Published on 26 January 2022
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Restraining overconfident CEOs through credit ratings

Credit ratings can be helpful in restricting the overinvestment behaviour stemming from overconfidence bias, say researchers led by Patrycja Klusak.

“Human minds are overconfident machines,”  David Brooks wrote in The Social Animal.

Overconfidence is known to skew human judgement and cause problems including legal disputes, stock market bubbles, high rates of entrepreneurial failure, failure of corporate mergers and acquisitions (M&As), and much more – even wars. (Bazerman and Moore, 2013)

Bias from overconfidence is a natural and an insidious human state (Griffin and Varey, 1996). In an interview with The Guardian, the psychologist and bestselling author of Thinking, Fast and Slow – Daniel Kahneman – admitted that if he had a magic wand, he would eliminate this trait.

Nevertheless, we might expect that Chief Executive Officers (CEOs) behave rationally and base their decision making about matters of business on facts, statistics, and sound logic. However, this may not always be the case. Despite the level of responsibility and expectations regarding their decision-making process, CEOs are just as likely to succumb to irrational behaviour as anyone else. Just think of the large number of failed acquisitions, as one illustration.

Overconfident CEOs may not only take riskier business decisions, but also they may downplay the riskiness of investments and overestimate their potential future value. Such (mis)judgements might result in overinvestment behaviour that could be detrimental to company’s value and its long-term success, particularly if the company has access to large internal capital and debt capacity (Malmendier and Tate, 2008). In the worst cases, such overinvestment behaviour could lead the company to fail.

How might such damaging over-confidence be tackled? One possibility is that credit ratings might be a disciplining mechanism. Credit rating agencies (CRAs) act as financial intermediaries, enabling firms, investors and shareholders to overcome market information asymmetries by issuing assessments about the ability of issuers to meet their repayment obligations on corporate debt. Corporate credit ratings are of utmost importance in key decisions. At the same time the strategies undertaken by firms can potentially affect their ratings, influence their cost of capital and their access to the external capital markets (Graham and Harvey, 2001). In fact, a relatively high rating might relax firms’ financial constraints, allowing them to undertake more investment through debt financing (Aktas et al., 2021).

M&As are often perceived to be worthwhile for companies, allowing for growth by integrating two companies and exploiting synergies (Renneboog and Vansteenkiste, 2019). That, at least in theory, reduces credit risks while improving profitability. However, M&A transactions negatively impact credit ratings of acquiring firms through increased credit risk (Furfine and Rosen, 2011, Vallascas and Hagendorff, 2011). Interestingly, the higher the rating of the acquiring firm, higher the risk of its being downgraded after an acquisition deal (Aktas et al., 2021).

In our research, we look at the potential rating downgrades following acquisition activity, to address the following questions: Do overconfident CEOs make more mergers and acquisitions as firms’ ratings improve? Do overconfident CEOs overinvest, if they have access to abundant internal funds and large debt capacity, even while aware of the downgrade risk? Could the pressure arising from a potential rating downgrade make overconfident CEOs reduce M&A investments when their firms’ initial rating is high?

To identify the impact of credit ratings on overconfident CEOs decision making, in our new working paper we utilise a sample of 916 US companies rated in the period 2006 and 2019. We find that overconfident CEOs engage in more acquisition activity than rational CEOs at low corporate rating levels, but the opposite behaviour is found at high rating levels, when overconfident CEOs engage in less acquisition activity than rational CEOs. We find a reduction of $12.43 billion in M&A investments for each one credit rating notch increase in the firms’ credit ratings. This holds true regardless of the choice of financing method for the acquisition. One possible reason for the reduced level of M&A activity is that overconfident CEOs do become more cautious about making such investments due to concerns of losing their high credit rating.

Consistent with this, we find that company share prices increase following the M&A announcements made by overconfident CEOs in firms with high credit ratings. Our results suggest credit ratings are a disciplining mechanism on overconfident CEOs, limiting their over-investment, especially in case of firms with abundant resources and large debt capacity. Credit ratings can be helpful in restricting the overinvestment behaviour stemming from overconfidence bias.


Aktas, N., Petmezas, D., Servaes, H., & Karampatsas, N. (2021). Credit ratings and acquisitions. Journal of Corporate Finance, 69, 101986.

Bazerman, M. H., & Moore, D. A. (2013). Judgment in managerial decision making (8th ed.). New York: Wiley.

Furfine, C. H., & Rosen, R. (2011). Mergers increase default risk. Journal of Corporate Finance, 17(4), 832–849.

Graham, J. R., & Harvey, C. R. (2001). The theory and practice of corporate finance: evidence from the field. Journal of Financial Economics, 60, 187-243.

Griffin, D. W., & Varey, C. A. (1996). Towards a consensus on overconfidence.  Organizational Behavior and Human Decision Processes, 65(3), 227-231.

Malmendier, U., & Tate, G. (2008). Who makes acquisitions? CEO overconfidence and the market’s reaction. Journal of Financial Economics, 89(1), 20–43.

Renneboog, L., & Vansteenkiste, C. (2019). Failure and success in mergers and acquisitions. Journal of Corporate Finance, 58(C), 650–699.

Vallascas, F. & Hagendorff, J. (2011). The impact of European bank mergers on bidder default risk. Journal of Banking & Finance, 35, 902-915.


The views and opinions expressed in this post are those of the author(s) and not necessarily those of the Bennett Institute for Public Policy.


Patrycja Klusak

Dr Patrycja Klusak

Affiliated Researcher

Dr Patrycja Klusak is an Associate Professor at Norwich Business School at University of East Anglia and an Affiliated Researcher at Bennett Institute for Public Policy at the University of...

Shee Yee Khoo

Shee Yee Khoo is a Lecturer in Finance at Bangor University. Her research areas of interest are corporate finance, behavioural finance and credit ratings.

Dr Thanos Verousis

Dr Thanos Verousis is a Reader in Finance at Essex Business School. He specialises in the study of financial markets and market microstructure. His main contribution is understanding investor behaviour...

Dr Huong Vu

Dr Huong Vu is a Lecturer in Finance at University of Aberdeen. She joined the University of Aberdeen in September 2018. Prior to that, Dr Huong Vu had three years...

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