What it means
The word comes from ancient Greek, where it described arrogance that offended the gods and led to a downfall. In modern business it describes a mindset in which a leader believes past success guarantees future success.
The belief shuts out criticism and makes warnings seem like timidity. In corporate finance, the best-known use is the hubris hypothesis of takeovers, proposed by the economist Richard Roll in 1986.
It suggests that acquiring managers overestimate their ability to improve the target and therefore pay too much. Studies of acquisitions have often found that the buyer's shareholders gain little or lose value, which is consistent with this idea.
Hubris tends to appear after a run of wins. A chief executive who has made three good deals starts to believe the next one cannot fail, so the board approves a larger and riskier transaction with less scrutiny.
The more a leader is praised, the harder it is for colleagues to disagree. Several habits help to counter it.
Boards can require an independent valuation, appoint a devil's advocate (someone assigned to argue against a proposal), and set walk-away prices before negotiations begin. Post-deal reviews that compare the original forecasts with actual results also keep leaders honest.
Hubris also shows up in everyday finance work, not only in headline deals. Analysts who fall in love with their own forecasts, managers who hide bad news to protect a record, and founders who spend ahead of revenue all display it.
Because the damage builds slowly, it is often visible in hindsight only. Hubris should not be confused with healthy confidence.
Entrepreneurs need to believe in their plans, and decisive leadership has real value. The line is crossed when belief replaces evidence, when risk limits are ignored and when people who raise concerns are sidelined.
In practice
Real-world examples.
Example
A retail chain with ten profitable years behind it buys a rival for $400,000,000, well above its advisers' valuation range. The chief executive says his team can fix the rival's problems quickly. Two years later the stores are still losing money and the group writes down $150,000,000 of the purchase price.
Example
A hedge fund founder who has beaten the market for five years raises his leverage (the level of borrowing) and ignores a risk officer's request to cut positions. A sudden market move wipes out 40% of the fund in a month.
Example
A technology start-up founder refuses to take advice from an experienced director about cash management, insisting that rapid growth will solve everything. The company runs out of money before the next funding round closes.
Formula
Calculation
Value destroyed by overpaying = Price paid - (Standalone value of target + Realistic synergies)
Suppose a target company has a standalone value of $100,000,000 and a careful analysis finds realistic synergies (extra value from combining the businesses) of $10,000,000. The most the buyer should pay is $100,000,000 + $10,000,000 = $110,000,000. If an overconfident chief executive pays $140,000,000 after a bidding contest, the overpayment is $140,000,000 - $110,000,000 = $30,000,000. That sum comes out of the buyer's shareholders' pockets unless the synergies turn out to be far larger than the careful analysis predicted.Case study
Seen in the real world.
Falcon Ridge Industries is an illustrative, fictional manufacturing group led by a charismatic chief executive who had completed four acquisitions in six years. Each had been celebrated in the press, and the board began to defer to his judgement without asking for detailed models.
When a fifth target came up, he insisted on a bid of $250,000,000, even though advisers valued it at $180,000,000 including synergies. He dismissed a junior analyst's warning that the target's largest customer was about to leave, and the bid was approved in a single meeting.
In this illustrative story the customer did leave, revenue fell by 20% and the group took a $90,000,000 write-down. A new chair introduced rules requiring an independent valuation and a walk-away price for every deal over $50,000,000. The lesson is that confidence needs a counterweight, and the right time to build one is after the successes, not after the failure.
Watch out
Common mistakes.
- Assuming that past success proves a leader's judgement, when it may reflect luck, timing or a favourable market.
- Treating dissent as disloyalty, which stops useful warnings reaching the decision-makers.
- Confusing hubris with confidence, when the key difference is whether the belief is backed by evidence and open to challenge.
Questions
People also ask.
What is the hubris hypothesis?
It is Richard Roll's 1986 idea that acquirers overpay because their managers overestimate their own ability to create value from a target.
How can a company guard against hubris?
It can use independent valuations, pre-agreed walk-away prices, devil's advocates and post-deal reviews that compare forecasts with results.
Is hubris the same as overconfidence bias?
They are closely related, but hubris usually refers to overconfidence combined with arrogance, often in leaders who have been successful.
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