The Benefit of Seeing the Brightside
Does a CEO’s positive thinking really impact a firm’s performance? A team of researchers including Gilles Hilary of Georgetown University’s McDonough School of Business explore the impact of optimistic thinking in firm leadership and the real impact this has on firm performance. And, the answer is yes, over-optimism is shown to boost firms’ profitability and value.
In a forthcoming study in the Journal of Accounting and Economics, the authors explore managerial over-optimism and its impact on firm market value and company welfare. Their results find a strong correlation between optimistic forecasts and performance that exceed previous expectations. The research suggests recent success spurs optimism within the company, creating a virtuous cycle of past success leading to positive forecasts, which leads to an increased effort from the firm executives, resulting in a return that would have been unattainable without this boost of energy.
For example: a manager unaffected by over-optimism has a final product of 10. A manager who is overly optimistic may believe their final product will be 20, putting a lot of time and resources into achieving that number. While in the end they will only achieve 15, less than they expected, this outcome is higher than 10, what they would have achieved had they not been motivated by over-optimism. The effects of this optimism range from higher earnings and higher stock returns to more aggressive company forecasts and a more upbeat tone in press releases (the authors use a quantitative textual analysis of the company language to evidence this point).
Through their analysis the authors established a clear path, which charts the cycle of managerial over-optimism. They establish that past success lead to over-optimism in the firm’s potential performance. With higher expectations of success at stake, managers will work harder to meet the elevated goals, resulting in higher firm return. These higher returns are looked back upon as success, starting the cycle in motion again.
By showing that the belief in future success has ebbs and flows, the study suggests that managers are made (not born) overly optimistic. For example, after experiencing recent successes, CEOs are more involved in the management of their firm. They also take the company plane to fly to vacation spots. Once the successes disappear, they return to their old habits.
As this cycle continues it can become increasingly hard to keep exceeding expectations, as the threshold grows with each past success. “You become optimistic because you’re exceeding expectations, but as you do that you become increasingly optimistic, which means it becomes increasingly difficult to exceed your own expectations. And so there’s a negative feedback mechanism that makes it hard to sustain the over-optimism” explains Hilary.
For this reason, often it is the more inexperienced or newer managers who mainly suffer from over-optimism. More seasoned CEOs who are used to riding out the ups and downs of business cycles tend not to give into over-optimism, and focus on more realistic projections.
Unlike over-optimism, overconfidence has been highly researched and linked to critical firm failure. When a CEO disregards basic business risks, believing they are invincible, the outcome can be disastrous; such as the dot com bust or the housing market meltdown. However, over-optimism is far less studied and it can be a force for good if it comes with the proper attention to risk. Hilary explains over-optimism as a type of bias. “Typically we think of bias as a negative in business,” explains Hilary. “However, in this case the bias of over-optimism has demonstrated a positive impact.”
The research establishes a series of links in managerial behavior. From past performance to overconfidence, from overconfidence to over-optimism, from over-optimism to effort, and from effort to performance. So long as the over-optimism is able to stay in check, as to not lift expectations to the point of unattainable returns, this cycle can benefit a company’s bottom line, at least in the short run.
So the next time you look at your firm’s projected numbers, remember to put on those rose-tinted glasses. Positive thinking could provide the boost you were looking for (along with the hard work it inspires).