avoiding the pitfalls of overconfidence

Avoiding the Pitfalls ofOverconfidence whileBenefiting from theAdvantages of Confidence

Alex B. Van ZantDon A. Moore

Successful 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 whichleaders are most prone to overconfidence and its concomitant risks. On the flip side, it explores those circum-stances under which confidence is most conducive to success. Using insights from recent research, the articleprovides recommendations on how managers can avoid the pitfalls of overconfidence while benefiting from theadvantages of confidence. (Keywords: Decision making, Entrepreneurship, Investments, Leadership, Organiza-tional behavior, Securities trading, Startups)

Leading up to its 2008 economic collapse, Iceland’s small economy, oncedominated by rugged fisherman, came to be run by confident younginvestment bankers armedwith degrees fromAmerican 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 inthe process, creating the illusion that Icelandic banks were profiting. However, asMichael Lewis explains in his best-selling book Boomerang, many believed that theirapparent success revealed something profound:

Icelanders—or at any rate Icelandic men—had their own explanations for why,when they leapt into global finance, they broke world records: the natural supe-riority of Icelanders. Because they were small and isolated, it had taken 1,100years for them—and the world—to understand and exploit their natural gifts,but now that the world was flat and money flowed freely, unfair disadvantageshad vanished.1

The authors would like to thank Linda Dong and Joe Mazzella for their help in finding examples ofoverconfidence. The first author would also like to thank California Management Review for financialsupport during his second year of graduate school.

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Icelandic bankers believed they were suc-cessful due to their natural superiority. Their beliefproved self-fulfilling for a time. However, when for-eigners who had invested in Icelandic banks startedto doubt the Icelandic miracle and tried to cash out,the value of these banks fell precipitously. Within ashort time, the major Icelandic banks failed andtook the small country’s economy downwith them.The overconfidence of bankers had blinded them to

their own limitations and the size of the risks they had taken.

It is easy to think of other business lessons that parallel the Icelandic parable.Whether America Online’s 2000 acquisition of Time Warner, the housing boom ofthe 2000s, or the inflation of the dot-com bubble in the late 1990s, overconfidencehas accompanied many of the most dramatic business follies. Analysts, journalists,and academics correctly highlight the role of overconfidence in helping set the stagefor many calamities. Some have even argued that “no problem in judgment anddecision making is more prevalent and more potentially catastrophic than overcon-fidence.”2 Indeed, the effects of overconfidence are routinely evident in many dif-ferent forms. Overconfident plaintiffs and defendants overestimate the chances ofa favorable court judgment and resist settling early.3 Their overconfident attorneysperpetuate the conflict by encouraging these beliefs. Likewise, overconfident invest-ors trade assets too much, sure that they have the distinctive insight that allowsthem to predict the next big investment opportunity.4 Indeed, scholars have goneso far as to claim that overconfidence is “perhaps the most robust finding in thepsychology of judgment.”5

In this article, we discuss the causes and consequences of overconfidence asidentified by research, much of which was conducted in experimental laboratories.However, in an effort to illustrate the impact of overconfidence beyond the labora-tory, we have identified many examples from the business world where overconfi-dence was important. A problem with such examples is that, as with the Icelandicbankers story, we identify overconfidence after we have observed results that revealan initial judgment was overconfident. Selecting instances in which actors appearoverconfident runs the risk of inferring overconfidence when bad luck is more toblame. The most persuasive way to address this concern is by studying overconfi-dence in the research laboratory where we can make stronger conclusions aboutcausation.We base our arguments here on research and employ examples from out-side the lab for the purposes of illustrating phenomena that have been demonstratedin empirical research. By using both, we show that the evidence has practical impli-cations for managers.

We begin by highlighting the adverse consequences of overconfidence forinvestors, managers, and entrepreneurs. However, overconfidence is far from uni-versal, and we identify the situations in which it is most likely to be a problem.6 Wethen consider the other side of the overconfidence coin and discuss some advantagesof displaying confidence. The display of confidence is useful for leaders who wish togain stature, credibility, and influence. Finally, we will provide recommendations

Alex B. Van Zant is a Ph.D. student in theManagement of Organizations group atthe Haas School of Business, UCBerkeley.

Don A. Moore is an Associate Professor inthe Management of Organizations groupas well as a Barbara and Gerson BakarFaculty Fellow at the Haas School ofBusiness, UC Berkeley.

Avoiding the Pitfalls of Overconfidence while Benefiting from the Advantages of Confidence

6 UNIVERSITY OF CALIFORNIA, BERKELEY VOL. 55, NO. 2 WINTER 2013 CMR.BERKELEY.EDU

for how to best avoid the pitfalls of overconfidencewhile taking advantage of the ben-efits to expressing confidence. Whether the goal is to simply improve one’s decisionsor to enhance the effectiveness of one’s organization, these recommendations aresimple to implement yet effective. However, we must first be clear about what wemean by overconfidence.

