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Overconfident CEOs more likely to get fired

Study finds that overconfident CEOs are 33 per cent more likely to get sued by shareholders than CEOs with normal confidence.

Washington DC: Can being overconfident be a reason behind someone's failure? Chief executives with big public persona ooze confidence. They are widely known for their innovation, forward-thinking, and value-creation, willing to take risks and make unconventional decisions. But what if they are way too confident?

According to a new study, researchers revealed that overconfidence has a flip side.

Researchers from Stevens Institute of Technology found that overconfident CEOs are 33 per cent more likely to get sued by shareholders than CEOs with normal confidence. However, that legal action is enough to shock their system, lower confidence and curb the future risk-taking behaviour.

"Shareholders are not powerless, their legal actions do make a difference in company operations and help the company better adhere to business regulations and laws," said researcher Suman Banerjee.

The researchers analyzed leadership rosters of 1,500 leading global companies and a Stanford dataset tracking nearly 1,400 shareholder-initiated class-action lawsuits against firms over the 16-year period from 1996 to 2012.

The team then assigned confidence scores to executives largely depending on what portions of their own companies' stock options they have retained or divested after vesting. Half of the team's total sample scored as overconfident by these measures.

Banerjee explained smart CEOs diversify investments; they would theoretically divest their own company's shares as soon as possible and invest in something different as a hedge against the unknown.

Sometimes CEOs don't do that, "They hold onto their own shares, even when they are underperforming in the market because they believe their own leadership is so superior and innovative that they will soon overcome market forces and gain a higher return anyway," said Banerjee.

The findings suggested that overconfident CEOs are more likely to make overly positive statements about their companies that are not yet supported by facts. For example, they might over-invest in the short term, or postpone the accounting or reporting of losses and other negative information.

Banerjee and team also looked at the number of lawsuits occurring after an initial shareholder-initiated lawsuit against an overconfident CEO.

They not only found that a lawsuit reduces the likelihood that an overconfident CEO is sued again but also in some instances, a shareholder-driven lawsuit reduced a CEO's confidence such that CEOs began taking more prudent actions with their own companies' stock options over time.

When the team investigated whether new CEOs inheriting companies from very confident CEOs react the same way, they found that the new CEOs learned from the mistakes of the past. That is, newly hired CEOs were less likely to be overconfident, as measured by stock option behaviours.

"It's a dynamic, self-correcting system, if shareholders are willing to use their power to rein in overoptimistic CEO behaviour, CEO performance and compliance, as well as company operations, can improve," said Banerjee.

The study appeared in the Journal of Financial and Quantitative Analysis.

( Source : ANI )
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