Avoiding the Pitfalls of Overconfidence

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Overconfidence Pitfalls


Avoiding the Pitfalls of Overconfidence while Benefiting from the Advantages of ConfidenceAlex B. Van Zant Don A. MooreSuccessful leadership depends on the confidence to rally support, win allies, and deter competitors. However, overconfident leaders have led their companies into disaster. This article identifies the circumstances in which leaders are most prone to overconfidence and its concomitant risks. On the flip side, it explores those circumstances under which confidence is most conducive to success. Using insights from recent research, the article provides recommendations on how managers can avoid the pitfalls of overconfidence while benefiting from the advantages of confidence. (Keywords: Decision making, Entrepreneurship, Investments, Leadership, Organizational behavior, Securities trading, Startups)eading up to its 2008 economic collapse, Icelands small economy, once dominated by rugged fisherman, came to be run by confident young investment bankers armed with degrees from American business schools. Taking lessons from the American banking industry, they borrowed money to purchase foreign companies they had no idea how to manage. Soon, Icelandic bankers were trading assets with each other and inflating their value in the process, creating the illusion that Icelandic banks were profiting. However, as Michael Lewis explains in his best-selling book Boomerang, many believed that their apparent success revealed something profound:Icelandersor at any rate Icelandic menhad their own explanations for why, when they leapt into global finance, they broke world records: the natural superiority of Icelanders. Because they were small and isolated, it had taken 1,100 years for themand the worldto understand and exploit their natural gifts, but now that the world was flat and money flowed freely, unfair disadvantages had vanished.1LThe authors would like to thank Linda Dong and Joe Mazzella for their help in finding examples of overconfidence. The first author would also like to thank California Management Review for financial support during his second year of graduate school.CALIFORNIA MANAGEMENT REVIEWVOL. 55, NO. 2WINTER 2013CMR.BERKELEY.EDU5Avoiding the Pitfalls of Overconfidence while Benefiting from the Advantages of ConfidenceIcelandic bankers believed they were successful due to their natural superiority. Their belief proved self-fulfilling for a time. However, when foreigners who had invested in Icelandic banks started Don A. Moore is an Associate Professor in to doubt the Icelandic miracle and tried to cash out, the Management of Organizations group the value of these banks fell precipitously. Within a as well as a Barbara and Gerson Bakar short time, the major Icelandic banks failed and Faculty Fellow at the Haas School of Business, UC Berkeley. took the small countrys economy down with them. The overconfidence of bankers had blinded them to their own limitations and the size of the risks they had taken.Alex B. Van Zant is a Ph.D. student in the Management of Organizations group at the Haas School of Business, UC Berkeley.It is easy to think of other business lessons that parallel the Icelandic parable. Whether America Onlines 2000 acquisition of Time Warner, the housing boom of the 2000s, or the inflation of the dot-com bubble in the late 1990s, overconfidence has accompanied many of the most dramatic business follies. Analysts, journalists, and academics correctly highlight the role of overconfidence in helping set the stage for many calamities. Some have even argued that no problem in judgment and decision making is more prevalent and more potentially catastrophic than overconfidence.2 Indeed, the effects of overconfidence are routinely evident in many different forms. Overconfident plaintiffs and defendants overestimate the chances of a favorable court judgment and resist settling early.3 Their overconfident attorneys perpetuate the conflict by encouraging these beliefs. Likewise, overconfident investors trade assets too much, sure that they have the distinctive insight that allows them to predict the next big investment opportunity.4 Indeed, scholars have gone so far as to claim that overconfidence is perhaps the most robust finding in the psychology of judgment.5 In this article, we discuss the causes and consequences of overconfidence as identified by research, much of which was conducted in experimental laboratories. However, in an effort to illustrate the impact of overconfidence beyond the laboratory, we have identified many examples from the business world where overconfidence was important. A problem with such examples is that, as with the Icelandic bankers story, we identify overconfidence after we have observed results that reveal an initial judgment was overconfident. Selecting instances in which actors appear overconfident runs the risk of inferring overconfidence when bad luck is more to blame. The most persuasive way to address this concern is by studying overconfidence in the research laboratory where we can make stronger conclusions about causation. We base our arguments here on research and employ examples from outside the lab for the purposes of illustrating phenomena that have been demonstrated in empirical research. By using both, we show that the evidence has practical implications for managers. We begin by highlighting the adverse consequences of overconfidence for investors, managers, and entrepreneurs. However, overconfidence is far from universal, and we identify the situations in which it is most likely to be a problem.6 We then consider the other side of the overconfidence coin and discuss some advantages of displaying confidence. The display of confidence is useful for leaders who wish to gain stature, credibility, and influence. Finally, we will provide recommendations6UNIVERSITY OF CALIFORNIA, BERKELEYVOL. 55, NO. 2WINTER 2013 CMR.BERKELEY.EDUAvoiding the Pitfalls of Overconfidence while Benefiting from the Advantages of Confidencefor how to best avoid the pitfalls of overconfidence while taking advantage of the benefits to expressing confidence. Whether the goal is to simply improve ones decisions or to enhance the effectiveness of ones organization, these recommendations are simple to implement yet effective. However, we must first be clear about what we mean by overconfidence. Overconfidence has basically been studied in three ways.7 The first is overestimation: thinking that youre better than you actually are. The second is overplacement: thinking that youre better than others when youre not. The third is overprecision: being too sure you know the truth. The first two are obviously related, and on any given task they are often correlatedbut they are not the same. To understand the difference, it is worth considering how different forms of overconfidence relate to individuals willingness to engage in competition.What Drives Market Entry Decisions?In a recent study, Cain, Moore, and Haran tested what kind of overconfidence has the greatest effect on competitive entry decisions.8 Participants in their study completed two tests of skill: an easy quiz and a