- New research has discovered a difference in over-exaggeration to investors between non-founder and founder CEOs
- Founding CEOs over-exaggerate by only 15% in forecasts to investors, whereas non-founder CEOs aver-exaggerate by 27%
- Non-founding CEOs ‘lack of long-term goals’ and ‘disregard for future investor relations’
In 2015, when Toshiba’s CEO Hisao Tanaka reported the company’s operating profit to investors as an amount that was 151.8bn yen over their actual profits, investors had no reason to be suspicious. After all the company was successful, and the business was trading well. Little did they know at the time, Tanaka had been overstating the company’s profits by almost triple the actual amount.
This overstating went on for over six years, with investors being none the wiser, and why would they be?
No one expects a CEO to lie to their investors, but new research suggests that perhaps investors should be more cautious of encountering over-exaggerating CEOs, especially if these CEOs are not the founder of their company, like Hisao Tanaka.
The research, conducted by Vlerick Business School and KU Leuven both in Belgium, found that the humble founder who set up their business completely from scratch is 12% less likely to exaggerate to their investors than an externally hired CEO. Not only this, but founder-CEO participants in their study also reported higher concerns around over-exaggerating and the effects of this on their relationship with the investor, proving to be much more trustworthy.
The researchers examined annual financial accounting information and financial predictions for a large European venture capitalist’s portfolio of companies. They were able to measure the forecast bias by identifying the difference between the annual forecasted and realised revenues of each company: the higher the bias, the more exaggerated the forecasting was.
Of course, investors are already aware that entrepreneurs can be overly optimistic in their forecasting particularly when they want to impress investors. Silicon Valley venture capitalist Guy Kawasaki even said that he considers this when receiving forecasts and reduces forecasts by multiplying by 0.1 which is a 90% reduction. The findings of the study suggest that Mr Kawasaki’s view may be a little cynical, and a smaller reduction of around 20% would be more appropriate.
Professor Veroniek Collewaert, lead researcher of the study, suggests that this extreme over-exaggeration could hinder many entrepreneurs. “There is a fine line between presenting oneself favourably and outright lying. Entrepreneurs are aware of the potential cost of providing overly-biased forecasts as investors’ value accuracy and credibility. They know investors expect to see high forecasts, but they also know that overpromising and then under delivering may lead to a loss of trust and credibility,” she says.
Prof. Collewaert believes there could be a number of reasons as to why there is a difference between the over-exaggerations. Though all entrepreneurs exaggerate according to the study, founder CEOs are much more attached to their company, given it is their own project, meaning they can be more focused on seeing it through as a long-term initiative and not just looking to the short-term for funding. With non-founding CEOs lacking long-term goals, and much more likely to leave the company and move to a different project, they often are happy to focus on earning as much money from investors as possible in the short-term.
Also, given founder-CEOS having a much more long-term vision, they are more likely to want to ensure they deliver on their promises to investors, and maintain strong long-term relationships by hitting their forecasts and milestones.
Prof. Collewaert says, “Relationships can be strained between entrepreneurs and investors if investors feel they’ve been lied to, and that entrepreneurs are not hitting their targets of growth or profit – hence, many founding CEO entrepreneurs who have a long-term strategy for their companies may be more cautious and conservative in their forecast predictions.”
Perhaps if this research was available prior to 2015, Toshiba’s investors would have discovered the forecast tampering a lot earlier, and Tanaka wouldn’t have been able to exaggerate forecasts for over six years. For CEOs, it seems a given, but it’s probably sound advice to try not to over-exaggerate your forecasts. After all, you won’t have long-term success or strong relationships with their investors if you constantly dramatically over-exaggerate to them.