Cash holding is on average more valuable when firms are managed by overconfident CEOs. Economically, having an overconfident CEO on board is associated with an increase of $0.28 in the value of $1.00 cash holding. The positive effect of CEO overconfidence on the value of cash concentrates among firms that are more likely to suffer from the underinvestment problem (i.e., financially constrained firms which exhibit high growth opportunities). In addition, CEO overconfidence affects negatively the value of cash in firms that are financially unconstrained, a finding which is consistent with the overinvestment hypothesis. The results are robust to various tests and alternative explanations.

This study presents a theoretical model that links chief executive officer (CEO) overconfidence to the value loss of corporate diversification. Consistent with the model's prediction, the findings show that diversified firms run by overconfident CEOs experience value loss compared to diversified firms run by their rational counterparts. Empirically, the value loss is economically significant and ranges between 12.5% and 14.1%. In addition, the model predicts heightened corporate refocusing activity by overconfident CEOs who pursued diversified investments in the past once realized returns fail to match initial expectations. The empirical odds of corporate refocusing decisions are 67% to 98% higher when past diversifications are undertaken by overconfident rather than rational CEOs. Another prediction of the model is that overconfident CEOs exhibit preference for diversified investments, especially in the presence of ample internal funds. This prediction is also strongly supported by the data. Overall, this study proposes CEO overconfidence as a unified and consistent explanation of why firms pursue value-destructive corporate diversification policies and later adopt refocusing policies aiming to restore value.