Faculty Rock Stars

Ulrike Malmendier

Homo Economicus MythBuster

Winner of the prestigious Fischer Black Prize for the Top Finance Scholar under 40, Ulrike Malmendier is carving out her own place in Berkeley’s rich history as a pioneer in behavioral economics.

By Ed Andrews

Ulrike Malmendier is a scholar on the economics of arrogance, among her many other accomplishments.

She doesn’t put it that harshly, and she doesn’t gloat in her findings. But over the past decade, she has produced a sweeping body of research on how over-confidence and other deeply rooted character traits underpin and often undermine “rational” business decisions.

In a series of path-breaking papers, Malmendier and her colleagues have mapped the characteristics and pitfalls of hubris at all levels: the remarkably subpar results of “superstar” CEOs; the overzealous bidders on e-Bay who pay more at auctions than they would in stores; and even the overly ambitious exercise enthusiasts whose optimism is exploited by fitness centers.

This is all part of behavioral economics, the study of how emotional biases and character traits affect economic decision-making. It’s a field in which Berkeley scholars have long been pioneers, starting with Nobel laureates George Akerlof and Daniel Kahneman and carrying on with Haas Professor Terry Odean.

“This is the birthplace of behavioral finance; Berkeley invented it,” says Malmendier, who is hoping to start fundraising soon for a proposed behavioral science research center that would build on that rich history.

Malmendier is at the vanguard of a new generation of researchers. Where previous generations often focused on the biases of individual investors and consumers in and of themselves, Malmendier looks at how those biases affect corporate decisions, stock prices, and markets in general.

“Biases don’t only affect decision-making by small investors and consumers; they also affect top business leaders,” Malmendier says. “Biases also are embedded in markets and consequently are relevant in explaining corporate outcomes.

No Respect

Until recently, behavioral economics didn’t get much respect, because classical economic and financial models essentially assume that people pursue their rational self-interest. The Great Financial Crisis, which revealed rampant self-destruction at every level of the financial system, jolted that complacency.

Malmendier likes to quote Warren Buffett, who once remarked, “I’d be a bum on the street with a tin cup if the markets were efficient.”

Overconfident chief executives aren’t necessarily braggarts or crooks. Malmendier studied business leaders who sincerely believed in their outsized abilities. These were the bold thinkers, the risk-takers, and the charismatic leaders.

“We need to dispel the notion that we were all born as Homo economicus. Past experience makes us into different people.”

One of Malmendier’s big contributions to the field was to identify reliable indicators of hubris. One tell-tale sign, she discovered, was an executive’s insistence on putting their own personal wealth on the line. Over-confident executives are reluctant to cash out stock options in the companies they run. They also tend to believe that the market is undervaluing their companies, so they don’t like to issue new shares.

That may sound like a reassuring sign of the CEOs’ commitment—and it is in the sense that these CEOs are putting their money where their mouth is and truly believe in their companies. But CEOs who overinvest in their own companies are also more likely to plunge into ill-starred mergers and overestimate the returns on their investment projects. Their companies are more likely to lag behind the competition, especially if the CEO has become a media celebrity.

Surprisingly, investors seem to understand this on an intuitive level. Malmendier and her longtime collaborator, Geoffrey Tate at the University of North Carolina, found that investors reacted significantly more negatively to merger announcements from companies with overconfident executives than to deals announced by more subdued leaders.

Celebrity CEOs

In another eye-popping study, Malmendier and Tate documented the special pitfalls of “superstar” CEOs who become celebrities. These are the executives who get lionized on the covers of glossy magazines and who win accolades such as “CEO of the Year” or “Innovator of the Year.” Among that study’s findings:

  • Chief executives who receive major awards tend to underperform their noncelebrity peers by as much as 26 percent over the three years after the award is bestowed.
  • Despite their slumping performance, superstar executives receive outsized increases in their compensation in the three years after they get big awards. That’s especially true at companies with weak governing boards.
  • Superstar celebrity executives are more likely to engage in more “earnings management,” or accounting maneuvers aimed at smoothing out a company’s reported earnings.

Malmendier’s work has attracted widespread attention. In 2013, she received the American Finance Association’s prestigious Fischer Black Award, which honors the top finance scholar under the age of 40. Her research has been cited in more than 6,000 other papers since 2009, according to Google Scholar. Her original paper on overconfident CEOs has been cited more than 1,300 times alone.

But the overconfidence of CEOs is a small part of Malmendier’s prolific research. She has closely analyzed the long-term impact on behavior of growing up during the Great Depression. She has found that people with military combat experience are much more willing to take risks.

In a study on the sources of entrepreneurial motivation, she and Josh Lerner of Harvard Business School made the startling discovery that close acquaintance with entrepreneurs does not motivate people to become entrepreneurs themselves.

