Overconfident managers as a poison pill

Activist investors play an important role in capital markets. They may not be the most popular people in the world, but a successful activist attack does make businesses more efficient and gets rid of lazy and satisfied managers.

But unlike a full takeover, activist investors have to choose their targets wisely. They are not taking over control of the target company but need to convince the existing management that they need to change their strategy, sell or restructure part of their company or reduce costs. But in order to convince someone, this person has to be open to arguments or to public pressure (if the arguments don’t work, go to the press). But there is one class of people who are less receptive to arguments or public pressure than most: overconfident people.

To be sure, we all are overconfident, I certainly am. But some people are more overconfident than others. And if you are very sure about yourself and your ideas, you tend to ignore diverging opinions. So, all things equal, activist investors should be less likely to engage with a company where the CEO or CFO is extremely self-assured and overconfident but rather engage with a company with more open-minded management. Of course, that is only one consideration among many and if the opportunity is large enough, activists will deal with overconfident management. If you had the choice, who would you rather deal with, Elon Musk or the famously nice former CEO of Zappos, Tony Hsieh?

But it’s not just the CEO. The CFO is almost as important since that person is typically the second most influential person in a company. And stock markets recognise that. A new study looked at CFO overconfidence in particular and found that just like with overconfident CEOs, activist investors are slightly less likely to engage with a company that has an overconfident CFO than with a company with a non-overconfident CFO. And when they do, then the share price reacts slightly less favourable if activist target a company with an overconfident CFO. It’s as if investors know the CEO and CFO of a targeted company, look at the activist engagement and say to themselves: “Good luck with that.” And all too often activist engagement with companies that are run by overconfident management fails or falls short of original targets. So, the doubt of investors is probably justified.

Stock market reaction to activist engagement with overconfident CFOs.

Source: Schreiber et al. (2022)