Smeal Professor Addresses CEO Confidence and Risk-Taking

Don Hambrick, the Smeal Chaired Professor of Management, joined the Smeal faculty in 2002. He is also the Samuel Bronfman Professor Emeritus of Columbia University’s Graduate School of Business, where he served for 23 years. Hambrick is an internationally recognized scholar in the field of top management and an acknowledged leader in his various fields of study. On January 29, 2010, he received an honorary doctorate degree from Université Panthéon-Assas, one of the major affiliates of the Universities of Paris, “particularly for his path-breaking research on executive leadership.” Below is an excerpt of Hambrick’s acceptance speech, in which he discusses his extensive research on top management teams and their risk-taking behaviors. 

My specialty is the study of strategy – those decisions that have large and long-term effects on the performance of business organizations. Within the domain of strategy, however, my deep and abiding interest is in the study of strategists -- the people whose actions, or lack of actions, can greatly influence what happens to companies. 

After all, strategy is a human construction. It is not determined by technical computation, nor is it determined by rules. If we want to understand why organizations do the things they do, or why they perform the way they do, we must understand the human factor – the biases, experiences, motives, jealousies, and fatigue of the people who head up our business enterprises. Consider the tremendous effect that Patrick Kron and his team are having on the revival of Alstom today, or consider how Louis Gerstner and his team saved IBM 15 years ago. 

My interest in strategists has drawn me to the study of chief executive officers (or CEOs), their top management teams, and boards of directors. Fortunately, many other scholars around the world have joined me in this interest. We have used a wide array of research methods to shed light on questions such as these: Under what conditions will an executive’s long experience in an industry be a plus versus a minus? How do incentive arrangements affect the behaviors of new CEOs, compared to those who are approaching retirement? And how can boards of directors be structured to effectively monitor management, while also providing helpful advice and counsel to management? 

In recent years, I have particularly devoted myself to the study of executive confidence and its close cousin, over-confidence. Executives are confident if they think there is a good chance their initiatives will work out; executives are over-confident if they are absolutely sure their initiatives will work out. 

But executives can be too sure of themselves, with disastrous consequences. This is true for political leaders who can take their countries into foolish wars; it is true for generals who can take their troops into foolish battles; and it is true for CEOs who can turn a blind eye to extreme business risk. 

In fact, hubris has been proposed as the reason why CEOs continue to make large acquisitions, even though it is well known that most acquisitions are money-losers. Apparently, the CEOs who make acquisitions believe they are more talented than their peers, and therefore the facts do not apply to them. 

So, what causes executive hubris? In our research, we have identified four major factors that bring about extreme risk-taking by CEOs. Each of these factors propels risk-taking, but various combinations lead to exceedingly risky actions. As I briefly describe these four ingredients, you might want to picture how some combinations might be especially potent or “combustible.” 

What are these four factors that stimulate extreme CEO confidence and risk-taking? 

First is the company’s recent performance. CEOs tend to interpret their recent performance as a signal of their overall ability. Sometimes such an interpretation is appropriate, but very often it is not. After all, company performance is due to many factors, including luck. In general, CEOs who have recently encountered success start believing that they cannot fail, and they become more aggressive in the bets they make. In the investment world, this is how bubbles come to exist. 

A second factor is media praise for the CEO – in the forms of flattering articles and major awards. Interestingly, media praise for CEOs is not very highly correlated with recent company performance, so it plays its own distinct role in affecting executive psychology. As you might imagine, media praise pushes up the confidence of CEOs. For example, we have found that media praise affects how much above market value a CEO will pay for an acquisition. For every glowing article that has recently appeared about a CEO, he will pay, on average, about five percent more above market value. Two glowing articles, he will pay ten percent more, and so on. These acquisition premiums, of course, directly indicate the CEO’s beliefs about how much more valuable the acquired company would be if he were running it. It seems that CEOs come to believe their own press. 

Third, extreme risk-taking is more likely to occur when the CEO is highly narcissistic. Narcissism is a personality trait: extreme self-admiration, coupled with an intense need for that self-admiration to be continuously reinforced by others. Narcissists crave attention and applause, which causes them to engage in colorful and dramatic acts. We have collaborated with psychologists to develop multiple ways to measure narcissism in CEOs. And we have found that the most narcissistic CEOs engage in various forms of grandiose strategic behaviors, including large acquisitions and dramatic shifts in corporate focus. Think of France’s own Jean-Marie Messier, who created his own fanciful Vivendi, or perhaps the American CEO Sandy Weill who tried to turn the great and reliable Citibank into a much more exotic and exciting Wall Street trading house – both with horrible consequences. 

Fourth, CEOs take bigger risks when their incentives carry large upside payoffs but small downside penalties. The largest problem is with stock options, which are heavily used in the United States and increasingly being used in other countries as well. The generous use of stock options causes executives to become careless in their risk-taking, essentially ignoring the chances of major loss. Several of the major financial institutions that caused our recent worldwide economic disaster had been paying their top executives – not surprisingly – primarily with stock options. 

Please do not misinterpret me. We need confident leaders, including in business. Confidence is essential for innovation, creativity, and progress of all types. But there is such a thing as too much confidence. And throughout history, including in the last 10 years, many citizens –in many countries, including mine and yours – have paid a colossal price for the excessive confidence, the hubris, of leaders.

To learn more about Hambrick's award and his background, please visit this site.