Optimal bank interest margin and shareholder interest conflicts under CEO overconfidence: a constrained option-pricing model

Authors:
Jyh-Horng Lin;Peirchyi Lii;Rosemary Jou
Affiliations:
Graduate Institute of International Business, Tamkang University, Tamsui, Taipei County, Taiwan;College of Management, Asia University, Tamsui, Taipei County, Taiwan;Graduate Institute of Management Sciences, Tamkang University, Tamsui, Taipei County, Taiwan
Venue:
WSEAS Transactions on Information Science and Applications
Year:
2009

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Abstract

Less is known about how equity returns allocated between current and new shareholders are altered to react to chief executive officer (CEO) overconfidence. This paper uses a nonlinear constrained contingent claim methodology of Black and Scholes (1973) and Merton (1974) to explore interest conflicts between current and new shareholders when an overconfident bank CEO overestimates returns on investment projects, and sequentially raises too much in external funds when internal resources become scarce. We show that low levels of bank interest margins or equity returns, which decrease the claims of current shareholders, are associated with investment distortions; but high levels of bank equity returns, which dilute the claims of current shareholders, are associated with external financing distortion.