Are CEOs Expected Utility Maximizers?
Are individuals expected utility maximizers? This question represents much more than academic curiosity. In a normative sense, at stake are the fundamental underpinnings of the bulk of the last half-century's models of choice under uncertainty. From a positive perspective, the ubiquitous use of benefit-cost analysis across government agencies renders the expected utility maximization paradigm literally the only game in town. In this study, we advance the literature by exploring CEO's preferences over small probability, high loss lotteries. Using undergraduate students as our experimental control group, we find that both our CEO and student subject pools exhibit frequent and large departures from expected utility theory. In addition, as the extreme payoffs become more likely CEOs exhibit greater aversion to risk. Our results suggest that use of the expected utility paradigm in decision making substantially underestimates society's willingness to pay to reduce risk in small probability, high loss events.
Thanks to Colin Camerer, Glenn Harrison, Kerry Smith, Chris Starmer, Robert Sugden, David Zilberman, and two referees for supplying comments. We thank Kenneth Train for supplying the GAUSS program with which we conducted our empirical estimation. An earlier version of this paper was presented at the World Conference for Environmental and Natural Resource Economists and the Southern Economic Association Meetings. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.
List, John A. & Mason, Charles F., 2011. "Are CEOs expected utility maximizers?," Journal of Econometrics, Elsevier, vol. 162(1), pages 114-123, May. citation courtesy of