difficult quiz. After taking both quizzes, each participant was informed that he or she was one of forty contestants competing for prizes that would be awarded on the basis of a raffle in which tickets were earned according to relative performance (i.e., the top person ranked out of 40 would receive 40 tickets while the bottom ranked person would receive only 1 ticket). Participants were given a choice to enter one of two contests: one that used their score on the easy quiz to determine ticket allocation and another that used their score on the difficult quiz to determine ticket allocation. For each participant, one contest had a prize of $45 while the other had a prize of $90. The researchers varied whether the big prize went with the easy quiz and the little prize went with the difficult quiz, or vice versa. Once participants had indicated which contest they would like to enter, they estimated their performance on each quiz and then estimated how others would perform. The results revealed that the easy quiz prompted excess entry whereas the difficult quiz produced insufficient entry. This was driven by the fact that the average participant tended to believe that he or she was better than others on the easy quiz but worse than others on the difficult quiz. Of course, this logic is wrong because people are, on average, average. Because the easy quiz was so popular, the average participant who entered earned only half as much as those who chose the difficult quiz. In fact, entering the easy quiz raffle earned participants less money even when the easy quiz came with a $90 prize and the difficult quiz only came with a $45 prize. Interestingly, participants who entered the easy raffle did not overestimate their performance on the easy quiz any more than participants who entered the difficult raffle. This evidence is strongly suggestive that when people make decisions to enter competitive markets, their decisions are guided more by overplacement than by overestimation. Given the relevance of overplacement in business contests, this article focuses on overplacement rather than overestimation or overprecision.CALIFORNIA MANAGEMENT REVIEWVOL. 55, NO. 2WINTER 2013CMR.BERKELEY.EDU7Avoiding the Pitfalls of Overconfidence while Benefiting from the Advantages of ConfidenceTABLE 1. Expected Participant Earnings by Raffle Prize Condition and Market EntryEasy Quiz Raffle Entry$45 Easy, $90 Difficult $90 Easy, $45 Difficult Mean expected earnings $1.76 $3.21 $2.52Difficult Quiz Raffle Entry$6.21 $3.75 $5.09Note: Results as reported in Experiment 1 of Cain et al. (2012)Adverse Consequences of Overplacement in Market SettingsThough the study discussed above examines entry into a simple laboratory contest as opposed to a more complex business market, the decision to enter a market for an uncertain prize involves many of the same decision processes as entering any other kind of competitive market. Potential entrants must assess their own capabilities and compare themselves to the competition. Then, they must assess their own risk tolerance, as chance factors may lead to unfavorable outcomes even for the most capable competitors. At the most fundamental level, entering any kind of market is no different from claiming your share of raffle tickets and hoping that fortune favors your success. When people overplace themselves or their organizations relative to the competition, they are prone to inflating their chances of success.Investment DecisionsOverconfidence leads people to make mistakes in allocating their investments. Although index funds allow people to diversify their risk, avoid transaction fees, and save their own valuable time, they often decide to manage their portfolios more actively by regularly trading assets. Presumably, those who are ready to invest their own time and money into maintaining an actively managed portfolio must have faith in their ability to outsmart the market. If they were accurate in their perception that they could beat the market, then one would expect these investors who actively manage their portfolios to outperform the market. However, Terrance Odean concluded that many investors trade too much.9 They spend their time and energy searching for investments that, on average, underperform the market. In a related study, Barber and Odean reported that from 1991 to 1996, the average household turned over 75% percent of its portfolio annually and earned 1.5% lower annual returns than the market index. The top 20% of households in terms of turnover earned annual returns that were 7.1% lower than households in the bottom 20% in terms of turnover. In the words of the authors, trading is hazardous to your wealth.10 Or in other words, overplacing your ability to forecast stocks is hazardous to your wealth.Corporate MergersOverconfident individuals make decisions that not only are detrimental to their personal finances, but to the finances of their organizations. When the key decision makers in a firm overplace their abilities relative to those of the management teams of other firms, they become more likely to believe they could better manage8UNIVERSITY OF CALIFORNIA, BERKELEYVOL. 55, NO. 2WINTER 2013 CMR.BERKELEY.EDUAvoiding the Pitfalls of Overconfidence while Benefiting from the Advantages of Confidencethe other firms. Indeed, Malmendier and Tate found that overconfident CEOs were more likely to engage in mergers.11 After ruling out alternative explanations for their findings, the authors concluded that CEOs who are overconfident in their ability to beat out the competition and earn future returns for their companies are more likely to engage in mergers than well-calibrated CEOs. As the result of engaging in too many mergers, these overconfident CEOs lose value for the shareholders of their firms, including themselves. Every company ought to be worried about the potential for overconfidence among managers at the top. After all, the way people get to the top is by having a career in which they both perform well and are favored by fortune. Top managers often express great faith in the quality of their own intuitive judgment, and indeed they have a careers worth of success to support that faith. However, while their skill may endure, the good fortune that helped put them at the top will not.The Introduction of New ProductsOverconfident CEOs not only put their companies at risk by undertaking value-destroying mergers, but they also have a tendency to encourage their firms to introduce risky products with a high risk of failure. In a study of small computer companies that were on the verge of launching new products, Simon and Houghton interviewed CEOs and high-level executives about the potential for their new products to succeed. Those who made statements expressing extreme certainty (i.e., definitely or completely sure) were the most likely to have introduced risky products.12 Google is one example of a company that fails often at the introduction of new products. With such ventures as Google Wave, Google Video, Google Checkout, and Google Answers that failed despite extensive investments and publicity, Google has had its share of failures. One way of looking at Googles failure rate is that it is the product of an