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Magdalena Kochanowicz
Plymouth University
5 Roma Court, TR7 3JH Newquay, Cornwall
[email protected]
01752 585515
CEO hubris and market reaction
Hubris, market reaction, content analysis, CEO letters to shareholders
Abstract:
1. Problem statement/rationale, including reference to key literature:
Executive leaders, ambitious and confident visionaries, they inspire, they promise delivery
of success, their charisma influences followers. These are the reasons why we put them in
charge of our organisations. However, at times, those very same people can transform
from ‘a butterfly to a beetle’ (Kafka, 1915). Their admirable traits when accelerated can
turn into dark hubristic behaviour of overconfidence, irrationality, recklessness, egotistical
and delusional ambitions. Hubristic leaders can take organisations to the top but also can
bring them down.
Research has shown that executive hubris- generally defined as executives’ extreme selfconfidence and overestimation of one’s actual ability, performance, level of control and
chance of success (Roll, 1986; Hayward & Hambrick, 1997; Hiller & Hambrick, 2005) - can
significantly affect firm-level decisions and outcomes: e.g. firm acquisition premiums
(Hayward & Hambrick, 1997), corporate financial policies (Malmendier & Tate, 2005),
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managerial risk taking (Siomon and Houghton, 2003; Li & Tang, 2010). However, we do
not know much about the impact of executive hubris on shareholders wealth. Thus,
studying CEO hubris provides opportunity to identify whether the market is sensitive to this
behavioral factor.
It could be argued that investors (the market) neglect risks associated with hubris, and that
they put too much weight on positive outcomes of CEO’s hubristic traits. Overconfidence,
riskiness and grandiose decision making could be mistakenly perceived as a strong
managerial vision and/or managerial ability. This could be due to the fact that the market
rewards confidence, optimism and risk (Koh et al., 2008). It is also possible that the
hubristic transformation of an executive is not captured early enough, and only after a big
downfall the market ‘wakes up’. One probable explanation of this delayed reaction could
be the inefficiency of the market (Shleifer and Vishny, 2003; Michell, Pulvino and Stafford,
2004). Investors make decisions under complex and uncertain conditions, therefore are
often prone to biases and heuristics in order to arrive at choices (Grinblatt and Keloharju
2001, Barberis, et al., 2003) Unfortunately, a retrospective recognition of hubristic
behaviour does not prevent organisational failure.
Accordingly, the researcher is asking the following questions: is the market capable of
capturing those benefits and risks? Is the market sensitive to hubris? If it is, does the
market punish or reward hubris?
2. Research design and methods of data collection and analysis or method inquiry:
This study intends to detect hubristic traces in the language of chief executive officers of
British public companies (FTSE250), in their letters to shareholders by applying a direct
approach of content analysis. In addition, it will test whether the market is sensitive to CEO
hubris. Analysis of the relationship between the market’s reaction to CEOs appointments
and departures and their linguistic makers in their letters to shareholders should reveal
whether the market rewards or punishes hubris.
Therefore, there are two themes of the project:
(1)
Executive hubris that will be identified using a text based content analysis.
(2)
Market reaction to hubristic CEOs that will be measured through an event study.
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The study will follow Craig and Brennan’s (2012) approach, and will adopt a premise that
corporate narratives in CEO letters to shareholders are a proxy for hubristic language, and
that hubristic language is a proxy for hubristic traits (CEO hubris). Discourse analysis will
be employed to address the first objective of the project. This method provides the
opportunity to directly detect linguistic traces of characteristics related to a subject of the
study (Brennan and Conroy, 2013), in this case to hubris. Lexical structures (words,
phrases, metaphors) of hubristic language will be extracted from CEOs letters to
shareholders and captured in a form of scores that will emerge from a DICTION 7.0 based
statistical analysis.
The second part of the study aims at detecting the market’s reaction to CEO hubris, in
other words, at identifying the effect of CEO hubris on company’s returns around
announcement dates of CEOs appointments and departures.
It is possible to examine the response of the market to CEO hubris by applying an event
study methodology and using daily stock prices, which would measure abnormal returns
around the studied event (market response). This type of method has been widely applied
in a similar type of enquires (Fama et al., 1969; MacKinlay and Craig, 1997; Malmendier
and Tate, 2008; Panayides and Gong, 2002; McGowan and Sulong, 2011; Zhu and
Malhotra, 2008). The main assumption is that the capital market is efficient and that
hubristic traits of chief executives will be reflected in the stock prices of those companies in
a form of abnormal returns (Seth, Song, Pettit, 2000).
3. Main findings:
The traditional view of hubris is that is it harmful, dysfunctional and maladaptive, leading to
individual and corporate failures (Roll, 1986; Hayward & Hambrick, 1997; Malmendier and
Tate, 2008; Hayward, 2007; Judge et al., 2009; Li and Tang, 2010; Claxton, et al., 2015). And
yet, there is another side to this profile; hubris may serve as advancement. It has been
observed that many political and business leaders exhibit hubristic traits, and the fact that
they are hubristic is what made them successful in the first place (Furnham, 2014). This is
because some hubristic traits like e.g. charisma, persuasiveness, strong self- potency and
self-confidence, or high risk appetite increase the probability of success (Hayward, 2007;
Owen, and Davidson, 2009; Shipman and Mumford, 2011; Johnson and Fowler, 2011;
Furnham, 2014). Consequently, this makes the characteristics of hubris disproportionally
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represented amongst CEOs (Maccoby, 2000; Rosenthal and Pittinsky, 2006).
This is not where the paradox of hubris ends, hubris can also be beneficial to organisations
(Petit & Bollaert, 2010; Galasso and Simcoe, 2011). For example, Tang et al., (2015) and
Hirshleifer et al., (2012) found a positive relationship between executive hubris and firm
innovation, claiming that innovation was a key factor determining firm’s ability to sustain its
competitive advantage (Brown and Eisenhardt, 1995; Miller, Fern and Cardinal, 2007). Jude,
et al., (2006), Chatterjee and Hambrick, (2007) and Li and Tang, (2010) on the other hand,
have reported an association of CEO hubris with an organisational strategic dynamism.
For that reason, hubris presents a potential conundrum, having positive and negative
attributes simultaneously, which is the paradox of hubris.
4. Discussion of implications:
Given the significant influence that leaders can have on organisations, it seems important to
understand the impact that executive hubris has on shareholders’ value. Such knowledge
could provide valuable investment related clues and important corporate governance signals
to a board of directors and other organisational stakeholders (Craig and Amernic, 2011).
CEO hubris may have significant implications for shareholders. If investors discount stocks of
companies lead by hubristic CEOs, which would indicate that the market punishes hubris;
consequently, shareholders returns would be adversely affected. This, in a sense, could be
interpreted as an agency problem (Jensen, 1986, Hayward and Hambrick, 1997). On the
other hand, the opposite could also be true (paradox of hubris), investors may favour CEO
hubris, which could result in positive abnormal returns for shareholders.
Therefore, this study may provide evidence which would make a strong case for considering
the impact of executive psychology on company’s stock prices, which would be of a great
practical significance. It may also provide a theoretical contribution, which would deepen our
understanding of the market efficiency. In accordance with the efficient market hypothesis, if
investors show sensitivity to behavioural factor like CEO hubris, in other words, if their
reaction is either positive or negative, this would indicate on a good efficiency of the market.
On the other hand, if there is a lack of reaction, then it would be a sign of the weak form of
market efficiency (Shleifer and Vishny, 2003; Michell, Pulvino and Stafford, 2004).
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