Overconfident CEOs are more likely to get sued

August 29, 2018

Chief executives with big public personae ooze confidence. They are widely celebrated as innovative, forward-thinking, and value-creating, willing to take risks and make unconventional decisions. But what if they are too confident?

Researchers from Stevens Institute of Technology and colleagues show that overconfidence has a flip side: overconfident CEOs are 33 percent 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 future risk-taking behavior.

"Shareholders are not powerless," says Suman Banerjee, professor at Stevens School of Business who led the work. "Their legal actions do make a difference in company operations and help the company better adhere to business regulations and laws."

In their work, published in the Aug. 29 issue of the Journal of Financial and Quantitative Analysis, Banerjee and his team 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.

In theory, Banerjee explains, 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," says Banerjee.

The finding suggests 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.

"It's indisputable that these sorts of actions lead to shareholder lawsuits," Banerjee says, "whether intentional or unintentional."

Banerjee and his team, including colleagues from the University of Texas-Dallas, University of New South Wales and Nanyang Technological University, 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.

Banerjee's team also looked at companies' legal compliance up to six years before and after passage of the Sarbanes-Oxley Act, a landmark 2002 securities law that required more diverse and independent board directors, nomination committees and auditors for companies; it also required that CEOs sign off, for the first time, on company results,

Overconfident CEOs worked to comply with the legislation if they were not already compliant.

When the team investigated whether new CEOs inheriting companies from very confident CEOs, 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 behaviors.

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


Stevens Institute of Technology

Related Confidence Articles from Brightsurf:

Just hours of training triples doctor confidence in use of handheld ultrasound devices
Filling a training gap, a Penn Medicine doctor created a geriatric medicine-centered course for point-of-care-ultrasound (POCUS) devices that doubled doctor confidence.

Sensational COVID-19 communication erodes confidence in science
Scientists, policymakers and the media should acknowledge inherent uncertainties in epidemiological models projecting the spread of COVID-19 and avoid ''catastrophizing'' worst-case scenarios, according to new research from Cornell University.

Confidence in the authorities' handling of COVID-19 provides good mental health
How did you react in March, when the country went into lock-down due to the coronavirus?

Classes set by ability are hitting children's self-confidence, study finds
The way a vast amount of schools are setup, with classes grouping children based on their ability, is severely affecting pupil's self-confidence.

Support plan boosts confidence of military spouses
A support program that aims to boost retention in the Armed Forces has received a positive research evaluation from Anglia Ruskin University (ARU), with military personnel reporting increased confidence in their employment prospects and increased goodwill towards the Armed Forces.

Self-care linked to greater confidence in parents of children with FASD
Children diagnosed with fetal alcohol spectrum disorders (FASD) -- caused by prenatal alcohol exposure -- often face lifelong developmental, cognitive and behavioral problems.

Study: lack of tolerance, institutional confidence threaten democracies
The stability of democracies worldwide could be vulnerable if certain cultural values continue to decline, according to a new study published in Nature Human Behavior.

Reflecting on photos helps young cancer survivors regain confidence
Young cancer survivors face unique medical and psychosocial challenges that can hinder their ability to move on mentally and socially, even years after their final treatment.

Growth mindset intervention boosts confidence, persistence in entrepreneurship students
A low-cost intervention aimed at fostering a growth mindset in students gave the students more confidence in their entrepreneurship abilities and helped them persist when challenges arose.

Facebook can help college students with lower confidence build relationships
Facebook can help first-semester college students maintain relationships with high school friends and assist them in creating new friendships, according to new research from Binghamton University, State University of New York.

Read More: Confidence News and Confidence Current Events
Brightsurf.com is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com.