Confidence is a necessary trait in CEOs. It can help them to be decisive in taking risks, convey their vision and persuade others to follow them. But when confidence crosses the line into overconfidence, or hubris, it can put a firm at a disadvantage.

Researchers have shown that overconfident CEOs lead their firms to pay higher acquisition premiums, rely on internal rather than external financing, inflate estimates of payoffs and undertake value-destroying mergers.

All of this gives rise to the question of what the relationship is between CEO hubris and risk taking, and whether there are factors that can mitigate it. Jiaotao Li and Yi Tang step into this surprisingly under-researched area to investigate the phenomenon of CEO hubris in China.

"Risk-taking is fundamental to decision-making and has important implications for firm performance and survival. Yet little previous research has looked at how the psychological characteristics of top managers affect risk-taking by a firm, and the boundary conditions of such a relationship. The effects of managers' psychological biases have also not been examined in non-Western contexts, notably the collectivist context of China," they say.

The authors use surveys of 2,790 manufacturing firms in China in 2000 to show that CEO hubris does indeed increase firm risk-taking and that there are factors that can reduce this.

Hubris here is indicated by a CEO's over-evaluation of their firm's financial performance in the previous half-year as measured against return-on-assets. The authors found that the higher the hubris score, the more likely the firm was to engage in risk-taking behavior such as investing in new or high technologies.

This link was stronger when the CEO had more discretion, or leeway, to follow through on their decisions. Firms where the same person was CEO and chaired the board offered greater discretion, thereby intensifying the link between CEO hubris and firm risk-taking. Firms with more intangible resources, as measured by R&D intensity, also offered more discretion. But the effect was dulled in older firms and larger firms.

Market traits also affected discretion. If the market was "munificent" - able to support sustained growth as measured by average industry growth over the past five years - this increased CEO discretion. Similar effects were found when the market was competitive and heterogeneous, and when it was unstable and uncertain.

There were also effects due to the particular characteristics of firms in China. Politically-appointed CEOs had less discretion and so showed a weaker link between CEO hubris and firm risk-taking. State ownership had a similar though less pronounced effect.

The authors say the results show firms should take steps to ensure CEO hubris is kept in check.

"Confidence is necessary for CEOs and moderate confidence can help spur executives to achieve more than they otherwise might have done. But when the executives overreach and their egos inflate, the resulting hubris can have serious consequences. If a firm allows too much discretion to a CEO driven by an inflated ego, hubris can have strong impacts on firm decisions and outcomes and may lead to undue risk taking, which may significantly influence the firm's performance."

"In such situations, firms may need to arrange governance structures to monitor the overconfident behavior of their CEOs and to protect the firms from ego-based decisions, for example by vigilant boards of directors and the separation of board chair and CEO positions," the authors say.