Managerial Miscalibration - Behavioral Finance

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Electronic copy available at: http://ssrn.com/abstract=1640552

M A N A G E R I A L M ISC A L I B R A T I O N

Itzhak Ben-David John R. Graham

F isher College of Business, The Ohio State University, Columbus, O H 43210, U S A

Fuqua School of Business, Duke University, Durha m, NC 27708, U SA National Bureau of Economic Research, Ca mbridge, MA 02912, U SA

Fuqua School of Business, Duke University, Durha m, NC 27708, U SA National Bureau of Economic Research, Ca mbridge, MA 02912, U SA

Campbell R. Harvey

August 2012

We test whether top financial executives are miscalibrated using a unique 10-year panel that includes over 13,300 probability distributions of expected stock market returns. We find that executives are severely miscalibrated, producing distributions that are too narrow: realized market returns are within the executives 80% confidence intervals only 36% of the time. We show that the lower bound of the forecast confidence interval is lower during times of high market uncertainty; however, ex-post miscalibration is worst during these episodes. We also find that executives who are miscalibrated about the stock market show similar miscalibration regarding prospects. Finally, firms with miscalibrated executives appear to follow more aggressive corporate policies: investing more and using more debt financing.

_________________________ We appreciate the detailed comments of Larry Katz and five anonymous referees. We also thank Hengjie Ai, Nick Barberis, Jim Bettman, Jack Bao, Audra Boone, George Constantinides, Werner DeBondt, Hui Chen, Simon Gervais, Michael Gofman, Markus Glaser, Dirk Hackbarth, Daniel Kahneman, Ulrike Malmendier, Don Moore, Justin Murfin, Terry Odean, Lubos Pastor, John Payne, Michael Roberts, Aner Sela, Hersh Shefrin, Doug Skinner, Jack Soll, Richard Thaler, Ivo Welch,...