Overconfidence has basically been studied in three ways.7 The first is overesti-mation: thinking that you’re better than you actually are. The second is overplacement:thinking that you’re better than others when you’re not. The third is overprecision:being too sure you know the truth. The first two are obviously related, and on anygiven task they are often correlated—but they are not the same. To understand thedifference, it is worth considering how different forms of overconfidence relate toindividuals’ willingness to engage in competition.

What Drives Market Entry Decisions?

In a recent study, Cain, Moore, and Haran tested what kind of overconfi-dence has the greatest effect on competitive entry decisions.8 Participants in theirstudy completed two tests of skill: an easy quiz and a difficult quiz. After taking bothquizzes, each participant was informed that he or she was one of forty contestantscompeting for prizes that would be awarded on the basis of a raffle in which ticketswere earned according to relative performance (i.e., the top person ranked out of40 would receive 40 tickets while the bottom ranked person would receive only1 ticket). Participants were given a choice to enter one of two contests: one thatused their score on the easy quiz to determine ticket allocation and another thatused their score on the difficult quiz to determine ticket allocation. For each partici-pant, one contest had a prize of $45 while the other had a prize of $90. Theresearchers varied whether the big prize went with the easy quiz and the little prizewent with the difficult quiz, or vice versa. Once participants had indicated whichcontest they would like to enter, they estimated their performance on each quizand then estimated how others would perform.

The results revealed that the easy quiz prompted excess entry whereas thedifficult quiz produced insufficient entry. This was driven by the fact that the aver-age participant tended to believe that he or she was better than others on the easyquiz but worse than others on the difficult quiz. Of course, this logic is wrongbecause 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 chosethe difficult quiz. In fact, entering the easy quiz raffle earned participants lessmoney even when the easy quiz came with a $90 prize and the difficult quiz onlycame with a $45 prize. Interestingly, participants who entered the easy raffle didnot overestimate their performance on the easy quiz any more than participantswho entered the difficult raffle. This evidence is strongly suggestive that when peo-ple make decisions to enter competitive markets, their decisions are guided more byoverplacement than by overestimation. Given the relevance of overplacement inbusiness contests, this article focuses on overplacement rather than overestimationor overprecision.



Adverse Consequences of Overplacement in Market Settings

Though the study discussed above examines entry into a simple laboratorycontest as opposed to a more complex business market, the decision to enter a mar-ket for an uncertain prize involves many of the same decision processes as enteringany other kind of competitive market. Potential entrants must assess their own capa-bilities and compare themselves to the competition. Then, theymust assess their ownrisk tolerance, as chance factors may lead to unfavorable outcomes even for the mostcapable competitors. At the most fundamental level, entering any kind of market isno different from claiming your share of raffle tickets and hoping that fortune favorsyour success. When people overplace themselves or their organizations relative tothe competition, they are prone to inflating their chances of success.

Investment Decisions

Overconfidence leads people to make mistakes in allocating their invest-ments. Although index funds allow people to diversify their risk, avoid transactionfees, and save their own valuable time, they often decide to manage their portfoliosmore actively by regularly trading assets. Presumably, those who are ready to investtheir own time and money into maintaining an actively managed portfolio musthave faith in their ability to outsmart the market. If they were accurate in theirperception that they could beat the market, then one would expect these investorswho actively manage their portfolios to outperform the market. However, TerranceOdean concluded that many investors trade too much.9 They spend their time andenergy searching for investments that, on average, underperform the market. In arelated study, Barber and Odean reported that from 1991 to 1996, the averagehousehold turned over 75% percent of its portfolio annually and earned 1.5% lowerannual returns than the market index. The top 20% of households in terms of turn-over earned annual returns that were 7.1% lower than households in the bottom20% in terms of turnover. In the words of the authors, “trading is hazardous to yourwealth.”10 Or in other words, overplacing your ability to forecast stocks is hazardousto your wealth.

Corporate Mergers

Overconfident individuals make decisions that not only are detrimental totheir personal finances, but to the finances of their organizations.When the key deci-sion makers in a firm overplace their abilities relative to those of the managementteams of other firms, they become more likely to believe they could better manage

TABLE 1. Expected Participant Earnings by Raffle Prize Condition and Market Entry

Easy Quiz Raffle Entry Difficult Quiz Raffle Entry

$45 Easy, $90 Difficult $1.76 $6.21$90 Easy, $45 Difficult $3.21 $3.75Mean expected earnings $2.52 $5.09

Note: Results as reported in Experiment 1 of Cain et al. (2012)



the other firms. Indeed, Malmendier and Tate found that overconfident CEOs weremore likely to engage inmergers.11 After ruling out alternative explanations for theirfindings, the authors concluded that CEOs who are overconfident in their ability tobeat out the competition and earn future returns for their companies are more likelyto engage in mergers than well-calibrated CEOs. As the result of engaging in toomany mergers, these overconfident CEOs lose value for the shareholders of theirfirms, including themselves.