experimenting corporate culture that preaches a willingness to take risks in order to identify the opportunities that have the most potential.13 Might it also be an expression of overconfidence? After all, Google is run by executives who earn $1 annual salaries with compensation packages that are completely dependent on corporate performance.14 Though one could argue that these executives accept such low salaries out of genuine altruism, as part of a public relations stunt, or as a means of inspiring their employees, it is also possible that they are so confident in their ability to beat out the competition and generate returns to their own holdings in the company that they see no need to claim a salary. Much like overconfident CEOs who delay the exercising of stock options because they are sure the value of their companies will rise above the competition, these executives may encourage investments into risky large-scale projects due to excessive faith in their ability to succeed.Startup BusinessesEntrepreneurs and the self-employed are particularly likely to display overconfidence.15 However, it does not follow that would-be entrepreneurs should want to be overconfident. If most new firms fail, the choice to found a new firm might be a negative-expected-value bet that risks the wealth of founders and investors alike.CALIFORNIA MANAGEMENT REVIEWVOL. 55, NO. 2WINTER 2013CMR.BERKELEY.EDU9Avoiding the Pitfalls of Overconfidence while Benefiting from the Advantages of ConfidenceUnlike an established firm like Google that has an enormous cushion of banked profits, when the founder of a startup company falls prey to the adverse effects of overconfidence, the consequences can be disastrous. This appears to have been the case of the online grocery delivery service Webvan. Despite being valued at $1.2 billion in 1999 and being a pioneer in an industry that was achieving modest success, Webvans leadership attempted to enter too many different geographic markets. Ultimately, this excessive ambition led to the companys demise in 2001.16 In a retrospective account of the overconfidence of Webvans leadership, CEO Robert Swan stated we made the assumption that capital was endless, and demand was endless.17 Essentially, Webvans key decision makers overplaced their abilities to outcompete other startups for additional venture capital funding and overplaced their ability to steal market share from well-established giants in the grocery industry. This led to a potentially successful business model failing because the company tried to do too much in too brief a time. Whether ones goal is to establish a company like Webvan or to start a local family-owned convenience store, the decision to enter a new market typically requires a financial investment. A large portion of these investments are lost, as people frequently underestimate the competition when they invest in startup businesses. Consequently, investors often put their hard-earned money on the line for ventures that have a low probability of succeeding. In fact, entrepreneurial overconfidence can explain differences in market entry rates and startup failure rates across countries. A survey of entrepreneurs across several countries by Koellinger, Minniti, and Schade found that in the countries where people are the most confident about their business acumen, market entry rates of startups are the highest and survival rates of startups are the lowest.18 While we have all heard of success stories in which the entrepreneurial spirit prevails against all odds, we hear less about people who fail. The reality is that most startups fail.When Are We the Most Likely to Overplace Our Relative Abilities?Though people frequently overplace their own abilities relative to others and suffer economically as a result, we are not always prone to overplacement. In fact, there are some situations where we may underplace our abilities relative to others and pass up on potentially rewarding opportunities. Before one can take preventative measures to avoid the ill effects of overplacement, he or she must be aware of the situations in which overplacement is the most likely to occur.When Its Easy, We OverplaceWe are particularly prone to fall victim to overplacement when a task is easier than we originally expected. While we often underestimate how well we perform on easy tasks, we tend to underestimate how well the competition performed to an even larger degree. This combination results in us overplacing our abilities relative to others. As demonstrated by Moore and Cain, overplacement and overentry occur on easy tasks, but underplacement and underentry occur on difficult tasks.19 Falling into this trap of underestimating the competition can be particularly detrimental for entrepreneurs. In a survey at Carnegie Mellon University, Cain et al. found that the industries in which would-be entrepreneurs perceived themselves10UNIVERSITY OF CALIFORNIA, BERKELEYVOL. 55, NO. 2WINTER 2013 CMR.BERKELEY.EDUAvoiding the Pitfalls of Overconfidence while Benefiting from the Advantages of Confidenceas the most prepared to start a business did indeed have the highest annual rates of entry. Given that industries with high entry rates also tend to have high exit and failure rates,20 it is the very same industries that people perceive as easy to enter that have the highest failure rates. Table 2 shows the results in the Cain et al. study for the ten industries considered to be the easiest and the ten industries considered to be the most difficult to start a new business. Note that grocery and food stores are among those with the greatest perceived ease of succeeding and the highest entry rates. This is one factor that likely drove Webvan, the failed online grocer, to overestimate its ability to steal market share from established stores. Given the tendency to overplace on easy tasks, it should come as no surprise that people are also prone to overplacement when a task gets easier. Whether a new legal regulation, a higher tax, or some external shock, organizations within an industry often deal with changing conditions that make things more easy or difficult than before a given change occurred. In cases where changing conditions make things easier for organizations, their leaders are prone to overplacement. Relatedly, when students learn that the final exam will be open-book, their collective expectations of getting an A goes up, even if the class will be graded on a forced curve. When things become easier, we tend to overplace our relative performance. People often behaveTABLE 2. Perceived Ease and Annual Entry Rates of the Twenty MostExtreme Industries Industry Perceived Ease Annual Entry Rate (Z-Score) (Per 10,000 Existing Firms)2.00 1.89 1.83 1.75 1.74 1.72 1.50 1.48 1.40 1.36 1.67 1.73 1.35 1.36 1.46 1.56 1.61 1.65 1.72 1.84 1.86 1.96 1.64 1.63 396 889 334 446 911 764 579 219 425 715 568 513 351 113 105 331 233 520 274 426 130 228 271 25210 Easiest Industries Food Stores Miscellaneous Durable Goods General Merchandise Stores Eating and Drinking Places Groceries and Related Products Beer, Wine, and Distilled Beverages Hobby, Toy, and Game Shops Liquor Stores Professional and Commercial Equipment Gift, Novelty, and Souvenir Shops Easy Mean Easy Median 10 Hardest Industries Fabricated Metal Products Depository Institutions Agricultural Crop Production Agricultural Services Fishing, Hunting, and Trapping Petroleum and Coal Products Forestry Metal Mining Agricultural ProductionLivestock Nonmetallic Mineral Mining, Except Fuel Hard Mean Hard MedianNote: Results as reported in the Field Data of Cain et al.CALIFORNIA MANAGEMENT REVIEWVOL. 