Research ties a CEO’s degree of optimism and confidence to a company’s performance
By Bob Woods
Photo by Drake Sorey

The CEO of a company sits in the catbird seat, one of power, prestige, influence, and often, a hefty paycheck. But that comes at a price, because he or she simultaneously occupies the hot seat, one of accountability, scrutiny, and expectations.

How CEOs approach this balancing act of risk and reward, particularly their degree of optimism and ­confidence, is the focus of study for a team of researchers including Gilles Hilary, the Houston Term Professor of Accounting at Georgetown University’s McDonough School of Business. The bottom line, said Hilary: Being overly optimistic and overconfident can actually­ buoy profits and market value — and leave the CEO standing tall.

The study, “The Bright Side of Managerial Over-optimism,” was published in the Journal of Accounting and Economics. It was the latest in a series of studies by Hilary and his co-authors that empirically examines systematic biases, specifically over-optimism and overconfidence, and whether they are relevant in the business setting. They define over-optimism as “essentially the perception that you will get lucky and that good things will happen to you,” Hilary said. “Overconfidence is putting too much weight on things that you think you control.”

In their initial research, Hilary and his colleagues measured whether financial analysts are subject to those biases in calculating their evaluations of companies, and found that indeed they are affected by overconfidence in their evaluations. A follow-up study among executives revealed they exhibit the same biases, leading them to become overconfident in their skills after a series of successes. The downside of the executives’ behavior, Hilary reported, is that analysts and investors eventually put less and less weight on forecasts provided by those executives.

Overconfidence is putting too much weight on things that you think you control.”
—Gilles Hilary, Houston Term Professor of Accounting

Yet there’s a bright side to this phenomenon as well, which the third study uncovered. This most recent study was based on more than 9,000 observations solicited from nearly 1,500 CEOs across various industry sectors. The research affirmed that com­panies’ continued success breeds overconfidence among CEOs, who attribute success to their own behavior. “That leads these CEOs to become over-optimistic about the future,” Hilary said. “Then they tend to spend more time working, putting more effort into what they’re doing.”

Think of it this way, he said. A well-calibrated CEO, unaffected by over-optimism, expects an end result of 5 and in the end gets 5. But the over-optimistic CEO expects to get 7 when he should expect to get 5. He starts working harder and gets 6. “That’s less than what he was hoping for,” Hilary said, “but it’s better than what he’d get if he had not been over-optimistic.”

Hilary boiled down his real-world application of the research to recommendations he calls the JUDO framework:

  • Justify your assumptions. Formalize and review them critically. Don’t pick and choose benchmarks to fit your results.
  • Understand successes and failures. One of the key success drivers of CEOs is sheer luck. Recognize this.
  • Dompt — adopted from the French term for tame or subdue — your tendency to take risk. In spite of your best effort, your estimated likelihood of success is still probably inflated.
  • Take the Outside view. Ask for feedback when you can. If you can’t, display a split personality. What would you say if someone else made a similar assumption?

The next step in this examination, Hilary concluded, would be to ask what effect the CEO’s optimism or confidence has on the rest of the organization. “We don’t know,” he said, “but future research might answer that question.”

 

Published in Georgetown Business magazine, Spring 2017