In that study, the researchers studied the records of nearly 6,000 students at Harvard Business School. It turned out that students who had a high proportion of current or former entrepreneurs as section-mates were actually less likely to launch startups themselves. The reason? Most startup companies don’t succeed, which meant that most of the classmates with entrepreneurial backgrounds had discouraging experiences. Instead of inspiring false confidence, many of those classmates were better positioned to see the flaws in new business ideas and help prevent ill-fated start-ups, while encouraging the most promising ideas.

Workout Weaknesses

Malmendier has also collaborated frequently with her husband, Stefano DellaVigna, a professor in Berkeley’s Department of Economics. The two met while working on their doctorates at Harvard. DellaVigna is also a specialist in behavioral economics, but his focus is more on the role of the media and political economy rather than on corporate decision-making.

One of their collaborations was on the study of fitness centers, which found that gyms induce people to overpay for monthly memberships that they often use very little.

In another collaboration, the husband-wife team analyzed the motivations of generosity. Based on field experiments using door-to-door solicitations by charitable groups, the researchers found that social pressure is often more important than the pleasures of altruism. People who were told in advance that a fund- raiser would be coming at a particular time were less likely to be home or to open the door. The team also found differences between men and women. Women became less generous if they had a chance to avoid meeting a fundraiser in person, suggesting that they might feel social pressure more strongly than men.

“Ulrike is great to work with,’’ DellaVigna says. “She really enjoys what she’s doing, and she’s a very creative researcher. She’s a very interactive person, and likes to engage with people about ideas. She’s a really good at listening to other people’s ideas and coming up with her own insights.”

Law and Order

Malmendier’s prolific academic effort goes back a long way. Born and raised in Germany, she earned a PhD in law at the University of Bonn in 2000 and is an expert on ancient Roman law. To this day, in fact, she writes academic articles on Roman law.

But by the time she earned her doctorate in law, she had also earned a master’s degree in economics. Forced to choose between two very different disciplines, she chose economics and earned a PhD from Harvard in 2002.

“In economics, part of the job is to think about designing better institutions, contracts, and other determinants of human behavior, while in law the main job is to take the given set of legal rules and case decisions and work a case through them such that we get to the right answer. Thinking about ‘what would be a better system’ is not part of the job—at least in the civil law system,” Malmendier says, explaining why she ultimately chose economics.

“I also like the international aspect of economics; with law you are pretty home-bound,” she adds. “And I have an affinity for mathematics, which was much better served in economics.”

After a teaching stint at Stanford and visiting positions at Princeton and the University of Chicago, she arrived at Berkeley in 2006 with an appointment in the Department of Economics, which was expanded into a joint appointment with Haas in 2010.

Her pace shows no signs of slowing down. The intricacies of economics in the messy real world, where economic decisions are influenced by childhood experiences, emotional impulses, and obscure longings, continue to fascinate her.

“We need to dispel the notion that we were all born as Homo economicus,” she says. “If you were born during the Depression, you are going to want to avoid the ups and downs of the stock market. If you grew up with inflation, you tend to over-expect future inflation and have higher debt levels. Past experience makes us into different people.”

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Professor Ulrike Malmendier


Prize-Winning Research
One major testament to the intellectual vigor, creativity, and originality of Prof. Ulrike Malmendier’s research is the Fischer Black Prize that she was awarded last year by the American Finance Association. The biennial award honors the top finance scholar under the age of 40 years old and is modeled after the Fields Medal in mathematics and the Clark Medal in economics.

Behavior and Biases
Here’s a quick look at the wide-ranging research and findings of behavioral economist Ulrike Malmendier.




Celebrity CEOs


CEOs who are featured on glossy magazine covers and win accolades such as “CEO of the year” tend to underperform noncelebrity peers at least in the three years after the award is bestowed, but they receive outsized compensation increases during that same period. Superstar executives are also more likely to engage in accounting maneuvers aimed at smoothing out reported earnings.




Gender and Generosity


When facing door-to-door solicitors, women and men were about equally generous—but women became less generous if they had a chance to avoid meeting a solicitor directly. People who were told in advance that a fundraiser would be coming at a particular time were less likely to be home or to open the door.




Entrepreneurial Influence


Close acquaintance with entrepreneurs does not motivate people to become entrepreneurs themselves, based on analysis of nearly 6,000 business school student records. Students with a high proportion of current or former entrepreneurs as section-mates were less likely to launch startups themselves because those classmates helped weed out bad ideas and encouraged only the most promising ones.




Fitness Fictions


Gyms induce people to overpay for monthly memberships that they often use very little, based on a study of almost 8,000 health club members over three years. Members who choose a contract with a flat monthly fee of more than $70 average 4.3 visits per month, paying more than $17 per visit when they could pay $10 using a 10-visit pass.