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The Ups and Downs of Managerial Overconfidence

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Without a certain amount of confidence, it鈥檚 virtually impossible for leaders to gain and maintain followers. But extreme self-confidence drowns out the doubts and dissenting voices that can pull leaders back from the brink of a disastrous decision. Managerial overconfidence, then, is a serious risk that has drawn increasing attention from executives, investors, and researchers in recent years.

A burgeoning body of academic literature links overconfidence to adverse consequences such as听,听, and . On the other hand, studies have suggested that overconfident leaders , especially in听.

These contradictory results may reflect basic uncertainty about what overconfidence means. 亚洲AV normally identify it based on executives鈥 tolerance for risk. In practice, however, managers with above-average self-belief may not always put the organization at risk. What really puts the 鈥渙ver鈥 in overconfidence is not having the skills to back it up.

Mindy (Hyo Jung) Kim
Mindy (Hyo Jung) Kim

Mindy (Hyo Jung) Kim, an assistant professor of accounting at Mason, has not only found that it鈥檚 possible to incorporate ability-adjusted overconfidence into real-world business assessments, but that it happens routinely.

To be sure, not everyone has the proper vantage point to make such assessments. It鈥檚 hardly in the best interests of managers to reveal their own overconfidence, colleagues may be either cowed or complicit, and external stakeholders are too far from the action. Kim identified a role whose proximity and status were perfectly positioned to test the true mettle of executives against their self-confidence: financial auditor.

Having worked as an auditor for Deloitte before switching to an academic career, Kim knew the job entailed assembling the most comprehensive picture possible of a firms鈥 financial health. In the process of reviewing quarterly and annual reports, auditors develop up-close-and-personal relationships with the firm鈥檚 top managers. At some of the larger firms, audit teams can be found more or less permanently camped in a conference room set aside for their use.

Kim鈥檚 recent paper in听听focuses on one of the more drastic steps auditors can take in preparing their reports. When auditors determine that a company is in such dire straits that its survival over the next year can no longer be assumed, they will include partly standardized language listing specific factors that 鈥渞aise substantial doubt about the Company鈥檚 ability to continue as a going concern.鈥 In the 12-month period ending May 31, 2021,听听received a so-called 鈥済oing-concern opinion鈥 from their auditor.

Analyzing the documentation of financially troubled companies for the years 2005-2013, Kim found a positive correlation between CEO/CFO overconfidence and the likelihood of the company receiving a going-concern opinion. As a proxy for overconfidence, she used managers鈥 decisions to either delay or exercise stock options鈥攐n the principle (well-established in research literature) that overconfident managers will bet on themselves, foregoing the opportunity to diversify their portfolio.

Adding a further layer of analysis, Kim employed a 鈥渕anagerial ability score鈥 devised by researchers to isolate the portion of firm revenues attributable to top executives. For the high-scoring firms (read: firms with above-average managers), the correlation between going-concern opinions and managerial overconfidence disappeared. This implies auditors are at least capable of distinguishing between 鈥渏ustified鈥 overconfidence and purely pernicious arrogance.

Here's where things get very interesting. As we鈥檝e seen, auditors occupy a strange position within firms. They are deeply plugged in, with ready access to higher-ups as well as the firm鈥檚 most vital financial data. At the same time, they can be replaced at will, like any external vendor. Kim hypothesized that overconfident leaders鈥攚hether they were high-skilled or not鈥攚ould be liable, after receiving a going-concern opinion, to shoot the messenger, i.e. terminate the auditor, rather than acknowledge error.

Looking at overconfident managers en masse, this trigger-happy tendency was evident, but not to a statistically significant degree. It was most pronounced among the subgroup of companies with less powerful audit committees鈥攊.e., where the average tenure of the committee members was less than that of the CEO and/or CFO. In other words, without a strong audit committee, overconfident managers could get away with murder, using their power to silence voices that threatened to make them look bad.

Kim鈥檚 research sheds light on why the CEO class remains a swaggering bunch. As research has shown, overconfidence has its upsides. It is not always false advertising 鈥 in Kim鈥檚 sample, 41 percent of companies with overconfident management also fell into the high-ability category. However, overconfident managers may merit close watching from unbiased and well-informed parties, such as financial auditors. Even more importantly, these observers need political firepower behind them in the form of robust corporate governance. Otherwise, the risks of managerial overconfidence may outweigh the rewards.