Every company ought to be worried about the potential for overconfidenceamong managers at the top. After all, the way people get to the top is by having acareer in which they both perform well and are favored by fortune. Top managersoften express great faith in the quality of their own intuitive judgment, and indeedthey have a career’s worth of success to support that faith. However, while theirskill may endure, the good fortune that helped put them at the top will not.

The Introduction of New Products

Overconfident CEOs not only put their companies at risk by undertakingvalue-destroying mergers, but they also have a tendency to encourage their firmsto introduce risky products with a high risk of failure. In a study of small computercompanies that were on the verge of launching new products, Simon and Houghtoninterviewed CEOs and high-level executives about the potential for their newproducts to succeed. Those who made statements expressing extreme certainty(i.e., “definitely” or “completely sure”) were the most likely to have introduced riskyproducts.12

Google is one example of a company that fails often at the introduction ofnew products. With such ventures as Google Wave, Google Video, Google Check-out, and Google Answers that failed despite extensive investments and publicity,Google has had its share of failures. One way of looking at Google’s failure rateis that it is the product of an experimenting corporate culture that preaches awillingness to take risks in order to identify the opportunities that have the mostpotential.13 Might it also be an expression of overconfidence? After all, Google isrun by executives who earn $1 annual salaries with compensation packages thatare completely dependent on corporate performance.14 Though one could arguethat these executives accept such low salaries out of genuine altruism, as part of apublic relations stunt, or as a means of inspiring their employees, it is also possiblethat they are so confident in their ability to beat out the competition and generatereturns 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 becausethey are sure the value of their companies will rise above the competition, theseexecutives may encourage investments into risky large-scale projects due to exces-sive faith in their ability to succeed.

Startup Businesses

Entrepreneurs and the self-employed are particularly likely to display over-confidence.15 However, it does not follow that would-be entrepreneurs should wantto be overconfident. If most new firms fail, the choice to found a new firmmight be anegative-expected-value bet that risks the wealth of founders and investors alike.



Unlike an established firm like Google that has an enormous cushion of banked pro-fits, when the founder of a startup company falls prey to the adverse effects of over-confidence, the consequences can be disastrous. This appears to have been the caseof the online grocery delivery service Webvan. Despite being valued at $1.2 billionin 1999 and being a pioneer in an industry that was achieving modest success,Webvan’s leadership attempted to enter too many different geographic markets.Ultimately, this excessive ambition led to the company’s demise in 2001.16 In a ret-rospective account of the overconfidence of Webvan’s leadership, CEO Robert Swanstated “we made the assumption that capital was endless, and demand was end-less.”17 Essentially, Webvan’s key decision makers overplaced their abilities to out-compete other startups for additional venture capital funding and overplaced theirability to steal market share fromwell-established giants in the grocery industry. Thisled to a potentially successful business model failing because the company tried to dotoo much in too brief a time.

Whether one’s goal is to establish a company like Webvan or to start a localfamily-owned convenience store, the decision to enter a new market typicallyrequires a financial investment. A large portion of these investments are lost, aspeople frequently underestimate the competition when they invest in startup busi-nesses. Consequently, investors often put their hard-earned money on the line forventures that have a low probability of succeeding. In fact, entrepreneurial over-confidence can explain differences in market entry rates and startup failure ratesacross countries. A survey of entrepreneurs across several countries by Koellinger,Minniti, and Schade found that in the countries where people are the most confi-dent about their business acumen, market entry rates of startups are the highestand survival rates of startups are the lowest.18 While we have all heard of successstories in which the entrepreneurial spirit prevails against all odds, we hear lessabout 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 andsuffer 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 othersand pass up on potentially rewarding opportunities. Before one can take preventa-tive measures to avoid the ill effects of overplacement, he or she must be aware ofthe situations in which overplacement is the most likely to occur.

