Overconfident Banks and Firm Innovations

We find that banks with overconfident CEOs (overconfident banks) have greater risk tolerance and lend more frequently to high-risk firms. However, overconfident banks also charge higher loan spreads to compensate for taking such risks. Moreover, overconfident banks prefer lending to high-risk firms with more innovative activities. After obtaining loans from overconfident banks, these firms undertake more R&D activities compared to other borrowers and they attain higher innovation outputs and market valuation than others. Overall, our findings indicate that a bright side of overconfident banks is the innovative activities of their borrowers to the benefit of the economy in general.