How overconfidence affects your firm’s fortunes

Research shows that the more confident a CEO is, the less likely they are to react to feedback about their business’s success.

by Lauren Brown
Last Updated: 06 Mar 2020

Everyone’s met someone who seems unphased by anything, even at times when the signs suggest that maybe they should be. 

Perhaps it’s an imperviousness to what other people think, or an enviable self-assurance, but whatever it is they remain stolid in their outlook whatever the weather. 

Research has revealed that this disposition has a significant boardroom impact. A recent study by the Strategic Management Society found that overconfident CEOs were likely to interpret feedback about the success of their current business strategy - good or bad - more optimistically. 

This, in turn, “causes them to exhibit a less pronounced reaction to both positive or negative performance feedback”, and directly affects how they respond to risk, researchers Christian Schumacher, Steffen Keck and Wenjie Tang found.

A sample of 847 American manufacturing firms, operating between 1992 and 2014, were used to test the hypothesis that a company's response to performance feedback fundamentally depends on how key decision makers interpret that information, rather than on an objective evaluation of firm performance.

Using return on assets as the main measure of performance, the researchers deduced CEO overconfidence from their willingness to hold more company equity in the form of stock options than what would have been optimal, “suggesting excessive confidence in their own managerial abilities to achieve a high financial outcome.” 

They found that overconfidence in CEOs was associated with a lower willingness to increase firm risk taking in the case of negative performance feedback and a higher willingness to decrease risk after receiving positive feedback.

“Boards as well as investors need to consider the possibility that when CEOs do not take action in the face of negative financial results, this reaction might frequently be driven more by CEOs prior personal beliefs rather than a purely objective interpretation of the firms' actual strategic situation,” say the researchers. 

It is therefore “crucial that managers are clearly aware of how their interpretations and reactions to feedback are affected by their own deeply held personal beliefs and dispositions.” 

Image credit: Ryan Pierse / Staff via Getty images


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