From "Journal of Financial and Quantitative Analysis Study"

BusinessBriefings.com
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.
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?

The answers to those questions should help investors determine if they are interested in buying the company's stock.
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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