HONG KONG SAR - Media
OutReach - 4 November 2021 - Overconfidence, or the tendency to underestimate risk and
overestimate returns, is often cited as a leading factor behind some of the
biggest corporate failures in history, from the Enron scandal at the turn of
the millennium, to the spectacular collapses of investment banks Bear Sterns
and Lehman Brothers during the global financial crisis of 2007 to 2008. With
the world now in the grip of a new crisis brought about by the COVID-19
pandemic, a recent research study is challenging the stereotypical discourse on
overconfident business leaders and suggests that a touch of conceit in CEOs may
help to lead their companies through the storm.
An area that overconfident CEOs excelled at is withholding
bad news and accentuating good news, according to the study. (Source: iStock)
The study CEO Overconfidence and the COVID-19 Pandemic was co-conducted by Maggie Hu,
Assistant Professor of Real Estate and Finance at the School of Hotel and
Tourism Management and the Department of Finance; Desmond Tsang,
Associate Professor at the School of Hotel and Tourism Management at The
Chinese University of Hong Kong (CUHK) Business School; and PhD candidate Wayne
Wan Xinwei at the University of Cambridge. The researchers theorised that
overconfident CEOs could be beneficial to their firms during unprecedented times
of crisis, and the COVID-19 pandemic provided a perfect backdrop for them to
test their theories. They found that companies with exceptionally confident
CEOs performed better in the stock market during the COVID-19 pandemic.
"The COVID-19 pandemic has
brought an unrivalled level of uncertainty to our world. It has also become a
test for CEOs in whether they can keep their companies intact," Prof.
Tsang says. "We found that overconfident CEOs actually provided strong
leadership and kept both their employees and investors positive during a
Overconfidence and Abnormal Returns
Using data from the U.S., the
research team looked at companies' stock market performance from January 22,
2019, to March 23, 2020. Only companies with the same CEOs since 2018 were
included in their sample to control for any possible haphazard performance of
newly appointed CEOs.
The researchers measured the level
of CEO overconfidence by investigating CEOs' options holdings. As senior
managers, CEOs typically are vested in their companies' stock options which
they can exercise anytime. A CEO is considered more confident by researchers if
they are willing to wait for a later date to exercise their stock options, as
it may mean the CEO is confident enough to seek a higher payoff somewhere down
According to the results, companies
with more self-assertive CEOs displayed significantly higher abnormal returns,
defined as returns that are unexpectedly and unusually large, during the
COVID-19 period compared with companies with CEOs that have relatively less
confidence. Given that COVID-19 brings negative impact of 0.52 percentage point
in terms of daily abnormal return and 1.57 percentage points in terms of
three-day cumulative abnormal returns, the overconfident CEOs mitigate the
negative impact of the COVID-19 by about 37% on abnormal returns, and 33.7% on
cumulative abnormal returns over the period studied, respectively.
The researchers then looked at
whether the positive effect of overconfident CEOs would differ among different
firms, specifically those highly affected by the pandemic. They measured how
much the sampled companies suffered from the COVID-19 pandemic. They looked at
companies' exposure to the pandemic by calculating the frequency of the
COVID-19-related keywords used when the management discussed their results in
their quarterly reports. They found that the positive effect of overconfident
CEOs was even more pronounced in firms that suffered more from the pandemic.
"Super confident CEOs had a
crucial role in mitigating negative market reaction due to the COVID-19
pandemic because their positivity helped them to manage investor perception,"
Prof. Tsang says.
The 'CEO Magic'
So how did self-assured CEOs
successfully manage investor perception during the crisis? The researchers
explain that while the market sentiment was generally pessimistic for all
firms, super confident CEOs tended to be more effective in managing public
perception, which then influenced investors' perception of their firms. As a
result, investors maintained a positive attitude towards the companies' stocks.
This ability to keep a positive image of the company was extremely important
for companies that faced high uncertainty and lack of resources during the
pandemic, according to the study.
Another area that overconfident CEOs
excelled at is withholding bad news and accentuating good news, according to
the study. While it's an activity that may be deemed questionable by some, it
turns out to be quite valuable during a crisis. According to the study results,
overconfident CEOs indeed withheld more bad news, which resulted in less
negative stock price reactions during the pandemic.
However, despite the marginal edge
gained by companies who are helmed by overconfident CEOs during the pandemic,
the researchers found that even a highly overconfident CEO would not be able to
save companies with inherently higher risk or weaker foundations from going
under. For firms with a high risk of failure and bankruptcy, rational investors
simply would not be swayed by any amount of spin-doctoring conjured up by
"Our study shows that extremely
confident CEOs can make a difference for the survival of a firm during a
crisis, but they are not all-powerful. If a company is fundamentally unsound,
then no matter how confident the CEOs are, it's going be hugely difficult for
them to pull a rabbit out of the hat and save the day regardless of how much
smoke and mirrors they employ," Prof. Hu says.
All in all, the beneficial impact of
conceited CEOs only worked for companies with more cash holdings, lower
leverage, higher ROA (return on assets) and larger market capitalisation before
the crisis. In addition, the study highlights that this positive effect only
lasted during the crisis period. This impact was no longer notable in the
post-crisis recovery period when companies started to bounce back following
government interventions and aids.
The researchers believe the study
has strong implications for companies searching for the right leader. "Companies
should think twice before turning down any overconfident CEO candidate because
they can be highly beneficial in curbing stock price crashes at crisis times,"
says Prof. Hu. "But they should also bear in mind that when the storm is over,
then the magic of overconfident CEOs could vanish immediately."
Hu, Maggie and Tsang, Desmond and Wan, Wayne
Xinwei, CEO Overconfidence and the COVID-19 Pandemic (November 22, 2020).
Available at SSRN: https://ssrn.com/abstract=3716618 or http://dx.doi.org/10.2139/ssrn.3716618
This article was first published in the China
Business Knowledge (CBK) website by CUHK Business School: https://bit.ly/3BDcmnE.