Commencement address by Professor Donald Hambrick at Penn State on May 15, 2011

Thank you, President Spanier. And thank you, graduates, families and friends, and esteemed colleagues.

It seems like just yesterday that I was sitting where you are today, receiving my own Penn State graduate degree. You should find that reassuring, and here’s why: Since I have a vivid recollection of being in exactly your seat, I’m keenly aware that, when it comes to this graduation speech, shorter is better. Actually, I promise you – just like a nurse who’s about to give you a shot – “You’re gonna feel just a pinch.”

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As President Spanier graciously said, my specialty is the study of strategy – those decisions that have large and long-term effects on the performance of businesses. Within the field of strategy, however, my deep and abiding interest is in the study of strategists — the executives whose actions, or lack of actions, can greatly influence what happens to companies.

After all, strategy is a human construction. It is not determined by technical computation, nor is it determined by rules. If we want to understand why organizations do the things they do, or why they perform the way they do, we must understand the human factor – the experiences, motives, and outlooks of the people who head up our business enterprises. I’ll bet every one of you has your own favorite example of an organization that has benefitted from superb executive leadership, as well as one that has been severely damaged by flawed leadership.

In recent years, I have especially devoted myself to the study of executive confidence and its close cousin, over-confidence. Executives are confident if they think there is a good chance their initiatives will work out; executives are over-confident if they are absolutely sure their initiatives will work out. As Voltaire said, “Being in doubt is not a pleasant condition, but being certain is absurd.”

Clearly, our business leaders have had a hard time re-gaining their confidence over the last three years. But recent signs indicate that many CEOs are starting to feel their oats again: profits are up, acquisitions are up, IPOs are up, capital spending is up. And – as night follows day – CEO compensation is up.

At one level, this rise in CEO confidence is a good thing. But when executive confidence gives rise to cockiness – which is what we’ve seen occur time and time again – the results can be catastrophic for individual companies as well as for overall economies.

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The ancient Greeks had a word for excessive confidence: hubris. In Greek mythology, hubris was man’s capital sin, and the gods would strike him down for it.

In our sons and daughters, and among young people in general, we always want to see more confidence. “You can do it!” is what we say to those we care about. And in many walks of life, there is no penalty, no problem, in being extremely confident.

But executives can be too sure of themselves, with disastrous consequences. This is true for political leaders who can take their countries into foolish wars; it is true for generals who can take their troops into foolish battles; and it is true for CEOs who can turn a blind eye to extreme business risk.

In fact, hubris has been proposed as the reason CEOs continue to make large acquisitions, even though it is well known that most such deals are money-losers. Basically all CEOs know that the general odds of coming out ahead after making a big acquisition are about the same as the odds of coming out ahead after a weekend in Atlantic City. Still they go ahead, believing that the odds only apply to the suckers, but then simply adding themselves to the roster of suckers in the process.

So, what causes executive hubris? In our research, we have identified four major factors that bring about extreme risk-taking by CEOs. Each of these factors propels risk-taking, but various combinations lead to especially risky actions. As I briefly describe these four ingredients, you might want to picture how some combinations might be especially potent.

What are these four factors that stimulate extreme CEO risk-taking?
First is the company’s recent performance. In general, CEOs who have recently encountered success start believing that they cannot fail, and they become more aggressive in the bets they make. In the investment world, of course, this is how bubbles come to exist.

A second factor is media praise for the CEO –in the forms of flattering articles and major awards. Interestingly, media praise for CEOs is not very highly correlated with company performance, so it plays its own distinct role in affecting executive psychology. As you might imagine, media praise pushes up the confidence of CEOs. For example, we have found that media praise affects how much above market value a CEO will be willing to pay for an acquisition. For every glowing article that has recently appeared about a CEO, he or she will pay, on average, about five percent more above market value. Two glowing articles, ten percent more, and so on. These acquisition premiums, of course, directly reflect a CEO’s beliefs about how much more valuable the acquired company would be if he or she were running it. It seems that CEOs come to believe their own press.

Third, extreme risk-taking is more likely to occur when a CEO is highly narcissistic. Narcissism is a personality trait of supreme self-admiration, coupled with an intense need for continuous applause. Narcissists crave attention, which causes them to engage in colorful and dramatic acts.
We have collaborated with psychologists to develop multiple ways to measure narcissism in
CEOs, and have found that the most narcissistic engage in various forms of grandiose actions, including large acquisitions and risky shifts in company focus. When it comes to narcissistic CEOs, I don’t like to name names; but I will say that some of the CEOs whose firms were at the center of the financial meltdown of 2008 were right up there on our scale.

Fourth, CEOs take greater risks when their incentives carry large upside payoffs but only small downside penalties. The biggest problem is with stock options, which are heavily used in the U.S. and increasingly used in other countries as well. The generous use of stock options causes executives to become careless in their risk-taking, hoping for big wins but essentially ignoring the chances of major loss. Here again, several of the financial institutions that brought about our Great Recession had been paying their top executives – not surprisingly – primarily with stock options.
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Please don’t misinterpret me. We need confident leaders, including in business. Confidence is essential for innovation and progress of all types. But there is such a thing as too much confidence. Throughout history, including our recent history, the excessive confidence of leaders – in business, finance, and government – has taken a colossal toll on citizens in many of the countries represented here today. One of our key responsibilities – as discerning members of organizations, and as discerning citizens – is to be on the lookout for hubris in those who are in leadership positions.
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Graduates, you deserve to be confident when you walk out the door today. After all, you have met the requirements for advanced degrees at one of the world’s premiere universities. And believe me when I say I want you to be confident.

But, as you accumulate your own successes, and as you attain positions of leadership – which, as Penn Staters, you are very likely to do – I implore you to be confident but not too confident. If we think of confidence levels on a 10-point scale, I want you – as a leader – to be a 7 or an 8, not a 10.

The more I learn about the successes and failures of executives, the more I agree with the wisdom of Andy Grove, the distinguished former CEO of Intel. He said, “Only the paranoid survive.”

And here’s my take on his advice: Be creative but careful. Be bold but also beware.

Now, one final word to the loved ones of our graduates here today. Moms, dads, brothers, sisters, spouses, partners… If your special grad starts getting a little too full of himself or herself – let’s say, for instance, they start wearing their stupendous academic robe around the house – just remind them of my message here today.

Congratulations to all of you.