However Awkward, Boards Need to Confront Overconfident CEOs

In “The Board’s Role in Strategy in a Changing Environment”, Reeves et a from BCG’s Henderson Institute note that in a complex and fast changing world, “corporate strategy is becoming both more important and increasingly challenging for today’s leaders.” They note that both investors and CEO’s are saying that boards need to spend more time on strategy.

We fully agree with these points. However, our research into the relationship between board chairs and CEOs raised an even more important point, which has recently appeared in two new research papers.

In “CEO Overconfidence and the Probability of Corporate Failure”, Leng et al find that, unsurprisingly, increasing CEO overconfidence raises the probability of firm bankruptcy. What was more interesting was their finding that large boards had a bigger impact on reducing the bankruptcy risk associated with overconfident CEOs than small boards. But when a CEO is not overconfident, the latter proved to be more effective.

However, another paper makes it clear that restraining an overconfident CEO is something that many boards find easier said than done. In “Director Perceptions of Their Board’s Effectiveness, Size and Composition, Dynamics, and Internal Governance”, Cheng et al note that almost all directors reported that the size of their board was “just right”, despite the wide variation in actual board size.

Moreover, while directors generally highly rated their board’s effectiveness, the weakest ratings were typically given to their performance in evaluating their CEO. The authors note that, “boards seem to see their primary function as providing counsel to, rather than monitoring the CEO.” This finding was backed by some painful director quotes, including

“We have not been effective in dealing with a highly aggressive CEO”

“Our board has been too slow to move on poorly performing CEOs”

“We put too much trust in the CEO and management team”

To be sure, this is not a new phenomenon. For example, in Berkshire Hathaway’s 1988 Annual Report, Warren Buffett famously observed hat “At board meetings, criticism of the CEO’s performance is often viewed as the social equivalent of belching.”

Unfortunately, heightened uncertainty tends to make human beings – including management teams and board directors – more likely to conform to the views of the group, even when it is led by an overconfident CEO. Indeed, in the face of uncertainty, overconfidence often increases in order to keep feelings of confusion and vulnerability at bay. You can see how this can easily trigger social dynamics that lead to organizational crisis and failure.

Challenging an overconfident CEO is never easy. But it is often one of the most critical activities non-executive chairs and directors perform.

blog comments powered by Disqus