Ulrike Malmendier and Geoffrey Tate examine how CEO overconfidence affects corporate investment decisions. They argue that overconfident managers overestimate the returns of their investment projects and view external financing as costly. As a result, they overinvest when they have ample internal funds but reduce investment when they need external financing. Using data on the personal portfolios and corporate investments of 500 U.S. CEOs from 1980 to 1994, they classify CEOs as overconfident if they persistently fail to reduce their exposure to company-specific risk. They find that overconfident CEOs have a higher sensitivity of corporate investment to cash flow, especially in equity-dependent firms. The authors propose an alternative explanation for investment-cash flow sensitivity, focusing on the personal characteristics of CEOs rather than firm-level factors. They argue that overconfident CEOs overestimate the value of their firm and are less likely to issue new equity because they believe their company's stock is undervalued. This leads to reduced investment when internal funds are insufficient. Additional cash flow allows overconfident CEOs to invest closer to their desired level. The study also finds that CEOs with engineering or scientific backgrounds show higher investment-cash flow sensitivity, while those with financial backgrounds show lower sensitivity. Additionally, "depression babies" born in the 1930s and CEOs with multiple roles in their companies show higher sensitivity. These findings suggest that personal characteristics, in addition to firm-level factors, are important in understanding corporate decision-making. The authors also address potential alternative explanations for their findings, such as inside information and signaling. They find that overconfident CEOs do not consistently outperform the market, suggesting that their behavior is not driven by private information. They also find that overconfident CEOs are not more likely to engage in opportunistic insider trading or to delay tax payments. Finally, they find that overconfident CEOs are more likely to conduct acquisitions and do not appear to procrastinate on corporate investments. The study concludes that overconfidence can lead to investment distortions, and that corporate governance structures may need to be strengthened to mitigate these effects. The findings suggest that traditional theories linking investment-cash flow sensitivity to capital market imperfections or misaligned incentives may not be sufficient to address managerial discretion.Ulrike Malmendier and Geoffrey Tate examine how CEO overconfidence affects corporate investment decisions. They argue that overconfident managers overestimate the returns of their investment projects and view external financing as costly. As a result, they overinvest when they have ample internal funds but reduce investment when they need external financing. Using data on the personal portfolios and corporate investments of 500 U.S. CEOs from 1980 to 1994, they classify CEOs as overconfident if they persistently fail to reduce their exposure to company-specific risk. They find that overconfident CEOs have a higher sensitivity of corporate investment to cash flow, especially in equity-dependent firms. The authors propose an alternative explanation for investment-cash flow sensitivity, focusing on the personal characteristics of CEOs rather than firm-level factors. They argue that overconfident CEOs overestimate the value of their firm and are less likely to issue new equity because they believe their company's stock is undervalued. This leads to reduced investment when internal funds are insufficient. Additional cash flow allows overconfident CEOs to invest closer to their desired level. The study also finds that CEOs with engineering or scientific backgrounds show higher investment-cash flow sensitivity, while those with financial backgrounds show lower sensitivity. Additionally, "depression babies" born in the 1930s and CEOs with multiple roles in their companies show higher sensitivity. These findings suggest that personal characteristics, in addition to firm-level factors, are important in understanding corporate decision-making. The authors also address potential alternative explanations for their findings, such as inside information and signaling. They find that overconfident CEOs do not consistently outperform the market, suggesting that their behavior is not driven by private information. They also find that overconfident CEOs are not more likely to engage in opportunistic insider trading or to delay tax payments. Finally, they find that overconfident CEOs are more likely to conduct acquisitions and do not appear to procrastinate on corporate investments. The study concludes that overconfidence can lead to investment distortions, and that corporate governance structures may need to be strengthened to mitigate these effects. The findings suggest that traditional theories linking investment-cash flow sensitivity to capital market imperfections or misaligned incentives may not be sufficient to address managerial discretion.