Animal Spirits and Extreme Confidence: No Guts, No Glory?

This study investigates to what extent extreme confidence of either management or security analysts may impact financial or operating performance. We construct a multidimensional degree of company confidence measure from a wide range of corporate decisions. We empirically test this measure for large US companies from 1980 -2008 and find significantly different company and performance characteristics between confidence extremes. Diffident firms tend to be smaller, more distressed, less conservatively financed and, except for the new millennium, yield a lower return on invested capital with higher variability. When adjusting stock returns for risk, the performance differences prior to moving to extreme confidence become even more pronounced. Extreme confidence could also distort earnings forecasts as analyst may overly rely on an anchor or make insufficient adjustments. Innate bias, anchoring to prior year earnings, risk attitude and responses to recent news are conditional on the level of analysis. Innate optimism prevails on the industry and analyst level. We find no support for anchoring by analysts with a long track record or across industries, which suggests a bottom-up approach. Long-term risk is considered as upside and short-term risk as downside potential. There is also a tendency to underreact to news, the extent of which seems conditional on the direction.

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