55, NO. 2WINTER 2013CMR.BERKELEY.EDU11Avoiding the Pitfalls of Overconfidence while Benefiting from the Advantages of Confidenceas if shared advantages will benefit them to a greater extent than it will benefit their competitors. In a series of studies, Windschitl, Kruger, and Simms demonstrated that when a game gets easier for everyone, people become more confident that they will win.21 One particular study illustrated this tendency in the context of a poker game. After providing participants with a poker tutorial, they were split into tables of 3-5 people to play a series of hands. For some hands, ten specific cards were identified as wild cards. Because the idea behind a wild card is that it can be used strategically by the cardholder to represent the card that gives him or her the best possible hand, the presence of wild cards represents an advantage that is shared by all members of the table. In hands with wild cards, bets on the table were much higher than they were in hands without wild cards. This finding is evidence of a belief where wild card holders acted as if they believed themselves to be particularly advantaged even though other players are very likely to also possess a wild card. Notably, experience with poker did not mitigate this effect. Even the most experienced players increased their bets in hands with active wildcards to a large degree. In the same way that shared advantages encourage overplacement, shared disadvantages encourage underplacement. When regulations tighten for an entire industry, it is nevertheless common for all firms to become more pessimistic about gaining market share. Some business owners complained of the additional costs imposed on them by the health care coverage requirements of the Patient Protection and Affordable Care Act passed by the Obama Administration,22 without acknowledging that their competitors will also face these costs. Because we tend to focus on how such changes will affect us, we typically underplace our performance relative to others when faced with shared challenges. In addition, this finding has also been illustrated in the domain of negotiations. Negotiators tend to believe that deadlines will hurt their negotiation outcomes even though their counterpart is also subject to the same deadline.23 This often results in underplacement even though deadlines can be beneficial for negotiators in some situations.When We Feel in Control, We CompeteAnother factor that drives overplacement is the extent to which we think we have control of a situation. In an experimental market, Camerer and Lovallo gave research participants $10 and a chance to enter markets whose outcomes were driven by chance or by skill.24 In markets dictated by skill, over-entry occurred and market entrants lost money on average. However, in markets dictated by chance, under-entry occurred and market entrants earned high profits. Generally, people prefer to compete or bet on their own success when they feel they have control, even if that control comes at the cost of lower odds of winning and more intense competition. Research by Heath and Tversky suggest that when people feel they are skilled at something, they are more likely to bet on their own ability.25 In contrast, when people think they are incompetent, they are more likely to leave their outcomes to chance. This conclusion is similar to the finding that people overplace and overenter competitions on easy tasks while they underplace and underenter competitions on difficult tasks.26 People prefer to bet on themselves when they feel knowledgeable and in control.12UNIVERSITY OF CALIFORNIA, BERKELEYVOL. 55, NO. 2WINTER 2013 CMR.BERKELEY.EDUAvoiding the Pitfalls of Overconfidence while Benefiting from the Advantages of ConfidenceWhen Information is Lacking or Ambiguous, We OverplaceObtaining clear feedback is crucial for calibrating ones judgment. Unfortunately, information is often anything but timely and unambiguous. It may take months or years before the wisdom of big choices becomes clear. Was Disneys 2012 acquisition of Lucasfilm a wise move? We will never know how Disney would have fared without it. Furthermore, during the time that people wait to receive information about important outcomes, they have likely made a series of other key decisions that may influence the very outcomes that they hope to use in calibrating their judgment. This makes information ambiguous, as it becomes difficult to tell whether a specific decision caused an outcome. For instance, Ford got a great deal of credit for weathering the 2008 economic downturn better than the other U.S. auto makers, but its success actually had less to do with superior ability to satisfy its customers and more to do with some lucky financing decisions it had made shortly before the economic collapse.27 One need not be the CEO of Ford to realize that in almost any competition, more is known about some competitors than others. Our degree of familiarity with a competitor drives the extent to which we overplace our performance. People tend to estimate the competitions ability by adjusting from prior expectations in response to new information about the competitions performance. The less reliable the information people have about the competition, the less they will adjust from prior expectations. Thus, when people partake in a task that is easier than expected, they often raise their expectations of the competitions performance to a lesser degree when the competition is unfamiliar than when it is familiar. Likewise, on tasks that are more difficult than expected, people tend to lower their expectations of the competitions performance to a lesser degree when they are unfamiliar with the competitions abilities than when they are. In combination, this suggests that when we are unfamiliar with a competitor, we should overplace on easy tasks and underplace on difficult tasks to a greater extent than when we are familiar with the competitor. Windschitl et al. illustrated this in a study by having participants consider how they would perform on various types of quizzes relative to a stranger or a friend.28 On hard quizzes, participants estimated that their relative performance would be even worse compared to a stranger than compared to a friend. On easy quizzes, participants estimated that their relative performance would be even better compared to a stranger than compared to a friend. Friends are more familiar to us and tend to be more similar to ourselves than strangers, so this finding suggests that we tend to make fewer errors when estimating the performance of individuals who are familiar to us and who are similar to ourselves. Often, rival organizations are familiar with one another and similar to each other29, so it should be the case that firms are more accurate at estimating the performance of established competitors than estimating the performance of relatively new and unknown firms. We may be at the most danger of underestimating the competitions ability when we face an unfamiliar competitor who is different from ourselves in a domain that we perceive to be easy. We not only need information about the competition to make accurate judgments about how we rank on a task, but we also need information about the task itself. Often, merely acquiring knowledge about a particular task can be an effectiveCALIFORNIA MANAGEMENT REVIEWVOL. 