When It’s Easy, We Overplace

We are particularly prone to fall victim to overplacement when a task is easierthanwe originally expected. While we often underestimate howwell we perform oneasy tasks, we tend to underestimate howwell the competition performed to an evenlarger degree. This combination results in us overplacing our abilities relative toothers. As demonstrated by Moore and Cain, overplacement and overentry occuron easy tasks, but underplacement and underentry occur on difficult tasks.19

Falling into this trap of underestimating the competition can be particularlydetrimental for entrepreneurs. In a survey at Carnegie Mellon University, Cain et al.found that the industries in which would-be entrepreneurs perceived themselves



as the most prepared to start a business did indeed have the highest annual rates ofentry. Given that industries with high entry rates also tend to have high exit and fail-ure rates,20 it is the very same industries that people perceive as easy to enter thathave the highest failure rates. Table 2 shows the results in the Cain et al. study forthe ten industries considered to be the easiest and the ten industries considered tobe the most difficult to start a new business. Note that grocery and food stores areamong those with the greatest perceived ease of succeeding and the highest entryrates. This is one factor that likely drove Webvan, the failed online grocer, to over-estimate its ability to steal market share from established stores.

Given the tendency to overplace on easy tasks, it should come as no surprisethat people are also prone to overplacement when a task gets easier. Whether a newlegal regulation, a higher tax, or some external shock, organizations within an indus-try often deal with changing conditions that make things more easy or difficult thanbefore a given change occurred. In cases where changing conditionsmake things eas-ier for organizations, their leaders are prone to overplacement. Relatedly, when stu-dents learn that the final exam will be open-book, their collective expectations ofgetting an A goes up, even if the class will be graded on a forced curve. When thingsbecome easier, we tend to overplace our relative performance. People often behave

TABLE 2. Perceived Ease and Annual Entry Rates of the Twenty MostExtreme Industries

Industry Perceived Ease(Z-Score)

Annual Entry Rate(Per 10,000 Existing Firms)

10 Easiest IndustriesFood Stores 2.00 396Miscellaneous Durable Goods 1.89 889General Merchandise Stores 1.83 334Eating and Drinking Places 1.75 446Groceries and Related Products 1.74 911Beer, Wine, and Distilled Beverages 1.72 764Hobby, Toy, and Game Shops 1.50 579Liquor Stores 1.48 219Professional and Commercial Equipment 1.40 425Gift, Novelty, and Souvenir Shops 1.36 715Easy Mean 1.67 568Easy Median 1.73 513

10 Hardest IndustriesFabricated Metal Products −1.35 351Depository Institutions −1.36 113Agricultural Crop Production −1.46 105Agricultural Services −1.56 331Fishing, Hunting, and Trapping −1.61 233Petroleum and Coal Products −1.65 520Forestry −1.72 274Metal Mining −1.84 426Agricultural Production—Livestock −1.86 130Nonmetallic Mineral Mining, Except Fuel −1.96 228Hard Mean −1.64 271Hard Median −1.63 252

Note: Results as reported in the Field Data of Cain et al.



as if shared advantages will benefit them to a greater extent than it will benefit theircompetitors.

In a series of studies,Windschitl, Kruger, and Simms demonstrated that whena game gets easier for everyone, people becomemore confident that they will win.21

One particular study illustrated this tendency in the context of a poker game. Afterproviding participants with a poker tutorial, they were split into tables of 3-5 peopleto play a series of hands. For some hands, ten specific cards were identified as wildcards. Because the idea behind a wild card is that it can be used strategically by thecardholder to represent the card that gives him or her the best possible hand, thepresence of wild cards represents an advantage that is shared by all members ofthe table. In hands with wild cards, bets on the table were much higher than theywere in hands without wild cards. This finding is evidence of a belief where wild cardholders acted as if they believed themselves to be particularly advantaged eventhough other players are very likely to also possess a wild card. Notably, experiencewith poker did not mitigate this effect. Even the most experienced players increasedtheir bets in hands with active wildcards to a large degree.

In the same way that shared advantages encourage overplacement, shareddisadvantages encourage underplacement. When regulations tighten for an entireindustry, it is nevertheless common for all firms to become more pessimistic aboutgaining market share. Some business owners complained of the additional costsimposed on them by the health care coverage requirements of the Patient Protectionand Affordable Care Act passed by the Obama Administration,22 without acknowl-edging that their competitors will also face these costs. Because we tend to focuson how such changes will affect us, we typically underplace our performance relativeto others when faced with shared challenges. In addition, this finding has also beenillustrated in the domain of negotiations. Negotiators tend to believe that deadlineswill hurt their negotiation outcomes even though their counterpart is also subjectto the same deadline.23 This often results in underplacement even though deadlinescan be beneficial for negotiators in some situations.

