Overconfident chief executives tend to lead to less corporate social responsibility in a company, our research shows. The more confident the chief executive, the less their firm invests in activity that has a positive impact on society.
We looked at 2138 firms with 3478 different chief executives from US exchange-listed firms across all industry sectors, and calculated overconfidence by measuring executive compensation. We looked at the share options provided to chief executives: if the chief executive fails to exercise these options (selling them off) it means they are overconfident about their company.
If a chief executive invests in corporate social responsibility it’s like an insurance policy. The chief executive is mitigating the risks in a number of areas by planning strategies around them, so the market is more lenient if the firm suffers some setback. These sorts of areas include: community involvement, corporate governance quality, workforce diversity, employee relations, environment, human rights and product quality.
For example, another study found firms with higher levels of corporate investment that were socially responsible suffer less damage to the company’s value in cases where there’s a product recall due to a defect. Being a good corporate citizen has positive spillover effects.
This lack of confidence reduced aspects of social responsibility the most in the institutional aspects of social responsibility, such as community and workforce diversity. This is in contrast to the technical aspects of corporate social responsibility such as corporate governance and employee relations.
Community aspects of social responsibility include giving to charity and support for non-profit organisations. Also included are support for housing initiatives or education that supports economically disadvantaged people, volunteer programs and indigenous peoples relations. Workforce diversity includes support for women on the board, outstanding employee benefits or other programs addressing work/life concerns.
We also found a significant difference between male and female chief executive confidence levels and the level of investment in corporate social responsibility each undertakes. Female chief executives are significantly less overconfident than male chief executives and undertake significantly more social responsible investment than male chief executives.
However, the gender of the chief executive doesn’t affect our original finding of overconfidence leading to less social responsibility investment.
Chief executive overconfidence has been blamed for business failure and financial distress. Research finds overconfident chief executives increase the risk of bankruptcy. There is also evidence to suggest overconfident chief executives take greater risks and insure less than their non-overconfident peers.
Shareholders are keen to invest in companies that are headed for success. They may therefore be attracted to the high-risk, high-reward strategy of the overconfident chief executive. On the other hand, shareholders are showing more interest in investing in firms who minimise risks associated with environmental damage and negative impacts on social wellbeing.
We argue that overconfident managers do not correctly recognise these risks and invest less in socially responsible behaviour than their less confident peers.
We also considered the impact of narcissism in our study. Chief executives that have narcissistic traits have a strong need for admiration from shareholders. Investment in social responsibility has been shown to be a good pathway to help chief executives obtain this admiration.
There’s also research that links narcissistic traits with overconfidence. However, our study found there was no relationship between narcissism and social responsibility. We found instead that the risk aspect of overconfident chief executives dominates.
The take-home message for shareholders is that if you want to invest in a more socially responsible firm, you need to consider more than just the chief executive’s resume. To invest in a firm with a continued focus on socially responsible investment, shareholders should select a chief executive who isn’t overconfident. The challenge then is balancing that with a lack of drive or direction in innovation and other positive risk-related activities that can result in growth.
It’s a trade-off that shareholders may struggle with. One solution may be for shareholders to use employment contracts with chief executives to specify the level of social responsibility they want to see happening in their firms. In this way, shareholders may be able to harness the positive attributes of an overconfident chief executive while maintaining a socially responsible focus.