55, NO. 2WINTER 2013CMR.BERKELEY.EDU13Avoiding the Pitfalls of Overconfidence while Benefiting from the Advantages of Confidencemeans of improving the calibration of ones judgment, even when he or she does not receive feedback about his or her own competence or the competence of a competitor. Kruger and Dunning pointed out that across a variety of domains, the very worst performers often overplace to the greatest extent.30 They attribute this observation to the fact that in many tasks, the most incompetent individuals often have the least information about the task. Because the very same information needed to perform well at a task is often the same information needed to evaluate ones competence at the task, the most incompetent individuals often lack the knowledge to adequately assess their own relative skill. Furthermore, the authors demonstrated that when incompetent people are provided with more information about a task, they improve their ability to estimate their relative performance. In a study where people completed a logic task, the authors had a random subset of participants complete a training session that helped them identify some of the skills necessary to succeed. Those who completed a training session became more accurate at estimating their relative performance across all levels of objective performance and those who were in the bottom quartile of performers improved the most in terms of accuracy, as they dramatically adjusted their estimated percentile ranks downward. Thus, learning more about the task improved everybodys ability to estimate their relative performance, especially those who had the least knowledge about the task in the first place. By simply becoming aware of the skills necessary to be successful at the task, incompetent participants became more capable of recognizing their own limitations. Learning more about the tasks we engage in allows us to better recognize our own limitations and the limitations of others. This reduces uncertainty and improves the accuracy of performance expectations. The more information we have about the competition and the domain in which we are competing, the better we are at judging our ability to compete. Unfortunately, we often process the information we do receive in a biased fashion. Managers from the CEO on down must make decisions with an eye to the long term. However, while they wait for time to elapse and the future to provide them with feedback about the quality of their own decisions, a variety of other factors come into play that may affect the very outcomes that they hope to use as feedback in helping them calibrate their judgment. The ambiguity of information about outcomes and its lack of timeliness often explains why people form biased perceptions of their own judgment. Many stand ready to accept credit for successes, but managers routinely blame forces outside of their control when things go badly. In the words of John F. Kennedy: Victory has one hundred fathers, but defeat is an orphan. Even when we do get good information and timely feedback about our own performance, we do not always make the best use of the information at our disposal. For example, Eil and Rao asked participants in a study to either complete an IQ test or to engage in a speed dating task.31 Those who completed the IQ test estimated their ranks on the test relative to others in their experimental session while those who completed the speed dating task estimated their physical attractiveness ranking as rated by members of the opposite sex. In a second ranking game, the experimenter drew a random card for each participant in the session to determine ranks by chance. Participants received information about how they compared to another randomly selected participant in their session, one at a time. Notably, this type of feedback14UNIVERSITY OF CALIFORNIA, BERKELEYVOL. 55, NO. 2WINTER 2013 CMR.BERKELEY.EDUAvoiding the Pitfalls of Overconfidence while Benefiting from the Advantages of Confidenceis incomplete, as it doesnt directly tell participants how they compare to all other participants. The incomplete information introduces an element of ambiguity in how it should be interpreted in updating ones ranking relative to other participants. Each time participants received new information, they updated their estimates of where they ranked relative to all participants in the experimental session. Interestingly, the authors found that for IQ and attractiveness, people responded quickly to information suggesting they ranked better than they had thought, yet were relatively unresponsive to the revelation that they ranked worse than they had thought. On the other hand, for the card-drawing task that was based on chance, participants were equally accurate in updating to both positive and negative information. This finding indicates that people are capable of objectively updating to new information that doesnt concern their own abilities, but when the information is relevant to their own abilities, they tend to update in a self-serving manner. People upgrade their estimated relative rank in response to information suggesting that they are better than others to a greater extent than they downgrade their estimated relative rank in response to information suggesting that they are worse than others. The evidence suggests that people update to new information in a biased manner when it directly involves their own relative abilities, particularly when they receive information suggesting that they do not compare as favorably to others as they previously thought. This self-serving bias is particularly conducive to overplacing ones abilities, as people are unlikely to adequately downgrade their beliefs about their relative abilities despite receiving information suggesting that they should. Even when people do their due diligence by acquiring as much information as they can about the competition and the tasks in which they are competing, they are often at risk of overplacement.The Benefits of ConfidenceWhile overconfidence can be a dangerous bias with harsh economic consequences in market settings, this does not mean that those with less confidence are always better off. Just as overestimating their relative placement can lead people to enter markets too frequently, underestimating their relative placement can prevent people from entering lucrative markets with little competition. In the words of hockey legend Wayne Gretzky: You miss one hundred percent of the shots that you dont take. Confidence not only has the benefits of motivating people to take on the risks necessary for achieving financial prosperity, but it also has social and competitive benefits that can allow people to get a leg up on the competition once they have chosen to enter a market. In fact, even if confidence manifests itself in the form of overplacement, overconfidence can have competitive advantages.Confidence Improves Social StatusWe often rely on nonverbal cues to assess others. We sometimes use these cues to infer the competence of others, despite the fact that the most assertive individuals are not necessarily the most competent.32 Overconfidence is one factor that canCALIFORNIA MANAGEMENT REVIEWVOL. 