Are Overconfident CEOs Better Innovators?
The Harvard Law School Forum on Corporate Governance and Financial Regulation 2012-04-06
In our forthcoming Journal of Finance paper, Are Overconfident CEOs Better Innovators?, we find that over the 1993 to 2003 period, CEO overconfidence is associated with riskier projects, greater investment in innovation, and greater innovation as measured by the number of patent applications and patent citations even after controlling for the amount of R&D expenditures. In other words, the R&D investments of overconfident CEOs are more productive in generating innovation. However, greater innovative output of overconfident managers is achieved only in innovative industries. We also find evidence that overconfident CEOs are more effective at exploiting growth opportunities and translating them into firm value, especially within innovative industries. We find that overconfidence remains a strong and significant predictor of innovation even when we remove managers with short tenures at their firms, which suggests that the endogenous hiring of overconfident managers by innovative firms is not the main driver of our findings.
The results of this study have a bearing on the usual presumption that overconfidence is undesirable. Business commentators often point to examples of headstrong, overconfident CEOs who made disastrous decisions. However, the chance of a big defeat may be a corollary to the chance of great victory, so the lesson to draw from examples is unclear. A more serious charge is provided by the evidence of Malmendier and Tate (2008) that the market reacts more negatively to acquisitions made by overconfident CEOs. This dark side to CEO overconfidence might seem to suggest that the CEO selection process should be designed to filter out oversized egos, or that compensation and governance should be designed to severely constrain such CEOs.