The Impact Of The Overconfidence Bias

Alex Wellens
Nov 22, 2017 · 4 min read

Entrepreneurs are more susceptible to be influenced by an overconfidence bias than managers. But is it necessarily a bad thing?

A bias in a probabilistic reasoning is defined as a systematic divergence between a person’s judgment and a norm. The overconfidence bias refers to the tendency that some people have to overestimate the exactness of their first judgment as well as reassessing it when new information is brought up.

One of the most salient demonstration of the overconfidence effect is overplacement. It occurs when people rate themselves above others. For instance, Svenson found out through one of his research that 93% of American drivers rate themselves as better than the median.

So, why entrepreneurs tend to be more influenced by an overconfidence bias than non-entrepreneurs?

First of all, an entrepreneur usually faces a much more uncertain environment than a manager of a large organization. The simple desire to start a business requires a lot of decision-making for which there is little information available. In addition, actions to reduce uncertainty are generally costly and inefficient for entrepreneurs. As a result, an increased use of biases and heuristics facilitates the overall understanding of the market.

Also, the context in which entrepreneurs make decisions tends to be more complex than the context facing managers. Indeed, large organizations have generally developed rules and procedures that help managers when making choices. These “routines” practices can greatly reduce the complexity of decisions within large companies. Entrepreneurs do not have the chance to use these procedures. Therefore, using biases and heuristics usually allows them to make decisions that exploit opportunities in a short range of action.

If entrepreneurs use biases more extensively in their decision-making processes than managers of large organizations, it is mainly to save time and money.

Optimistic Martyrs

We tend to think that the overconfidence bias has an extremely negative effect on our society and it’s probably due to one of its best known consequence : the illusion of control that some investors may exhibit when it comes to the stock market. They overestimate what they know compared to what others know. Meaning they don’t act rationally anymore which can obviously lead to destructive situations.

But what we should also see is the positive impact that overconfidence may have.

It is no secret that most of new ventures fail. Everyone knows that and yet some crazy, foolish, delusional adventurers decide to start their own businesses. In a very insightful paper, Dosi and Lovallo define entrepreneurs as “Optimistic Martyrs”. It’s based on the observation of a “probabilistically poor but socially useful” bet that some individuals take in creating their new ventures.

Arnold Cooper, Carolyn Woo and William Dunkelberg conducted a study on 2994 entrepreneurs by asking them two very simple questions: “What are the chances of success of your business? And “What are the chances of success of another company similar to yours? “. On average, 81% of founders felt that their business had a great chance of success, but only 59% were as optimistic about another company although similar to theirs. Even more impressive, one out of three entrepreneurs said his project had a 100% chance of success.

We must then acknowledge that overconfidence is of interest when it comes to the initial decision of starting a new company. Those who have the courage to start new ventures are those who most overrate their abilities relatively to others’. And it is a good thing so it forces the entrepreneur to move forward with his project.

Overconfidence is the kickstart.

Obviously, being aware of the consequences that it may have on future decisions is paramount. Indeed, overconfidence has also been shown to impact many other aspects of the entrepreneurial life and proved itself to have important strategic implications.

It may influence negotiations.

It may bias profit forecasts.

It may change entrepreneurs’ response to new information.

It may affect how founders represent their company when facing strategic partners or potential customers.

Companies can definitely collapse when there is a substantial lack of congruence between the entrepreneur’s perception of the environment and the actual environmental context.

Therefore, it’s important to always keep in mind that we all tend to overestimate our knowledge and predictions. Nevertheless, it’s even more important to be fearless and overconfident so you and your company can stand out from the crowd.

“I’ll be in there as the big favorite. But I play my best in the finals, in the important matches. That’s why I’m number one. There’s no secret… I’m not overconfident, but very confident.” — Roger Federer

The Post-Grad Survival Guide

We're confused twenty-somethings, but we know the 9–5 isn't for us. Tips on blogging, freelancing, and building your side hustle. A good bit of life lessons and travel tips thrown in, too. Living life on our own terms.

Alex Wellens

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Aspiring Inspiring Human Being | Millennial | 25 | Belgian | Contributor To The Post-Grad Survival Guide, The Writing Cooperative and The Startup

The Post-Grad Survival Guide

We're confused twenty-somethings, but we know the 9–5 isn't for us. Tips on blogging, freelancing, and building your side hustle. A good bit of life lessons and travel tips thrown in, too. Living life on our own terms.