55, NO. 2WINTER 2013CMR.BERKELEY.EDU15Avoiding the Pitfalls of Overconfidence while Benefiting from the Advantages of Confidencedrive individuals to exhibit cues that are associated with competence. In a series of studies, Anderson et al. demonstrated that the most overconfident individuals tend to be perceived as the most competent.33 One study in particular experimentally manipulated overconfidence by giving participants randomized feedback about their performance. Some participants received performance feedback that was accurate while others received feedback telling them that they received a high score. This manipulation served as a successful induction of overplacement, as those participants told that they received a high score estimated their percentile rank on the task to be higher than those who received accurate feedback. After receiving feedback, each participant then completed the task again in a dyad with another participant. At the conclusion of the dyadic task, participants then rated one another in terms of how competent they perceived each other to be and how much influence they perceived each other to have over the decision-making process in the dyadic task. The results of the study demonstrated that people perceived overconfident partners to be better at the task relative to other participants than people who received accurate feedback. Additionally, overconfident people were rated as more influential over the decisionmaking process in the dyadic task than accurate people. In another set of studies building on this research, Kennedy et al. found that overconfident individuals were not only rated as more influential than others, but their partners changed their responses on a task to a greater extent while interacting with these overconfident individuals.34 The data suggest that this was partly because people tend to be influenced by others who they perceive to be competent. Whether you are a young entrepreneur trying to secure venture capital funding, a sales representative who seeks to convince a client to hire his or her firm, or an experienced CEO who wants to instill confidence in employees, the appearance of competence and the ability to influence others are crucial for success in competitive markets. The display of confidence is one route through which individuals can reap these benefits. However, it is unclear whether confidence is something that can be easily faked. The results of one study in the research by Anderson et al. described above suggests that being perceived as competent has much more to do with ones nonverbal behavior than explicit claims. As illustrated by Table 3, overconfident people tend to speak more often, to provide information relevant to a problem, to offer the first answer in dyadic tasks, and to speak in confident tone with a relaxed demeanor. It should be immediately obvious that these behaviors are likely to be diagnostic cues of competence. Those who actually are capable should be those who speak first, speak most, and speak assertively. In many ways, that is the ideal: those who take control are also those whose abilities justify that confidence. If you actually are the best, then you cannot overplace yourself. However, others may have to choose how much confidence to display given their limited abilities and their desire to assert control, attain status, or frighten off potential rivals.Confidence Deters CompetitionGiven that the display of confidence allows one to be perceived as competent, it should come as no surprise that the strategic display of confidence is an effective means of deterring others from competing. If people think that the competition is16UNIVERSITY OF CALIFORNIA, BERKELEYVOL. 55, NO. 2WINTER 2013 CMR.BERKELEY.EDUAvoiding the Pitfalls of Overconfidence while Benefiting from the Advantages of ConfidenceTABLE 3. Correlations between the Display of Particular Behavioral Cues,Overconfidence, and Observer-Perceived Competence Behavioral CuePercent of time spoke Confident and factual vocal tone Provided information relevant to problem Expanded posture Calm and relaxed demeanor Offered an answer later Offered an answer first Statements of certainty in estimate Statements about ease or difficulty of task Statements about ones own competenceOverconfidence.25* .29* .19* .00 .22* .10 .27* .17 .07 .14Perceived Competence.59* .54* .51* .37* .34* .24* .21* .21* .18 .09Note: Results as reported in Study 4 of 33. Cameron Anderson, Sebastien Brion, Don A. Moore, and Jessica A. Kennedy, A Status-Enhancement Account of Overconfidence, Journal of Personality and Social Psychology, 103/4 (October 2012): 718-735. * Statistically significant at the .05 level.top notch, then they are going to be reluctant to compete against it. Charness, Rustichini, and Van de Ven tested whether people who signal to others that they are highly competent are successful at deterring the competition.35 Some participants in their study were given a strategic choice of whether to enter a competition with another participant where the person with the higher score on an intelligence test would win $10 and the loser would earn nothing. Those facing the entry decision were given the choice of whether to accept a guaranteed payment for not entering the competition or to enter the competition and risk earning nothing. Furthermore, among those choosing whether to enter the competition, some were provided with the other participants estimates about his or her percentile rank relative to others on the intelligence test. The results indicate that the more confident the opponent, the less likely participants were to enter the competition. Specifically, it appears that the primary driver of decisions to enter the competition was participants estimates of their percentile rank relative to their opponents estimates of their own percentile rank. In one condition where participants faced a decision of whether to enter the competition or to receive a $5 payment, those who had more confidence in their relative abilities than their opponent entered the competition 92% of the time while those who had less confidence in their relative abilities than their opponent only entered the competition 17% of the time. Even though participants were generally guilty of overplacement in this study, it appears that people who overplaced to a greater extent than their opponent were successful at deterring the competition. In reality, people and organizations may not necessarily indicate their degree of confidence by publicizing explicit estimates about their relative abilities. Nevertheless, there are other, more subtle ways to signal confidence. People may strategically draw comparisons between themselves and high-status others in job interviews and pitch meetings with clients. Organizations may indicate their perceptions of how they rank relative to other companies through the language they use in marketing materials, press releases, and quarterly earnings statements. AllCALIFORNIA MANAGEMENT REVIEWVOL. 