*High ROE -0. 041 [0. 029] Net Buyer*High Alpha(t+1) Constant Controls Property Type Year Dummy Observations Number of REITs R-squared -0. 092 [0. 111] Yes Yes 538 143 0. 20 -0. 143 [0. 112] Yes Yes 538 143 0. 21 0. 031 [0. 121] Yes Yes 493 135 0. 15 0. 084 [0. 117] Yes Yes 538 143 0. 14 0. 085 [0. 116] Yes Yes 538 143 0. 14 (6) Purchasing (USD value) 0. 031 [0. 024] 0. 065 [0. 120] Yes Yes 493 135 0. 14 9

Extended Overconfidence Measure …outperforming net buyers sell more VARIABLES (1) (2) (3) (4) (5) Sales Sales (USD value) (USD value) Net Buyer*Low ROA -0. 046*** [0. 010] Net Buyer*Low ROE -0. 045*** [0. 010] Net Buyer*Low Alpha(t+1) -0. 024** [0. 009] Net Buyer*High ROA 0. 036*** [0. 012] Net Buyer*High ROE 0. 033*** [0. 012] Net Buyer*High Alpha(t+1) Constant Controls Property Type Year Dummy Observations Number of REITs R-squared -0. 028 [0. 051] Yes Yes 538 143 0. 06 -0. 021 [0. 052] Yes Yes 538 143 0. 07 -0. 079 [0. 053] Yes Yes 493 135 0. 04 -0. 112** [0. 051] Yes Yes 538 143 0. 06 -0. 104** [0. 051] Yes Yes 538 143 0. 06 (6) Sales (USD value) -0. 001 [0. 010] -0. 102* [0. 053] Yes Yes 493 135 0. 03 10

Concluding Remarks • Overconfident CEOs significantly purchase more properties than nonoverconfident counterparts. • Overconfident CEOs significantly sell less properties than nonoverconfident counterparts. • Overconfident CEOs significantly have worse operating performance than non-overconfident counterparts. • An interaction dummy of being a bad performer and being a net buyer of own company stocks gives stronger results. • When we use an interaction dummy of being a good performer and a net buyer of own company stocks, it even has opposite impacts on purchasing and sales activities. 11