The Effect of CEOs' Overconfidence on Performance during Macroeconomic Recessions

Despite decades of analysis on the effect of recessions on firms' financial performance, managers often fail to implement strategies that research has proven to be successful when facing macroeconomic contractions. We analyze the effect of CEOs' overconfidence on the performance of their companies during macroeconomic recessions. In general, overconfidence biases CEOs' decisions, leading them to overinvest in low-value projects and underestimate risk, therefore decreasing firm's organizational and financial flexibility. During recessions, firms require a greater ability to adapt to organizational changes, as there are greater nontrivial pressures on companies' profitability. Therefore, we contend that a CEO's overconfidence is especially dangerous to the performance of his/her company during a recession. We also argue that a CEO with previous experience in that position during an economic recession can help mitigate the negative effect of overconfidence. Empirical results from 214 industries in the US during the period 1992 - 2015 strongly support our reasoning.