When We Feel in Control, We Compete

Another factor that drives overplacement is the extent to which we think wehave control of a situation. In an experimental market, Camerer and Lovallo gaveresearch participants $10 and a chance to enter markets whose outcomes weredriven by chance or by skill.24 In markets dictated by skill, over-entry occurred andmarket entrants lost money on average. However, in markets dictated by chance,under-entry occurred and market entrants earned high profits. Generally, peopleprefer to compete or bet on their own success when they feel they have control, evenif that control comes at the cost of lower odds of winning and more intense competi-tion. Research by Heath and Tversky suggest that when people feel they are skilled atsomething, they are more likely to bet on their own ability.25 In contrast, whenpeople think they are incompetent, they are more likely to leave their outcomes tochance. This conclusion is similar to the finding that people overplace and overentercompetitions on easy tasks while they underplace and underenter competitions ondifficult tasks.26 People prefer to bet on themselves when they feel knowledgeableand in control.



When Information is Lacking or Ambiguous, We Overplace

Obtaining clear feedback is crucial for calibrating one’s judgment. Unfortu-nately, information is often anything but timely and unambiguous. It may takemonths or years before the wisdom of big choices becomes clear. Was Disney’s2012 acquisition of Lucasfilm a wise move? We will never know how Disney wouldhave fared without it. Furthermore, during the time that people wait to receive infor-mation about important outcomes, they have likely made a series of other key deci-sions that may influence the very outcomes that they hope to use in calibrating theirjudgment. This makes information ambiguous, as it becomes difficult to tell whethera specific decision caused an outcome. For instance, Ford got a great deal of credit forweathering 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 customersand more to do with some lucky financing decisions it had made shortly before theeconomic 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 witha competitor drives the extent to which we overplace our performance. People tendto estimate the competition’s ability by adjusting from prior expectations in responseto new information about the competition’s performance. The less reliable the infor-mation people have about the competition, the less they will adjust from priorexpectations. Thus, when people partake in a task that is easier than expected, theyoften raise their expectations of the competition’s performance to a lesser degreewhen the competition is unfamiliar than when it is familiar. Likewise, on tasks thatare more difficult than expected, people tend to lower their expectations of the com-petition’s performance to a lesser degree when they are unfamiliar with the compet-ition’s abilities than when they are. In combination, this suggests that when we areunfamiliar with a competitor, we should overplace on easy tasks and underplaceon 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 theywould perform on various types of quizzes relative to a stranger or a friend.28 Onhard quizzes, participants estimated that their relative performance would be evenworse compared to a stranger than compared to a friend. On easy quizzes, partici-pants estimated that their relative performance would be even better compared toa stranger than compared to a friend.

Friends are more familiar to us and tend to be more similar to ourselves thanstrangers, so this finding suggests that we tend tomake fewer errors when estimatingthe performance of individuals who are familiar to us and who are similar to our-selves. Often, rival organizations are familiar with one another and similar to eachother29, so it should be the case that firms are more accurate at estimating the perfor-mance of established competitors than estimating the performance of relativelynew and unknown firms. We may be at the most danger of underestimating thecompetition’s ability when we face an unfamiliar competitor who is different fromourselves in a domain that we perceive to be easy.

We not only need information about the competition to make accurate judg-ments about how we rank on a task, but we also need information about the taskitself. Often, merely acquiring knowledge about a particular task can be an effective



means of improving the calibration of one’s judgment, even when he or she doesnot receive feedback about his or her own competence or the competence of a com-petitor. Kruger and Dunning pointed out that across a variety of domains, the veryworst performers often overplace to the greatest extent.30 They attribute this obser-vation to the fact that in many tasks, the most incompetent individuals often havethe least information about the task. Because the very same information needed toperform well at a task is often the same information needed to evaluate one’s com-petence at the task, the most incompetent individuals often lack the knowledge toadequately assess their own relative skill. Furthermore, the authors demonstratedthat 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 randomsubset of participants complete a training session that helped them identify some ofthe skills necessary to succeed. Those who completed a training session becamemoreaccurate at estimating their relative performance across all levels of objective perfor-mance and those who were in the bottom quartile of performers improved the mostin terms of accuracy, as they dramatically adjusted their estimated percentile ranksdownward. Thus, learning more about the task improved everybody’s ability to esti-mate their relative performance, especially those who had the least knowledge aboutthe task in the first place. By simply becoming aware of the skills necessary to be suc-cessful at the task, incompetent participants became more capable of recognizingtheir own limitations. Learningmore about the tasks we engage in allows us to betterrecognize our own limitations and the limitations of others. This reduces uncertaintyand improves the accuracy of performance expectations.

The more information we have about the competition and the domain inwhich we are competing, the better we are at judging our ability to compete. Unfor-tunately, we often process the information we do receive in a biased fashion.Manag-ers 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 withfeedback about the quality of their own decisions, a variety of other factors come intoplay that may affect the very outcomes that they hope to use as feedback in helpingthem calibrate their judgment. The ambiguity of information about outcomes and itslack of timeliness often explains why people form biased perceptions of their ownjudgment. Many stand ready to accept credit for successes, but managers routinelyblame forces outside of their control when things go badly. In the words of JohnF. Kennedy: “Victory has one hundred fathers, but defeat is an orphan.”

