A Cognitive Perspective of Real Options Investment: CEO Overconfidence



While real options theory has been applied with the rationality assumption, actual real options investments are made by managers, who are often subjective to cognitive biases, especially under uncertainty. In this paper, we focus on one important type of cognitive bias, overconfidence, to provide new insights on real options literature. We argue that overconfident CEOs will invest less in real options than non-overconfident CEOs. We also predict that the relationship between overconfident CEOs and firms’ real options intensity will be strengthened when market uncertainty is higher. In a study of U.S. public firms, we find strong support across various tests that use multiple measures of overconfidence in CEOs and real options intensity, and control for potential selection issues and other endogeneity concerns.