CEO Overconfidence Leads to Inflated Financial Projections
June 20 2011 by ChiefExecutive.net
Chief Executives should be confident and most likely have gotten to the C-suite because of others’ confidence in their skills. That confidence, however, should not alter the public appearance of the company. A new study by Wharton accounting professor Holly Yang and University of Iowa professor Paul Hribar has found that CEO overconfidence may exaggerate the health of the company, thus skewing investor and analyst perceptions higher than reality.
The study found that CEOs who can be described as overconfident are more likely to have an optimistic bias when forecasting the company’s future earnings. These CEOs are 10 percent more likely to overestimate their future earnings than CEOs who are not considered overconfident.
Professors Yang and Hribar write, “Overconfident CEOs are more likely to issue optimistically biased forecasts because they overestimate their ability to affect their financial results and/or they underestimate the probability of random events.”
Market crashes and natural disasters are outside of a CEO’s control, but considering the current economy and the recent earthquake and nuclear crisis in Japan, accounting for unpredictability is an important skill.
The paper did not delve into the legality of such exaggeration in extreme cases, but said that if leaders are held accountable for predictions, then such forecasts would cease to exist.