Why Investors Bet On Humble Leaders

Financial analysts consistently undervalue the performance of humble executives. This creates an easily exceeded 'expectation discount' which such leaders - and unbiased analysts - can use to outperform their rivals.

And it illustrates how perceptions can mislead some while giving others the opportunity to optimize results. JL


Matthew Kassel reports in the Wall Street Journal:

Humble CEOs benefit from an “expectation discount,” which can lead to increased market returns for their companies. Analysts underestimate the earnings potential of companies run by humble chief executive officers. That leads to artificially low earnings forecasts, which the firms can more easily beat. The effect could result in a 7% increase in total shareholder returns annually. Analysts might be unaware that their own psychological biases affect how they appraise companies. There could be an opportunity for traders to engage in arbitrage if they can identify humble CEOs. “We’re always influenced by our perceptions of others.”
Humble CEOs don’t inspire much confidence among financial analysts—but that might be good news for people who invest in the CEOs’ companies.

A new study accepted for publication in the Strategic Management Journal found that analysts tend to significantly underestimate the earnings potential of companies run by humble chief executive officers. That leads to artificially low earnings forecasts from the analysts, which the firms can then more easily meet or beat.
While humble CEOs aren’t any more or less capable leaders than their more brash peers, they tend to benefit from an “expectation discount,” which can lead to increased market returns for their companies following earnings announcements, says Federico Aime, a professor of management at the Oklahoma State University’s Spears School of Business and one of the study’s authors.
The paper found that the magnitude of the boost depended on how humble the CEO was, but that the effect could result in at least a 7% increase in total shareholder returns annually.
The researchers—who also included Tessa Recendes, an assistant professor of management and organization at Pennsylvania State University’s Smeal College of Business; Oleg Petrenko, an assistant professor of management at Texas Tech University’s Rawls College of Business; and Jeffrey Chandler, an assistant professor of management at Western Kentucky University—focused on a sample of 185 CEOs culled from firms in the S&P 500 between 2000 and 2013. To measure humility, they recruited senior undergraduate students, as well as experts in psychology, to rate videos in which the CEOs appeared, using a scale that includes such characteristics as modesty, fairness and sincerity.
Experts say the study is a novel contribution to the academic literature on senior executives and their effect on organizational outcomes. “I like the central conceit, which is the idea that humble CEOs underpromise and overdeliver,” says Craig Crossland, an associate professor of business at the University of Notre Dame’s Mendoza College of Business, whose research focuses on strategic management.
But Dr. Crossland points out some inherent challenges associated with the research. For example, the video survey isn’t measuring humility, per se, but “independent observers’ perceptions of humility based on a pretty small snippet of information,” he says. “That creates bias.”
Still, there are lessons to be drawn from the study, says J.P. Eggers, an associate professor of management and organizations at New York University’s Stern School of Business and an editor of Strategic Management Journal.
From an investing perspective, he says, there could be an opportunity for traders to engage in arbitrage if they can identify humble CEOs on their own. It would require buying stock after analysts issue forecasts for those companies and selling it when the numbers beat expectations. Because the research shows that humble CEOs tend to outperform expectations on average, he cautions that employing this strategy on a single investment might not be wise.
Dr. Aime, meanwhile, says analysts themselves might benefit most from reading the study, as they might be unaware that their own psychological biases can affect how they appraise companies and the CEOs that lead them.
“We’re always influenced by our perceptions of others,” he says.