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A Model of Managerial Overconfidence, Moral Hazard and Corporate Investments

The paper studies the impact of managerial overconfidence on corporate investments under the moral hazard framework. By assuming a fully competitive and information-transparent capital market as well as rational investors, the study finds that managerial overconfidence reduces moral hazard, but may result in over- or under-investments; the relationship between managerial overconfidence and inefficient investment probability is non-monotonic; managerial overconfidence is positively related to investment-cash flow sensitivity. The paper also analyses the roles of supervision and incentives in preventing inefficient investments by overconfident managers.