In an era where corporate mergers and acquisitions (M&A) are pivotal growth strategies, understanding the cognitive biases that influence executive decision-making has drawn increasing attention. Recent research uncovers a compelling mechanism through which credit rating agencies can act as effective external monitors, curbing the sometimes reckless behavior of overconfident chief executives. Traditionally viewed as mere indicators of financial stability, credit ratings are now revealed to significantly shape the strategic risk-taking behavior of CEOs, especially during consequential M&A activities.
The study, spearheaded by researchers from Bangor University in Wales along with collaborators from Heriot-Watt University, Vlerick Business School, and the University of Aberdeen, delves deeply into the intersection of executive psychology and corporate finance. Analyzing longitudinal data covering 916 U.S. firms rated by the renowned credit ratings agency Standard & Poor’s (S&P) over a thirteen-year period, the research illuminates how fluctuating creditworthiness can recalibrate executive ambitions. Credit ratings, it turns out, do more than assess default risk—they actively influence managerial risk appetites by either emboldening or restraining CEOs according to the company’s credit standing.
A key revelation of the research is that overconfident CEOs, known for their optimistic and sometimes unrealistic assessments of investment outcomes, tend to increase acquisition attempts when their firms’ credit ratings improve from lower tiers. This behavioral amplification stems from lower borrowing costs detected through better credit ratings, which provides executives with greater financial flexibility and confidence to pursue expansion. However, this dynamic reverses sharply when the specter of a downgrade looms, particularly when a company faces slipping from investment-grade status into speculative-grade territory. In these instances, overconfident executives exhibit markedly more caution than their more rational peers, fearing the consequent restriction in access to affordable debt.
This risk-averse shift is profoundly significant because it demonstrates how external financial institutions, beyond conventional board oversight and governance structures, exert tangible influence over managerial decision-making. As the lead author, Dr. Shee-Yee Khoo of Bangor University’s Business School explains, the “threat of credit rating downgrades raises the stakes for CEOs, effectively compelling even those with inflated confidence levels to reconsider hasty acquisitions.” This finding challenges and extends traditional understandings of corporate governance mechanisms by incorporating the nuanced psychological interplay between managerial confidence and financial market signals.
The implications of these findings are especially pertinent given the dual role CEO overconfidence plays in corporate strategy. On one hand, confident leadership can incubate innovative ventures, bold strategic pivots, and visionary long-term planning. Yet on the other hand, unchecked overconfidence frequently results in miscalculated risks, value-destroying acquisitions, and managerial hubris. Professor Patrycja Klusak from Heriot-Watt University, an expert on credit agencies, emphasizes this dichotomy, noting that the behavioral adjustments linked to credit rating pressures highlight the ratings agencies’ powerful regulatory function in contemporary finance.
Moreover, the research underscores a structural gap in current governance practices where traditional mechanisms—such as board oversight or shareholder activism—might not suffice to temper the strategic overreach of CEOs. Professor Thanos Verousis of Vlerick Business School asserts that credit ratings act as a critical “external control mechanism,” safeguarding firm value by providing real-time, market-based feedback to executive leaders. This becomes particularly vital as complex M&A transactions, which inherently carry considerable risk, continue to shape corporate trajectories and investor returns globally.
Further insights emerge from Dr. Huong Vu of the University of Aberdeen, whose contributions highlight how these rating-induced behavioral shifts are integrally linked to executives’ debt management strategies. Overconfident managers, inclined to view their company’s equity as undervalued, preferentially leverage debt financing over equity to fund investments. This proclivity intensifies their sensitivity to credit ratings, which directly affect access to low-cost debt. Consequently, rating agencies not only act as financial health barometers but also function as strategic gatekeepers, indirectly steering CEOs toward more prudent investment policies.
Underlying this complex dynamic is the well-documented tendency among overconfident CEOs to overestimate their capacity to create value and to underestimate associated risks. Such cognitive biases propel them into intricate, high-stakes transactions that can jeopardize corporate sustainability. The study’s granular data-driven approach reveals that credit rating adjustments can serve as pivotal inflection points, modulating CEO behavior and hence influencing firm-level outcomes. The researchers’ meta-analysis confirms that firms with leadership exhibiting high confidence become acutely responsive to credit rating signals, adjusting acquisition activity accordingly to preserve access to affordable capital.
This research also contributes to a broader understanding of corporate finance by drawing attention to the subtle psychological and institutional factors shaping risk-taking beyond quantitative financial metrics. As markets grow increasingly complex, the interplay between executive psychology, credit market assessments, and firm strategy becomes an indispensable area of scholarly inquiry. Companies and policymakers alike stand to benefit from recognizing and harnessing the protective influence exerted by credit rating agencies as non-traditional monitors of managerial conduct.
Ultimately, this pioneering study instills renewed respect for credit rating agencies, situating them not just as evaluators of default risk but as active participants influencing how CEOs make one of the most consequential decisions—whether and when to pursue mergers and acquisitions. As M&A continues to be a cornerstone of corporate strategy worldwide, these findings invite further exploration into how external financial signals integrate with human factors to shape the corporate landscape.
This groundbreaking work, published in the journal European Financial Management, sets a new benchmark for interdisciplinary research blending corporate finance, behavioral economics, and governance. It signals promising avenues for future investigations into how financial institutions can help align CEO incentives with long-term shareholder value and corporate stability. By revealing credit rating agencies’ capacity to temper managerial overconfidence, the study offers both an innovative perspective and practical implications for improving corporate decision-making governance.
Subject of Research: The influence of credit ratings on restraining overconfident CEOs, focusing on acquisition behavior and managerial risk-taking during mergers and acquisitions.
Article Title: Restraining overconfident CEOs through credit ratings
News Publication Date: 12-May-2025
Web References:
https://doi.org/10.1111/eufm.12557
Image Credits: Heriot-Watt University
Keywords: Economics, Finance
