April 20, 2024

Founder CEOs less likely to exaggerate their forecasts to investors than non-founder CEOs

CEOs who are also the founder of their company are less likely to over-exaggerate their forecasts to their existing investors than CEOs who did not found the company, according to new research from Vlerick Business School and KU Leuven.

Veroniek Collewaert, Professor of Entrepreneurship at Vlerick Business School and KU Leuven, and colleagues from Ghent University, University of Exeter, UNSW Business School, and KU Leuven, conducted a series of studies examining how CEOs present their forecasts to their existing investors. Forecasts allow entrepreneurs to present themselves more favourably to investors.

The first study involved the cooperation of a large European venture capitalist and looked at annual financial accounting information and financial predictions for all its portfolio companies. The researchers measured forecast bias by finding the difference between the annual forecasted and realised revenues of each company: the higher the bias, the more exaggerated the forecasting was.

Their findings showed that all entrepreneurs overestimate realised revenues in the next year by an average of 22%, however there is a difference between founder- and non-founder-CEOs. Founder-CEOs tend to overshoot realised revenues by around 15%, while non-founder-CEOs overshoot by 27%.

Professor Collewaert says,

“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 underdelivering may lead to a loss of trust and credibility.”

It is clear that entrepreneurs want to present the most favourable picture possible of the company’s future to maintain the support from their investors, hence all entrepreneurs on average overestimating their forecasts. However, a potential explanation for the difference between founder- and non-founder-CEOs is that non-founder-CEOs have shorter-term career goals so care less about how overshooting may impact relationships with investors. For founders, this is their life’s work so they have to balance being positive in their forecasts while not exaggerating too much, as they want strong long-term relationships.

This was shown in their second study where participants were put in the shoes of a founder- or non-founder-CEO of a company. They were then asked to provide a revenue forecast to investors and asked how important it was for them to be found trustworthy or credible. Founder-CEO participants reported stronger identification with the company, and also reported higher concerns around over-exaggerating and the effects of this on their relationship with the investor.

These findings illustrate considerations that motivate entrepreneurs to exaggerate their forecasts and how these differ depending on founder status of the CEO, suggesting investors may want to differentiate between founders and non-founders.

Also, investors are already aware that entrepreneurs can be overly optimistic and consider this when receiving forecasts: Silicon Valley venture capitalist Guy Kawasaki has said that he reduces forecasts by multiplying by 0.1 which is a 90% reduction. Our findings however suggest investors should apply a substantially smaller discount of around 20%.