55, NO. 2WINTER 2013CMR.BERKELEY.EDU17Avoiding the Pitfalls of Overconfidence while Benefiting from the Advantages of Confidenceof these strategies are subtle ways for people and organziations to generate the perception that they are a force to be reckoned with. Strategies for deterring the competition could be even more subtle, such as investing larger amounts of resources than are necessary to launch new products. For example, Apple completed construction on a new one-million square foot data center that required an investment of a billion dollars. Apple has publicly stated that the new center will be used to coordinate the updating of multimedia content on the devices of all Apple users, but some analysts have been pointing out that the new data center seems to be excessively large for the amount of data that it actually needs to store. This excess of storage space, in combination with the fact that people have noticed very little activity at the center, has led some to speculate that the center is primarily in existence to intimidate the competition.36 We may never find out why Apple built such a large data center, but its large investment could simply be an indication that its leadership is confident in the companys ability to continue growing and developing innovative new products. This public display of confidence could potentially deter competitors who hope to one day steal market share away from Apple. In this sense, what initially appears to be overconfidence may eventually become a self-fulfilling prophecy.Can Confidence Backfire?Confidence can backfire when it is exposed as overconfidence. Eyewitnesses, advisors, and leaders lose credibility when their confident claims are revealed to be false. For example, in one study by Tenney and colleagues describing a hypothetical criminal case, one particular eyewitness was perceived as more credible when he or she expressed certainty in the accuracy of a sworn testimony claiming that a defendant is guilty and the testimony turned out to be true than when he or she expressed uncertainty in the accuracy of the very same true testimony.37 However, when the testimony turned out to be incorrect, the same eyewitness was considered less credible when expressing certainty than when expressing uncertainty. Not only was the certain eyewitness considered less credible, but participants were less likely to think that the defendant was guilty when the eyewitness was certain in the inaccurate testimony than when he or she was uncertain about the same testimony. Though expressing confidence is risky because it may be clearly exposed as overconfidence, in many situations people do not have sufficient evidence to determine whether an individuals confidence is warranted or merely the result of poor calibration. Often it is costly to acquire information about the accuracy of others and people choose to trust those who express confidence in their abilities without investing costs into gathering the information necessary to assess their accuracy.38 Even when accuracy feedback is free, it still can be difficult to decipher exactly how accurate people are when they express confidence in their abilities. We often fail to account for how accurate people are when we judge their credibility unless their decisions have had a direct impact on us in the past.39 Even in cases where a confident individual is clearly exposed as being inaccurate, we tend to give him or her benefit of the doubt when there appears to be a legitimate excuse for being inaccurate.40 Although overconfidence can backfire when exposed, it is quite difficult for people to expose it in the first place. Thus, the strategic display of confidence can18UNIVERSITY OF CALIFORNIA, BERKELEYVOL. 55, NO. 2WINTER 2013 CMR.BERKELEY.EDUAvoiding the Pitfalls of Overconfidence while Benefiting from the Advantages of Confidencework in a wide variety of situations. The more ambiguous and the more costly the information needed to assess our accuracy, the more likely confidence is to be a successful means of appearing competent and deterring the competition.Practical RecommendationsWhat can the research tell us about the best strategies for avoiding the dangers posed by overconfidence while enjoying the potential benefits of confidence? The research presented above suggests several courses of action that may be effective in avoiding the pitfalls of overconfidence while benefiting from the advantages of confidence.Calibrate Your Own BeliefsWork on calibrating your own private beliefs. When you have important decisions to make, fooling yourself into thinking youre better than the competition is generally a bad strategy. Thinking you can fly is dangerous if it increases your propensity to jump off the building without a safety net below you. Sometimes, taking excessive risks can lead to personal tragedy. Sometimes, when overconfidence becomes a shared delusion, such as the belief that home prices will increase indefinitely, it can produce economic cataclysms on a more spectacular scale. This is especially important for political and organizational leaders to keep in mind, as their overconfidence may not only bias their own decision making, but create a sense of invincibility that permeates their organizations and society as whole. Tips on calibrating your own private beliefs follow.Ask Yourself If It Feels Too EasyWe are particularly in danger of overplacing our relative abilities when a task is easier than we expected. Though we are often correct in updating our beliefs about our own performance on easy tasks, we often fail to update our beliefs about the competition. This combination results in overplacement. Thus, when something feels easy, you should ask yourself whether your assessments of your own relative performance are too good to be true. Rather than only considering how your predictions of your own performance may be miscalibrated, rethink the accuracy of your predictions for the competition.Ask Yourself If You Are Really in ControlWe seldom encounter situations in which we truly have no control. However, a large proportion of our successes, whether it be in our stock market investments, the crops we plant, or the fate of a new product, are driven by complex factors beyond our control. These forces can include the weather, the actions of our competitors, and larger macroeconomic forces. We are at the greatest risk of overestimating our objective degree of control when we have little control over outcomes.41 We also are the most likely to enter competitions in domains that we are skilled at when we feel like we have control over outcomes. However, so are our rivals. As we face more competition over limited resources, our outcomes become more dependent on the competitions performance and less dependentCALIFORNIA MANAGEMENT REVIEWVOL. 