According to their study, an overconfident CEO can either help or hinder a firm’s turnaround performance depending on whether the overconfident CEO is the incumbent who steered the organisation into dire straits or a successor hired during the decline.
As the chief decision-makers of their companies, CEOs have persistently been shown to have a substantial influence on their firms’ trajectories. This means achieving certain outcomes for the organisation is—to an extent—reliant on a CEO’s personal dispositions, how they perceive and interpret the task at hand, and how they make strategic decisions, the researchers explain.
They define overconfidence as the systematic overestimation of personal abilities and the underestimation of uncertain, negative outcomes. Prior research suggests CEOs who exhibit this bias can be linked to negative outcomes for firms, such as investment distortion, inflated acquisition premiums, or exaggerated earnings forecasts.
“However, there is a puzzling mismatch in the theory and research into CEO overconfidence, acknowledging that many firms place CEOs with an inflated view of their own capabilities at their helm while documenting the various adverse effects of this type of behaviour on organisations,” says Kowalzick.
The group of researchers were particularly interested in how CEO overconfidence factors into company performance during turnaround situations, defined by them as a substantial crisis of a firm that used to perform satisfactorily, specifically in terms of profitability, but no longer does.
To investigate whether CEO overconfidence results in negative or positive impacts on firms going through the turnaround process, they analysed data on firms’ performance and CEO overconfidence at 240 companies in the S&P 1500 index during the fiscal years 1992-2016.
Their findings show that CEOs with an exaggerated self-confidence can be beneficial to a company’s turnaround performance if they are the successor brought in to right the ship. However, if overconfidence characterizes the incumbent CEO who drove the company onto the rocks in the first place, this same conviction is likely to only make performance worse.
“Turning a firm around is an arcane managerial art, sometimes even considered ‘black magic,’ because even small deviations from the path to restore organisational health can lead to certain failure,” says Ahrens.
Overconfident CEOs might hurt turnaround performance by ignoring opposition to their current strategic orientation or by attempting to ride out organisational decline. On the other hand, they might help turnaround performance by formulating bold visions for organisational recovery that reassure stakeholders and invigorate employees in a context that rewards vigorous decision-making, the researchers explain.
By showing that overconfidence in an incumbent is harmful in turnaround situations whereas in a successor it is a favourable fit for such circumstances, the researchers highlight that there is more to CEO replacement than a conventional readjustment of CEO attributes to counteract current challenges.
Specifically, because the very same attribute can play out differently between incumbent and successor CEOs, CEO turnover appears to shape how certain behaviours and attitudes will translate into organisational outcomes.
Considering that the attributes of newly onboarded CEOs often resemble those of their predecessors, unless circumstances call for change, this challenges prior studies on CEO turnover by showing that installing a new CEO with similar attitudes to their precursor may be fruitful at times.
The researchers offer several suggestions for companies going through turnaround situations. They find that hiring an overconfident successor can be a wise decision, as it seems to evoke positive reactions from stakeholders.
“Yet, while such ‘good overconfidence’ might carry an organisation far when an overconfident CEO’s targets are met, increased board vigilance seems to be necessary when they are not, as the CEO’s bias makes them especially prone to misperceiving their own failure,” says Lauterbach.
According to the researchers, it might be possible to discern the dawn of this ‘bad overconfidence’. When a firm is aware of their CEO’s overconfidence, which is increasingly assessed upon them taking the position, early crisis indications already deserve vigilant oversight. For instance, assigning an active chairman over the CEO can be a prescription for early crises, in case the board chooses not to look for a replacement, they explain.
The study also provides important findings for future research on the topic. Notably, accounting- and market-based measures of firm performance seem to react differently to the two main ways of measuring CEO overconfidence in prior literature.
The first measure is the option-based approach, based on the idea that in order to minimise exposure of their personal wealth to the performance of their firm, the average, unbiased CEOs should exercise in-the-money stock options for their firm in a timely manner.
However, an over-abundance of self-belief should lead some CEOs to continuously hold options that are deep in the money, in the conviction that their company is undervalued given their superior ability to improve firm value. This type of analysis yields significant and robust findings exclusively on accounting-based performance, the researchers say.
The press portrayal of CEOs is the other key measure of overconfidence, associated with analysing market-based performance. Data can be gathered, for instance, by studying how many times terms like ‘confident’, ‘confidence’, or ‘optimistic’, are used in the business press to describe a CEO.
The researchers explain this type of assessment can run into obstacles because CEOs often carefully manage their impression with the media to create a thoughtfully constructed professional image. Therefore, a CEO’s press image might sometimes be a misleading façade that does not reliably get reflected in their accounting-based performance.
Nevertheless, the researchers find that the market’s impression of firm value is driven more by press impressions and less by the CEO’s track record of option-exercising behaviour. For this reason, they advise future researchers to carefully align the ways they are measuring firm performance and CEO overconfidence depending on their research question.