Even when we do get good information and timely feedback about our ownperformance, 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 orto engage in a speed dating task.31 Those who completed the IQ test estimated theirranks on the test relative to others in their experimental session while those whocompleted the speed dating task estimated their physical attractiveness ranking asrated by members of the opposite sex. In a second ranking game, the experimenterdrew a random card for each participant in the session to determine ranks by chance.

Participants received information about how they compared to another ran-domly selected participant in their session, one at a time. Notably, this type of feedback



is incomplete, as it doesn’t directly tell participants how they compare to all otherparticipants. The incomplete information introduces an element of ambiguity in howit should be interpreted in updating one’s ranking relative to other participants. Eachtime participants received new information, they updated their estimates of wherethey ranked relative to all participants in the experimental session. Interestingly, theauthors found that for IQ and attractiveness, people responded quickly to informationsuggesting they ranked better than they had thought, yet were relatively unresponsiveto 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 accuratein updating to both positive and negative information. This finding indicates that peo-ple are capable of objectively updating to new information that doesn’t concern theirown abilities, but when the information is relevant to their own abilities, they tendto update in a self-serving manner. People upgrade their estimated relative rank inresponse to information suggesting that they are better than others to a greater extentthan they downgrade their estimated relative rank in response to information suggest-ing that they are worse than others.

The evidence suggests that people update to new information in a biasedmanner when it directly involves their own relative abilities, particularly when theyreceive information suggesting that they do not compare as favorably to others asthey previously thought. This self-serving bias is particularly conducive to overplac-ing one’s abilities, as people are unlikely to adequately downgrade their beliefs abouttheir relative abilities despite receiving information suggesting that they should. Evenwhen people do their due diligence by acquiring as much information as they canabout the competition and the tasks in which they are competing, they are often atrisk of overplacement.

The Benefits of Confidence

While overconfidence can be a dangerous bias with harsh economic conse-quences in market settings, this does not mean that those with less confidenceare always better off. Just as overestimating their relative placement can lead peopleto enter markets too frequently, underestimating their relative placement can pre-vent people from entering lucrative markets with little competition. In the words ofhockey legend Wayne Gretzky: “You miss one hundred percent of the shots thatyou don’t take.”

Confidence not only has the benefits of motivating people to take on the risksnecessary for achieving financial prosperity, but it also has social and competitivebenefits that can allow people to get a leg up on the competition once they have cho-sen to enter a market. In fact, even if confidence manifests itself in the form of over-placement, overconfidence can have competitive advantages.

Confidence Improves Social Status

We often rely on nonverbal cues to assess others. We sometimes use thesecues to infer the competence of others, despite the fact that themost assertive individ-uals are not necessarily the most competent.32 Overconfidence is one factor that can



drive individuals to exhibit cues that are associated with competence. In a series ofstudies, Anderson et al. demonstrated that the most overconfident individuals tendto be perceived as the most competent.33 One study in particular experimentallymanipulated overconfidence by giving participants randomized feedback about theirperformance. Some participants received performance feedback that was accuratewhile others received feedback telling them that they received a high score. Thismanipulation served as a successful induction of overplacement, as those participantstold that they received a high score estimated their percentile rank on the task to behigher than those who received accurate feedback. After receiving feedback, eachparticipant then completed the task again in a dyad with another participant. At theconclusion of the dyadic task, participants then rated one another in terms of howcompetent they perceived each other to be and how much influence they perceivedeach other to have over the decision-making process in the dyadic task. The resultsof the study demonstrated that people perceived overconfident partners to be betterat the task relative to other participants than people who received accurate feedback.Additionally, overconfident people were rated as more influential over the decision-making process in the dyadic task than accurate people. In another set of studiesbuilding on this research, Kennedy et al. found that overconfident individuals werenot only rated as more influential than others, but their partners changed theirresponses on a task to a greater extent while interacting with these overconfidentindividuals.34 The data suggest that this was partly because people tend to be influ-enced by others who they perceive to be competent.

Whether you are a young entrepreneur trying to secure venture capital fund-ing, a sales representative who seeks to convince a client to hire his or her firm, or anexperienced CEO who wants to instill confidence in employees, the appearance ofcompetence and the ability to influence others are crucial for success in competitivemarkets. The display of confidence is one route through which individuals can reapthese benefits. However, it is unclear whether confidence is something that can beeasily faked. The results of one study in the research by Anderson et al. describedabove suggests that being perceived as competent has much more to do with one’snonverbal behavior than explicit claims. As illustrated by Table 3, overconfidentpeople tend to speak more often, to provide information relevant to a problem, tooffer the first answer in dyadic tasks, and to speak in confident tone with a relaxeddemeanor.

