The influence of a CEO’s prior performance on her risk taking: A prospect theory perspective

We investigate how a CEO's prior performance affects her managerial decision making. Controlling for CEO fixed effects and employing reference points, we find that CEOs choose less risky projects after making gains. This result suggests that following good performance, a CEO feels relaxed and prefers to work on safe projects, consistent with an “S”-shaped value function, as posited in prospect theory. The negative relationship between risk and prior performance exists only among CEOs for whom stock-based compensation is not a main component of total compensation. The results suggest overall that CEOs are subject to behavioral biases and that such biases can be mitigated by taking appropriate measures.