Over-confident CEOs can put companies at risk, research shows

July 9, 2013

CEOs need to demonstrate strong leadership and good decision-making skills, but CEOs with over-confidence can involve their companies in riskier ventures and put investors' funds at risk, according to a new study from the University of Missouri, Georgia Tech University and the University of Texas-Arlington.

"Over-confident CEOs feel they have superior decision-making abilities and are more capable than their ," said Stephen Ferris, professor of finance in the MU Trulaske College of Business. "Unfortunately, they tend to make decisions about mergers or acquisitions that can be viewed as risky. For example, CEOs who are over-confident tend to target companies that do not focus on their core line of business. Generally speaking, mergers that diversify companies don't work."

Ferris also found that CEOs who are over-confident often use cash to purchase or merge with other businesses. Over-confident CEOs do this because they believe their stock is undervalued, but Ferris is concerned that this action can deplete a company of important resources and leave it vulnerable to financial problems.

"In our study, we focused on because those actions can involve millions and billions of dollars," Ferris said. "Mergers and acquisitions can either strategically position companies or they can bankrupt them."

While over-confident CEOs can be found in companies across the globe, Ferris and his colleagues found that over-confident CEOs tend to come from countries with that emphasize individualistic characteristics compared to CEOs who are from countries that have cultures emphasizing "long-term orientation" or success through more conservative financial actions. Cultures that emphasize individual characteristics can be found in the U.S., France, Germany and the United Kingdom, while cultures that emphasize more "long-term orientation" can be found in Japan, Brazil and Mexico.

"An over-confident CEO can be a good asset to a company, but investors need to know how to determine if that is the case," Ferris said. "Over-confident CEOs tend to be more at ease and successful when launching innovative products or services and breaking through corporate inertia. No one wants to follow a timid leader; confidence is very contagious and can enhance investor interest and help with innovation. Confidence can create many positive actions for a company."

When deciding to invest in a company, Ferris recommends that new investors should review the financial fundamentals of the company, but also determine the personality of the CEO. If the CEO appears to be over-confident, it's important that the board of directors is independent. Ferris says investors should ask questions such as:

  • Who is looking over the CEO's shoulder and determining if decisions are being made too fast?
  • Is the board asking good questions before major decisions are made?
  • Does the CEO follow the board's direction or make decisions without any consultation with board members?

The answers to those questions should help investors determine if they are interested in buying the 's stock, Ferris said.

Ferris, who also is the senior associate dean for Graduate Studies and Research for the college, and his co-authors, Narayanan Jayaraman from Georgia Tech University and Sanjiv Sabherwal from the University of Texas-Arlington, published the study, "CEO Overconfidence and International Merger and Acquisition Activity," in the Journal of Financial and Quantitative Analysis.

Explore further: CEOs reap financial benefits from mergers regardless of stock performance

Related Stories

Study links personal, corporate risk-taking

August 10, 2011

(PhysOrg.com) -- A CEO who enjoys the adrenaline rush of flying a private airplane is more likely than other chief executives to exhibit similarly bold management characteristics, according to a new study by finance professors ...

Corporate hoarding of cash has roots in CEO's past

June 4, 2013

(Phys.org) —As some U.S. corporations rankle investors by holding unprecedented levels of cash, research from the University of Michigan indicates that the CEO's prior job experience could have something to do with it.

Recommended for you

Early human diet explains our eating habits

August 31, 2015

Much attention is being given to what people ate in the distant past as a guide to what we should eat today. Advocates of the claimed palaeodiet recommend that we should avoid carbohydrates and load our plates with red meat ...

Just how good (or bad) is the fossil record of dinosaurs?

August 28, 2015

Everyone is excited by discoveries of new dinosaurs – or indeed any new fossil species. But a key question for palaeontologists is 'just how good is the fossil record?' Do we know fifty per cent of the species of dinosaurs ...

0 comments

Please sign in to add a comment. Registration is free, and takes less than a minute. Read more

Click here to reset your password.
Sign in to get notified via email when new comments are made.