It should be immediately obvious that these behaviors are likely to be diag-nostic cues of competence. Those who actually are capable should be those whospeak first, speak most, and speak assertively. In many ways, that is the ideal: thosewho take control are also those whose abilities justify that confidence. If you actu-ally are the best, then you cannot overplace yourself. However, others may have tochoose how much confidence to display given their limited abilities and their desireto assert control, attain status, or frighten off potential rivals.

Confidence Deters Competition

Given 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 effectivemeans of deterring others from competing. If people think that the competition is



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 theyare highly competent are successful at deterring the competition.35 Some participantsin their study were given a strategic choice of whether to enter a competition withanother participant where the person with the higher score on an intelligence testwould win $10 and the loser would earn nothing. Those facing the entry decisionwere given the choice of whether to accept a guaranteed payment for not enteringthe competition or to enter the competition and risk earning nothing. Furthermore,among those choosing whether to enter the competition, some were provided withthe other participant’s estimates about his or her percentile rank relative to otherson the intelligence test.

The results indicate that the more confident the opponent, the less likelyparticipants were to enter the competition. Specifically, it appears that the primarydriver of decisions to enter the competition was participants’ estimates of their per-centile rank relative to their opponents’ estimates of their own percentile rank. Inone condition where participants faced a decision of whether to enter the competi-tion or to receive a $5 payment, those who had more confidence in their relativeabilities than their opponent entered the competition 92% of the time while thosewho had less confidence in their relative abilities than their opponent only enteredthe competition 17% of the time. Even though participants were generally guilty ofoverplacement in this study, it appears that people who overplaced to a greaterextent than their opponent were successful at deterring the competition.

In reality, people and organizations may not necessarily indicate theirdegree of confidence by publicizing explicit estimates about their relative abilities.Nevertheless, there are other, more subtle ways to signal confidence. People maystrategically draw comparisons between themselves and high-status others in jobinterviews and pitch meetings with clients. Organizations may indicate their per-ceptions of how they rank relative to other companies through the language theyuse in marketing materials, press releases, and quarterly earnings statements. All

TABLE 3. Correlations between the Display of Particular Behavioral Cues,Overconfidence, and Observer-Perceived Competence

Behavioral Cue Overconfidence Perceived Competence

Percent of time spoke .25* .59*

Confident and factual vocal tone .29* .54*

Provided information relevant to problem .19* .51*

Expanded posture .00 .37*

Calm and relaxed demeanor .22* .34*

Offered an answer later −.10 .24*

Offered an answer first .27* .21*

Statements of certainty in estimate .17 .21*

Statements about ease or difficulty of task .07 .18Statements about one’s own competence −.14 .09

Note: 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.



of these strategies are subtle ways for people and organziations to generate theperception that they are a force to be reckoned with.

Strategies for deterring the competition could be even more subtle, such asinvesting larger amounts of resources than are necessary to launch new products.For example, Apple completed construction on a new one-million square foot datacenter that required an investment of a billion dollars. Apple has publicly stated thatthe new center will be used to coordinate the updating of multimedia content onthe devices of all Apple users, but some analysts have been pointing out that thenew data center seems to be excessively large for the amount of data that it actuallyneeds to store. This excess of storage space, in combination with the fact that peoplehave noticed very little activity at the center, has led some to speculate that the cen-ter is primarily in existence to intimidate the competition.36 We may never find outwhy Apple built such a large data center, but its large investment could simply bean indication that its leadership is confident in the company’s ability to continuegrowing and developing innovative new products. This public display of confidencecould potentially deter competitors who hope to one day steal market share awayfrom Apple. In this sense, what initially appears to be overconfidence may eventu-ally 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 befalse. For example, in one study by Tenney and colleagues describing a hypotheticalcriminal case, one particular eyewitness was perceived as more credible when he orshe expressed certainty in the accuracy of a sworn testimony claiming that a defen-dant is guilty and the testimony turned out to be true thanwhen he or she expresseduncertainty in the accuracy of the very same true testimony.37 However, when thetestimony turned out to be incorrect, the same eyewitness was considered less credi-ble when expressing certainty than when expressing uncertainty. Not only was thecertain eyewitness considered less credible, but participants were less likely to thinkthat the defendant was guilty when the eyewitness was certain in the inaccurate tes-timony than when he or she was uncertain about the same testimony.

