Companies must walk a fine line when searching for leaders that are confident versus overconfident, new research suggests.
A study from the University of Missouri, Georgia Tech University and the University of Texas-Arlington revealed that CEOs with overconfidence can involve their companies in riskier ventures and put investors' funds at risk.
Stephen Ferris, a University of Missouri professor and one of the study's authors, said overconfident CEOs feel they have superior decision-making abilities and are more capable than their peers.
"Unfortunately, they tend to make decisions about mergers or acquisitions that can be viewed as risky," he said.
As an example, CEOs who are overconfident tend to target companies that do not focus on their core line of business. However, Ferris said that generally speaking, mergers that diversify companies don't work.
"In our study, we focused on mergers and acquisitions 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 overconfident CEOs can be found in companies across the globe, researchers found they tend to come from countries with cultures that emphasize individualistic characteristics, such as the United States, France, Germany and the United Kingdom.
Ferris said overconfident leaders can be a good asset to a company, but investors need to know how to determine whether that is the case.
"Overconfident CEOs tend to be more at ease and successful when launching innovative products or services and breaking through corporate inertia," he said. "No one wants to follow a timid leader; confidence is very contagious and can enhance investor interest and help with innovation."
When deciding to invest in a company, Ferris recommends that investors review the financial fundamentals of the company, as well as determine the personality of the CEO. If the CEO appears to be overconfident, it's important that the board of directors is independent. Specific questions Ferris advises asking include:
- 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 study, co-authored by Narayanan Jayaraman from Georgia Tech University and Sanjiv Sabherwal from the University of Texas-Arlington, was recently published in the Journal of Financial and Quantitative Analysis.