Managerial Miscalibration: How Executives Miscalibrate Risk & Investments
Abstract: (via Ben David, Graham, Harvey)
Miscalibration is a form of overconfidence examined in both psychology and economics. Although it is often analyzed in lab experiments, there is scant evidence about the effects of miscalibration in practice. We test whether top corporate executives are miscalibrated, and study the determinants of their miscalibration. We study a unique panel of over 11,600 probability distributions provided by top financial executives and spanning nearly a decade of stock market expectations. Our results show that financial executives are severely miscalibrated: realized market returns are within the executives’ 80% confidence intervals only 33% of the time. We show that miscalibration improves following poor market performance periods because forecasters extrapolate past returns when forming their lower forecast bound (“worst case scenario”), while they do not update the upper bound (“best case scenario”) as much. Finally, we link stock market miscalibration to miscalibration about own-firm project forecasts and increased corporate investment.