Managers are senior persons, who are empowered to take decisions for the smooth functioning of a company. At the same time, they are accountable for their actions. However, overconfidence and decisions, not backed by sound reasons, could result in risks with potentially disastrous consequences for the company.

Financial resources are very important for every company. The source of funds could be internal or could be external, such as borrowings etc. There is always a cost-return analysis of funds that has to be considered, before taking decisions relating to investment. The investment by a company could be in a new business, in expanding the existing business, in research and development, or in treasury (which in turn will invest it in different places). Some companies that have surplus cash, but do not have an immediate investment in business, also park them with their banks. Cost associated with funds could be either the cost of borrowed funds, when borrowed from external sources, or the cost of not deploying them in one investment, but choosing another one. Another important decision to be taken is the time horizon within which return is expected.

Consequently, finance is one of the most important functions of a company. It helps in deciding the strategy for business’s investment decisions, both for the present and for the future. This strategy helps in deciding the course of business, both in the short term and long term, as also deciding on the competitive advantage that a business would have.

Decisions for investment should ideally be based on a number of factors. These include operations and requirements of the company, company’s future plans, return, investment tenure, need for investment in research and development, and the risk taking ability of the company, to name only a few.

The problem arises when one or more managers in a company become overconfident about decisions, and try to short circuit the process of decision-making or decide impulsively. This could result in decisions which are not backed by adequate research on the need of the company. It could also result in taking risks, which are beyond the risk appetite of the organization. Greed, self interest or ignorance could also result in overconfidence.

One of the time tested methods of addressing overconfidence at the managerial level is accountability. Investment decisions of the company require Board approval. The Board should ensure that the company has systems in place by which decisions relating to financial investments come to it for approval. The relevant agenda notes should contain proper, detailed, and complete analysis of the need for such an investment, along with projections for return. It should also contain alternative avenues for investment, so that the Board can take an informed decision on where and how to deploy funds. There should also be a mechanism for accountability, by which persons who have presented the investment, are held accountable for the projected returns at the end of the project, unless the results are unduly influenced by unanticipated externalities. The Board should also ensure that proper checks and balances are in place to prevent incidents of personal greed being the basis of a decision.

Financial viability of any business decision is paramount to ensure that the company continues to operate effectively. At the end of the day, owners, including retail shareholders, desire return on capital. There exists a thin line between confidence and over confidence. It is the role of the Board to ensure that the processes created by them prevent overconfidence.

Ekta Mishra