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Published on Sep 17, 2013 in Issue 167 - September 2013, Current Issue, Highlights
CEOs need to demonstrate strong leadership and good
decision-making skills, which makes them appear confident. However, according to
a new study in the Journal of Financial and Quantitative Analysis, CEOs
with over-confidence can involve their companies in riskier ventures and
put investors' funds at risk.Published on Sep 17, 2013 in Issue 167 - September 2013, Current Issue, Highlights
For example, CEOs who are over-confident tend to target companies for acquisition that do not focus on their core line of business. Generally speaking, such mergers, which involve diversification, don't work.
Similarly the researchers found that over-confident
CEOs often use cash to purchase or merge with other businesses. Over-confident
CEOs do this because they believe their stock is undervalued, but this action
can deplete a company of important resources and leave it vulnerable to
financial problems.
Despite the risks, the researchers also observe
that an over-confident CEO can be a valuable asset to a company 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.
Therefore, when deciding to invest in a company,
investors need to assess the personality of the CEO. If the CEO appears to be
over-confident, it's important that the board of directors be independent. The
investors should ask questions like:
- 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?
References
Journal of financial and Quantitative,
February 2013, Vol. 48, Iss. 1, "CEO Overconfidence and International Merger and
Acquisition Activity," by Stephen P. Ferris, et al. © 2013 Cambridge University
Press. All rights reserved.
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