Investors punish companies whose chief executives sound too confident and directors are also more likely to fire them if performance disappoints, according to recent research.
Analyzing almost 7,000 transcripts of CEO interviews on CNBC, investigators at Singapore’s Nanyang Technological University examined the relationship between instances of self-attribution bias (attributing good performance to one’s ability and bad performance to bad luck or the environment) and the market’s response to acquisition announcements and CEO dismissal.
Results reveal an inverse ‘U’ relation between self-attribution bias (SAB) and market response to M&A announcements, and an almost 10 percent positive abnormal return in the event of CEO turnover announcements.
‘Investors want a CEO to be confident, but only up to a certain optimal degree,’ says study author Andy Kim, assistant professor of finance at Nanyang Business School. ‘If SAB becomes extreme, investors become worried over-confidence will lead the company into excessively risky areas.’
For their part, by comparison with the period before Sarbanes-Oxley, directors are also more sensitive to performance issues when they’re dealing with an overconfident chief executive. ‘Governance theory suggests you want to have an overconfident manager’s incentives tightly tied to performance,’ says Kim. ‘To that extent, our data suggests SOX was effective at strengthening corporate governance.’
While using linguistics-based ‘big data’ to predict CEO behavior is, for now, primarily the domain of sophisticated hedge funds, Kim believes IROs need to encourage more careful use of language by their CEOs.
‘The [computational linguistics] technique is getting increasingly sophisticated and is generating much interest among academics,’ he notes. ‘It may take time before it is used more universally among market participants but, as long as there is a quantifiable technique, it is worth investigating.’
Who would have guessed?
A University of California at Berkeley study finds individual investors not only invest more in companies with better financial disclosure, but also profit from it, especially unsophisticated buy-and-hold investors.
‘The clearer and more concise the disclosure, the better the individual investor returns,’ says study author Alastair Lawrence, assistant professor of accounting at the Haas School of Business. ‘Some say individual investors don’t use financial statements, so what good does it do to keep changing financial disclosure rules for their benefit? The empirical evidence suggests individual investors do use these statements, however, and are gravitating toward companies they can better understand.’
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