55, NO. 2WINTER 2013CMR.BERKELEY.EDU19Avoiding the Pitfalls of Overconfidence while Benefiting from the Advantages of Confidenceon our own performance. Thus, overestimating the amount of control we have over our own outcomes often leads us to enter competitive markets where success is dictated largely by random chance. By coming to more realistic assessments of how much control you really have over your own outcomes, you can avoid entering oversaturated competitive markets.Listen to Humbling EvidenceWhen we find out that we are not ranked as favorably as we previously thought, we often fail to correctly update our beliefs in response to this information. As a result, we typically continue to believe that we stack up favorably against the competition even in the face of more humbling evidence. Paying attention to the evidence right in front of you and updating your beliefs can go a long ways towards improving your judgment. You may even need to rely on trusted advisors to tell you whether you are appropriately accounting for the information available to you. This might not boost your ego, but it could save you from making more costly mistakes. As consumers of advice, we also must be vigilant for information suggesting that we may not be receiving the most accurate advice. Knowing the persuasive power of confidence displays, how can we avoid being gulled by arrogant windbags? The answer is that when we have a choice to make about how much to trust others, we must actively seek out data that can help us assess how honest and wellcalibrated they are. One reason that overconfidence often goes unchecked is that people do not collect the data necessary to assess the accuracy of confident advisors. You should pay special attention to the more humble and modest advisors, as they are often discounted even though they may be more accurate than advisors who behave confidently. Generally speaking, objective and unbiased data are critical for assessing the accuracy of ones judgment and the judgment of others. By performing statistical analyses of outcomes and comparing actual outcomes to their predictions, people can learn to better calibrate their judgment and to benchmark their performance. Furthermore, for judgments with a complex array of factors in play, data can allow for the creation of algorithms that make decision making effortless for managers and more accurate than simply relying on intuition. Collecting objective data allows people to not only adopt what Kahneman and Lovallo refer to as the outside view42 and objectively evaluate the precision of their judgment, but it can also improve the efficiency and accuracy of their future decisions.Portray an Image of ConfidenceSpeaking frequently, volunteering to speak first, talking with a factual tone, providing the first answer to problems, and adopting a calm demeanor are all things that are natural signals of confidence. The benefits of confidence come primarily through its display to others. The implication is that acting confident is beneficial. It is indeed most useful when that confidence can increase the dedication of customers, investors, voters, or employees. But given the risks associated with false displays, leaders should avoid making claims of confidence on which they cannot deliver. The best and most persuasive claims of confidence are those20UNIVERSITY OF CALIFORNIA, BERKELEYVOL. 55, NO. 2WINTER 2013 CMR.BERKELEY.EDUAvoiding the Pitfalls of Overconfidence while Benefiting from the Advantages of Confidencethat are backed up by substance. When your claims are informed by data and consultation with outsiders, you not only will appear persuasive, but you will make more accurate predictions and be less likely to suffer the consequences of poor calibration. Research has demonstrated that the mere experience of power makes people excessively certain in the accuracy of their judgment and reduces their likelihood of listening to others advice.43 By instituting systems of checks and balances where ones predictions must be approved by others before the predictions are made public, people can reduce the likelihood of becoming exposed as an overconfident advisor who lacks credibility. Typically such checks are only instituted for low-level employees, but the evidence suggests that they actually may be the most effective with high-level executives who are particularly prone to experiencing the confidence-enhancing effects of power.ConclusionOverconfidence in ones private beliefs can produce risky actions that lead to economically disastrous outcomes. However, the display of confidence can also be helpful for gaining status, influence, and support. Recent research has uncovered some of the situations in which we are particularly prone to overconfidence. Fortunately, this research also suggests some practices that managers may adopt in an effort to improve their decisions. By strategically conveying confidence to others, making an effort to collect performance data, and making a conscious effort to calibrate their beliefs, managers can leverage the benefits of confidence without subjecting their organizations to the pitfalls of overconfidence. Notes1. 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MacCoun, Cheap Talk and Credibility: The Consequences of Confidence and Accuracy on Advisor Credibility and Persuasiveness, unpublished manuscript, 2010. 39. Joseph R. Radzevick and Don A. Moore, Competing to Be Certain (But Wrong): Market Dynamics and Excessive Confidence in Judgment, Management Science, 57/1 (January 2011): 93-106.22UNIVERSITY OF CALIFORNIA, BERKELEYVOL. 55, NO. 2WINTER 2013 CMR.BERKELEY.EDUAvoiding the Pitfalls of Overconfidence while Benefiting from the Advantages of Confidence40. Elizabeth R. Tenney, Barbara A. Spellman, and Robert J. MacCoun, The Benefits of Knowing What You Know (and What You Dont): How Calibration Affects Credibility, Journal of Experimental Social Psychology, 44/5 (2008): 1368-1375. 41. Francesca Gino, Zachariah Sharek, and Don A. Moore, Keeping the Illusion of Control Under Control: Ceilings, Floors, and Imperfect Calibration, Organizational Behavior and Human Decision Processes, 114/2 (March 2011): 104-114. 42. Daniel Kahneman and Dan Lovallo, Timid Choices and Bold Forecasts: A Cognitive Perspective on Risk Taking, Management Science, 39/1 (January 1993): 17-31. 43. Kelly E. See, Elizabeth W. Morrison, Naomi B. Rothman, and Jack B. Soll, The Detrimental Effects of Power on Confidence, Advice Taking, and Accuracy, Organizational Behavior and Human Decision Processes, 116/2 (November 2011): 272-285.California Management Review, Vol. 55, No. 2, pp. 523. ISSN 0008-1256, eISSN 2162-8564. 2013 by The Regents of the University of California. All rights reserved. Request permission to photocopy or reproduce article content at the University of California Presss Rights and Permissions website at http://www.ucpressjournals.com/reprintinfo.asp. DOI: 10.1525/cmr.2013.55.2.5.CALIFORNIA MANAGEMENT REVIEWVOL. 55, NO. 2WINTER 2013CMR.BERKELEY.EDU23Copyright of California Management Review is the property of California Management Review and its content may not be copied or emailed to multiple sites or posted to a listserv without the copyright holder's express written permission. However, users may print, download, or email articles for individual use.