CEO Overconfidence, Lack of Board Vigilance and Corporate Derivative Hedging Decisions

Abstract

This study investigated the effects of management overconfidence and variables of lack of board vigilance on corporate hedging decisions to hedge financial risk. More specifically, it investigates how level of overconfidence affects firms decision to hedge foreign currency exchange and interest rate derivative exposures. The purpose of the paper is that overconfident managers undervalue risk and tend to use less derivative hedging than lower-confident managers. Weak Board Vigilance cant stop overconfident managers from pursuing their own strategy and thus, Board Directors can not serve well for shareholders interests. The study used a logit regression model to estimate the relationship between CEO overconfidence and hedging decisions for a sample of non-financial companies from S&P 500 firms that use foreign currency exchange risk and interest rate risk exposures. The results show a statistical positive and significant relationship for interest rate derivatives and percentage of insider directors. The results also illustrate that foreign sales ratio and quick ratios are in positive and significant relationship with firm usage of foreign exchange derivatives. Also, results show that long term debt ratio and firms quick ratios are positively, and significantly related to firms usage of interest rate derivatives.