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Managerial Overconfidence and Credit Rating Agencies Essay (Article)

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Updated: Apr 26th, 2021

Behavioral CEO’s: The role of managerial overconfidence

In the United States, Chief Executive Officers (CEOs) have been observed to portray larger-than-life personalities and images (Malmendier and Tate 37). They have continued to grace news headlines in different parts of the country. Some have even gone further to publish books in an attempt to share their ideas with the rest of the world. Such aspects and achievements explain how the image of such managers is rooted in the concept of self-confidence.

In an attempt to cultivate the best personas, such CEOs have continued to engage in numerous investment decisions. Unfortunately, such decisions have been observed to produce negative results. In the article “Behavioral CEOs: The Role of Managerial Overconfidence”, the authors argue that many Chief Executive Officers (CEOs) have continued to portray symptoms and signs of overconfidence whenever making their business decisions. The authors use various approaches to measure CEO overconfidence. The first one is the CEOs’ “willingness to keep their wealth undiversified by holding stock options until their expiration” (Malmendier and Tate 57).

Some other widely-used measures include survey responses and psychometric tests. The article defines overconfidence as the belief that the price of a company is higher than it might be. External mergers and internal investments can therefore be used to track the available cash held by different firms. The article indicates that CEO overconfidence is also noticeable when “these leaders rely less on external equity-based finance or paying less in dividends” (Malmendier and Tate 57).

Some CEOs will also force their firms to pursue various innovative strategies. More often than not, CEOs have been working hard to pursue their personal goals and benefits. At the same time, claim holders and shareholders expect such CEOs to be aware of their interests. Evidence has also shown conclusively that many managers focus on the best approaches to maximize shareholder-value (Malmendier and Tate 58). However, such leaders might fail to increase claim holder value because they have overconfident notions or beliefs. The fact that CEO overconfidence has become a major problem is something that calls for new corporate governance strategies. The article argues that firms should provide equity-linked compensations. However, such measures might be ineffective towards affecting the choices and options made by different overconfident managers.

New measures will also be needed to ensure there is active monitoring of different firms (Hart 29). The relevant authorities monitoring the performance and behaviors of different CEOs should also remain rational to address every issue affecting their respective corporations. Recent works and studies have presented new approaches through which effective governance can be used to minimize managerial overconfidence and bias (Malmendier and Tate 57).

However, the authors show clearly that the current literature is not adequate regarding the role of effective governance towards mitigating such biases. Evidence has also shown conclusively that overconfidence is a major behavioral bias that affects the outcomes and choices of agents who are subject to CEOs (Malmendier and Tate 57). This overconfidence also affects many agents who contract, interact and transact in the marketplace (Hart 73).

This article, therefore, explains why proper managerial strategies are needed to tame the goals and objectives of these CEOs. Such leaders should be monitored in an attempt to pursue specific goals that have the potential to add value to the targeted shareholders and claim holders (Dempsey 129). By so doing, the targeted companies will realize their potentials and remain profitable.

Markets: The Credit Rating Agencies

The article “Markets: The Credit Rating Agencies” explores the role and future of credit rating agencies. By the year 2000, the issuers of securities only turned to the three leading credit-rating agencies. Such agencies were critical towards providing the required ratings (White 211).

These agencies included Fitch, Standard and Poor’s (S&P), and Moody’s. However, the existence of financial regulatory measures continued to force these credit rating agencies to make serious mistakes. Such mistakes would eventually result in negative consequences in the global financial sector. Since the year 2000, many financial regulators have been outsourcing their ideas and judgments from these credit rating agencies. The bond creditworthiness information used by financial institutions was provided by the major rating agencies” (White 212).

As well, the interaction between these agencies and regulatory authorities became a new barrier. Consequently, this association contributed a lot to “the subprime mortgage debacle and the subsequent financial crisis” (White 212). During the same period, the leading credit rating agencies chose “to shift their business models from investor pays to issuer pays” (White 212). These issues show clearly that government regulations and strategic behaviors can have numerous impacts on different markets. This issue forces governments and regulatory agencies to consider the best public policies regarding the effectiveness of the credit-rating industry (White 212).

The first route suggested by the author is tightening the regulation of these credit-rating firms or agencies. The other appropriate route is reducing the centrality of these agencies. By so doing, the bond information procedure will be opened therefore minimizing chances of downturns or financial crises (Mattarocci 62). Financial regulators should be on the frontline to achieve their business goals. This approach will ensure there are safety judgments regarding the effectiveness of bond information.

This should remain the responsibility of recognized and regulated financial institutions. At the same time, there should be an oversight by authorized regulators to address various mistakes committed by different credit rating companies. This new approach to public policy will make it easier for “many financial institutions and banks to make numerous choices whenever getting advice regarding the safety of bonds that they might hold in their portfolios” (White 219).

This public policy will make it easier for financial institutions to make the most desirable researches on specific bonds. At the same time, they can rely on available information in the credit market. This policy will also make it easier for many companies to get relevant information from outside advisers. The information can also be obtained from fixed-income advisers or analysts. Such analysts can be obtained from investment institutions or advisory agencies that might be unknown to many players in the industry. The article goes further to explain why “regulators should continue monitoring and overseeing the safety of every institution’s bond portfolio” (White 220).

These suggestions show clearly that the bond information sector will be characterized by new concepts and ideas in the future. The current technological changes and business models will ensure the bond information industry is revolutionized (White 221). The author also anticipates that the issuer-pays model might survive in the future. Bond managers in different banks and financial firms should have the required market sophistication to hire qualified advisors (Darbellay 83). This approach will minimize most of the mistakes and consequences that have been encountered in the past few years.

Works Cited

Darbellay, Aline. Regulating Credit Rating Agencies. Northampton, MA: Edward Elgar, 2013. Print.

Dempsey, Michael. Stock Markets, Investments and Corporate Behavior. New York, NY: World Scientific, 2014. Print.

Hart, Roderick. Communication and Language Analysis in the Corporate World. Hersey, PA: IGI Global, 2012. Print.

Malmendier, Ulrike and Geoffrey Tate. “Behavioral CEOs: The Role of Managerial Overconfidence.” Journal of Economic Perspectives 29.4 (2015): 37-60. Print.

Mattarocci, Gianluca. The Independence of Credit Rating Agencies. New York, NY: Elsevier, 2013. Print.

White, Lawrence. “Markets: The Credit Rating Agencies.” Journal of Economic Perspectives 24.2 (2010): 211-226. Print.

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IvyPanda. (2021, April 26). Managerial Overconfidence and Credit Rating Agencies. Retrieved from https://ivypanda.com/essays/managerial-overconfidence-and-credit-rating-agencies/

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"Managerial Overconfidence and Credit Rating Agencies." IvyPanda, 26 Apr. 2021, ivypanda.com/essays/managerial-overconfidence-and-credit-rating-agencies/.

1. IvyPanda. "Managerial Overconfidence and Credit Rating Agencies." April 26, 2021. https://ivypanda.com/essays/managerial-overconfidence-and-credit-rating-agencies/.


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IvyPanda. "Managerial Overconfidence and Credit Rating Agencies." April 26, 2021. https://ivypanda.com/essays/managerial-overconfidence-and-credit-rating-agencies/.

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IvyPanda. 2021. "Managerial Overconfidence and Credit Rating Agencies." April 26, 2021. https://ivypanda.com/essays/managerial-overconfidence-and-credit-rating-agencies/.

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IvyPanda. (2021) 'Managerial Overconfidence and Credit Rating Agencies'. 26 April.

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