CEO Psychology and Their Overconfidence Tendencies

If you need more reasons to dislike former Bear Stearns CEO Jimmy Cayne, apparently William Cohan’s new book about the fall of Bear gives you plenty more. I’m just judging from the excerpts in Malcolm Gladwell’s new article in The New Yorker, which is really about the tendency toward overconfidence among the people who rise to the top on Wall Street, but also quotes Cayne saying that people he doesn’t like are gay – and he doesn’t mean it in a nice way.

Gladwell tries to position psychology as an alternate explanation of the financial crisis:

Since the beginning of the financial crisis, there have been two principal explanations for why so many banks made such disastrous decisions. The first is structural. Regulators did not regulate. Institutions failed to function as they should. Rules and guidelines were either inadequate or ignored. The second explanation is that Wall Street was incompetent, that the traders and investors didn’t know enough, that they made extravagant bets without understanding the consequences. But the first wave of postmortems on the crash suggests a third possibility: that the roots of Wall Street’s crisis were not structural or cognitive so much as they were psychological.

I think this is a bit much. The fact that some Wall Street actors were megalomaniacs does not change the facts that regulators did not regulate, or that rules and guidelines were inadequate. Nor is overconfidence inconsistent with incompetence.

But Gladwell is probably right that overconfidence was a factor in the terrible decisions made by so many people. The problem, Gladwell argues, is that overconfidence is a useful trait to have in many settings – perhaps even an evolutionary adaptation. But then we fall into the trap:

“I’m good at that. I must be good at this, too,” we tell ourselves, forgetting that in wars and on Wall Street there is no such thing as absolute expertise.

In addition, the business world tends to breed overconfidence in CEOs. There is dumb luck in everything. But people who are successful tend to think that their success is a product of their own abilities, which leads them to overestimate those abilities. The sycophantic nature of the corporate culture at most large companies only reinforces this delusion. Then there is the insistence by the media, analysts, and institutional investors that CEOs project constant, Herculean confidence. If a CEO were to say the truth on an earnings call – “I’m pretty happy about how we did last quarter; we got lucky and closed a couple of big deals we might not have won; if things go well next quarter we’ll meet our targets, but any number of things could go wrong” – investors would fall over themselves trying to dump his or her stock.

But all of these problems are endemic to modern American capitalism, not just Wall Street banks (although Wall Street trading floors are particularly fertile breeding grounds for overconfidence, given the nature of trading gains and losses, and the amount of money being made). I would tend to put it more in the category of problems that will always be with us than the category of specific causes of the financial crisis. Maybe the specific problem here was that megalomaniacs ascended to be head of systemically important banks that could bring down the entire financial system, rather than running airlines, telecom companies, private equity firms, high-tech companies, baseball teams, or other organizations whose collapse would not have such dire consequences.

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