Selling to Overconfident Customers: The Impact on Operating Risk

Abstract

Research has shown that firms with overconfident CEOs are more likely than others to overinvest because of an unrealistically optimistic estimate of their firms’ future performance. We argue that such managerial biases in customer firms could bias upstream supplier firms’ estimation of future sales, which could lead them to a higher level of investment in productive assets as well as exposure to a higher level of operating risk. We find strong evidence to support this argument, especially when customers invest intensively in capital and perform mergers and acquisitions, and also when they possess high market power. Such effects are mitigated, however, when the economic importance of the supplier-customer relationship increases. The results are robust using OLS regressions and firm fixed effects with controls of various firm-specific and relationship-specific characteristics.