Overconfidence in CEO is an overestimation of the value of manager on what they can achieve. Such managers have a belief that the current company assets are undervalued, and therefore they generate low investment returns while others overestimate the value of future investment they make (Van den Steen, 2011). In an organisation, the manager can only make two investment decisions namely whether private investment is composed of internal investment and external investment. The second decision that CEO can make is whether the financing of any investment portfolio depends on domestic cash flow verses foreign equity capital. Overconfidence CEO such as Tim Cook believes that the market price for a less risky debt financing is more accurate by do not accept the ability of new stockholders as to what equity stake worth and hence on the appropriate price of newly issued shares. Because of this, the model has two preferable predictions concerning the difference in behaviour between rational and overconfidence CEO.
Tim Cook is a current CEO of Apple Inc. He is a CEO made various decisions that changed the performance of Apple Inc. Tim Cook is a decidedly riskier CEO who have overconfidence in any kind of investment he makes. His overconfidence was linked with investment in a very riskier project (Van den Steen, 2011). He therefore invested most in innovation which could be measured regarding the number of patents applications and citations. The decision to invest in innovation is a riskier decision that Tim Cook made to ensure that Apple Inc performs better than its competitors. The overconfidence decision to invest in the generation innovation was a critical decision that made Apple Inc successful. The output of innovation for overconfidence managers can be met in innovative industries like Technology industry. Overconfidence CEO like Tim Cook can exploit growth opportunities that come their way and ensure that they are converted into firm's value.
Overconfidence improves decision making. Overconfidence give CEO to make a firm decision that can either enhance or decrease the performance of the company. Overconfidence makes CEO to invest in risky investment projects. Overconfidence is a philosophy that gives people to believe in their knowledge, ability and potential. It, therefore, allows an individual to make a hard decision than any other ordinary person. It gives Tim Cook courage to invest in riskier innovations that have higher investment returns. Under this condition, Apple Inc could generate high investment returns because its CEO took risky decisions that made Apple Inc different from others. Overconfidence is therefore undesirable as it makes managers enter into risky investment projects that have a high likelihood of loss (Yates & Li, 1996). This kind of leaders can easily make disastrous decisions that can make the company lose substantial financial resources.
There are other effects of overconfidence on the investment of a business organization. It always ensures that managers are optimistic about the kind of investment they make thus giving the managers confidence to go on with their investment portfolio. It therefore prevents managers from trying a new investment portfolio. Because of overestimation, confidence managers can overvalue future investment thus over borrow money or increase the cost of financing the project (Van den Steen, 2011). This is because overestimation of the value of the firm make the investment project be seen as very risky thus making financial institutions to charge extra cost on the cost of finance. As a result, a business organization with overconfidence CEOs must have great investment-cash flow sensitivity because they always predict that the firm is investing in a costly and riskier investment project. At the same time, because Apple Inc has confident CEO who has mis-calibrated beliefs, it is able to take greater capital expenditure.
On the contrary, there are other adverse effects of having overconfidence managers in the organisation. They are usually likely to provide optimistically biased forecasts because they over believe in their ability and knowledge. They are always associated with a higher probability of earnings management and financial frauds. These managers usually do not prefer using external sources of finance and therefore issue less equity to the general public.
The essential qualities of overconfidence are that they are great innovators, they are mostly linked with acquisition. They always believe that they can achieve what other managers cannot and this gives them the power to do more (Tenney & Moore, 2015). These managers are mostly risk-averse. They are therefore able to take audacious risks which is more important to the company. Tim Cook as he is an overconfidence manager, he had more adverse effect for external acquisition as compared to internally driven innovation. Tim Cook also can participate in building the company through acquisition because they overvalue their potential to manage a large number of workers than any other person.
Tim Cook as an overconfidence manager does not like investing in external equity capital because they have the belief that market forces set the price of a bond and therefore it is too low, and they are working hard to secure the existing investors from dilution. They therefore first utilise all internal sources of finance and change their investment decision because they can use inner cash flow balance.
Yates, J. F., Price, P. C., Arbor, A., & Li, C. (1996). Right probabilistic forecasters: The "consumer"s' perspective. International Journal of Forecasting, 12(1), 41-56. http://doi.org/10.1016/0169-2070(95)00636-2
Van den Steen, E. (2011). Overconfidence by Bayesian-rational agents. Management Science, 57(5), 884-896. http://doi.org/10.1287/mnsc.1110.1323
Tenney, E. R., Logg, J. M., & Moore, D. A. (2015). (Too) Optimistic about optimism: The belief that confidence improves performance. Journal of Personality and Social Psychology, 108(3), 377-399. http://doi.org/10.1037/pspa0000018
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