Study also reveals that smart CEOs sell their company’s shares
Some of the world’s most successful entrepreneurs are flamboyant characters who don’t shy away from publicity; think Elon Musk or Richard Branson.
But when chief executives become overconfident, they may take risks and face the wrath of investors.
A new study by New Jersey’s Stevens Institute of Technology finds that overconfident CEOs are 33% more likely to be sued by shareholders.
They may make overly positive statements about the company that are not backed up by facts or hold back from revealing losses or other negative information.
"It's indisputable that these sorts of actions lead to shareholder lawsuits, whether intentional or unintentional," says Suman Banerjee, professor at Stevens School of Business who led the work.
That’s because legal action often shocks the CEO into less risk-taking behaviour in the future. And while entrepreneurs are often praised for taking risks, in a more litigious, regulated, business environment, that may not be appropriate.
“Shareholders are not powerless," adds Banerjee. "Their legal actions do make a difference in company operations and help the company better adhere to business regulations and laws."
Smart CEOs sell their own shares
The study also determined that the smartest CEOs don’t hold onto all of their own company’s shares but diversify their investments as a hedge against the unknown.
Those that don’t, even when stock prices slip, may again be victims of their own overconfidence.
"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 full study is published in the Aug. 29 issue of the Journal of Financial and Quantitative Analysis.
