by Christian Basi, University of Missouri
July 10, 2013 (TSR) – CEOs need to demonstrate strong leadership and good decision-making skills, but CEOs with over-confidence and bloated Egos can involve their companies in riskier ventures and put investors’ funds at risk, according to a new study.
“Over-confident CEOs feel they have superior decision-making abilities and are more capable than their peers,” says Stephen Ferris, professor of finance at the University of Missouri.
“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.”
They often use cash to purchase or merge with other businesses, Ferris says, because they believe their stock is undervalued. But such action can deplete a company of important resources and leave it vulnerable to financial problems.
“In our study, we focused on mergers and acquisitions because those actions can involve millions and billions of dollars,” Ferris says. “Mergers and acquisitions can either strategically position companies or they can bankrupt them.”
The study is published in the Journal of Financial and Quantitative Analysis.
While over-confident CEOs can be found in companies across the globe, they tend to come from countries with cultures 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 US, France, Germany, and the United Kingdom. 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 says. They “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, new investors should review the financial fundamentals of the company, but also determine the personality of the CEO, Ferris says.
If he or she appears to be over-confident, it’s important that the board of directors is independent. Investors should consider:
- 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?