Over-confident CEOs increase risk

A recent international study undertaken by a team, including an Australian researcher, hypothesises that an over-confident CEO is “more likely to engage in reckless or intentional actions that give rise to securities class actions (SCAs).”

Fortunately, good governance and appropriate incentive alignment can reduce the likelihood of a class action against the company.

Unsurprisingly, class actions also have the effect of reducing the risk of further SCAs, often by the resultant change in the chief executive officer (CEO) and the study found that those CEOs subsequently exhibited reduced over-confidence.

In Australia, the incidence of SCAs is relatively low, with less than ten commenced in the last year and only around 40 in the past five years. The study concerns itself mainly with the over-confident CEO and the reasoning behind their actions, and also quantifies the likelihood that such over-confidence can actually result in fraudulent actions by the CEO either through mis-statement of results or omission of facts.

While directors of listed companies should familiarise themselves with these behavioural attributes, the reputational risks also apply to private entities and not-for-profits .

The study, based on the US experience and data, also concludes that good governance results in reduced over-confidence in CEOs. Particularly the report cites introduction of Sarbanes-Oxley Act in the US as providing the external catalyst which forced companies to have a majority of independent directors and a completely independent audit committee as being the main factor in “reining-in” the over-confident CEO. 

Listed company guidelines in Australia recommend an independent chairman and a majority of independent directors on the board. Of course, mis-statements, omissions and outright fraud have a severe ongoing impact to any organisation so both independent and non-independent directors have an interest in ensuring these do not occur in any circumstance.

While CEOs that act in this way are often subsequently dismissed, the study reveals that those CEOs with close ties to other executives and the board are less likely to be fired. Also, internally appointed CEOs are less likely to be fired following such behaviour.  For directors, these attributes should be included in risk assessments. 

The full paper can be found here.