Though expressing confidence is risky because it may be clearly exposed asoverconfidence, in many situations people do not have sufficient evidence to deter-mine whether an individual’s confidence is warranted or merely the result of poorcalibration. Often it is costly to acquire information about the accuracy of othersand people choose to trust those who express confidence in their abilities withoutinvesting costs into gathering the information necessary to assess their accuracy.38

Even when accuracy feedback is free, it still can be difficult to decipher exactlyhow accurate people arewhen they express confidence in their abilities.We often failto account for how accurate people are when we judge their credibility unless theirdecisions have had a direct impact on us in the past.39 Even in cases where a confi-dent individual is clearly exposed as being inaccurate, we tend to give him or herbenefit of the doubt when there appears to be a legitimate excuse for being inaccu-rate.40 Although overconfidence can backfire when exposed, it is quite difficult forpeople to expose it in the first place. Thus, the strategic display of confidence can



work in a wide variety of situations. The more ambiguous and the more costly theinformation needed to assess our accuracy, the more likely confidence is to be a suc-cessful means of appearing competent and deterring the competition.

Practical Recommendations

What can the research tell us about the best strategies for avoiding the dan-gers posed by overconfidence while enjoying the potential benefits of confidence?The research presented above suggests several courses of action that may be effec-tive in avoiding the pitfalls of overconfidence while benefiting from the advantagesof confidence.

Calibrate Your Own Beliefs

Work on calibrating your own private beliefs. When you have importantdecisions to make, fooling yourself into thinking you’re better than the competitionis generally a bad strategy. Thinking you can fly is dangerous if it increases yourpropensity to jump off the building without a safety net below you. Sometimes,taking excessive risks can lead to personal tragedy. Sometimes, when overconfi-dence becomes a shared delusion, such as the belief that home prices will increaseindefinitely, it can produce economic cataclysms on a more spectacular scale. This isespecially important for political and organizational leaders to keep in mind, as theiroverconfidence may not only bias their own decision making, but create a sense ofinvincibility that permeates their organizations and society as whole. Tips on cali-brating your own private beliefs follow.

Ask Yourself If It Feels Too Easy

We are particularly in danger of overplacing our relative abilities when a taskis easier than we expected. Though we are often correct in updating our beliefsabout our own performance on easy tasks, we often fail to update our beliefs aboutthe competition. This combination results in overplacement. Thus, when somethingfeels easy, you should ask yourself whether your assessments of your own relativeperformance are too good to be true. Rather than only considering how your pre-dictions of your own performance may be miscalibrated, rethink the accuracy ofyour predictions for the competition.

Ask Yourself If You Are Really in Control

We seldom encounter situations in which we truly have no control. How-ever, a large proportion of our successes, whether it be in our stock market invest-ments, the crops we plant, or the fate of a new product, are driven by complexfactors beyond our control. These forces can include the weather, the actions ofour competitors, and larger macroeconomic forces. We are at the greatest risk ofoverestimating our objective degree of control when we have little control overoutcomes.41 We also are the most likely to enter competitions in domains that weare skilled at when we feel like we have control over outcomes. However, so areour rivals. As we face more competition over limited resources, our outcomesbecome more dependent on the competition’s performance and less dependent



on our own performance. Thus, overestimating the amount of control we haveover our own outcomes often leads us to enter competitive markets where successis dictated largely by random chance. By coming to more realistic assessments ofhow much control you really have over your own outcomes, you can avoid enter-ing oversaturated competitive markets.

Listen to Humbling Evidence

When we find out that we are not ranked as favorably as we previouslythought, 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 thecompetition even in the face of more humbling evidence. Paying attention to theevidence right in front of you and updating your beliefs can go a long ways towardsimproving your judgment. You may even need to rely on trusted advisors to tellyou whether you are appropriately accounting for the information available toyou. This might not boost your ego, but it could save you from making more costlymistakes.

As consumers of advice, we also must be vigilant for information suggestingthat we may not be receiving the most accurate advice. Knowing the persuasivepower of confidence displays, how can we avoid being gulled by arrogant wind-bags? The answer is that when we have a choice to make about how much to trustothers, we must actively seek out data that can help us assess how honest and well-calibrated they are. One reason that overconfidence often goes unchecked is thatpeople 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 theyare often discounted even though they may be more accurate than advisors whobehave confidently.

Generally speaking, objective and unbiased data are critical for assessing theaccuracy of one’s judgment and the judgment of others. By performing statisticalanalyses of outcomes and comparing actual outcomes to their predictions, peoplecan learn to better calibrate their judgment and to benchmark their performance.Furthermore, for judgments with a complex array of factors in play, data can allowfor the creation of algorithms that make decision making effortless for managersand more accurate than simply relying on intuition. Collecting objective data allowspeople to not only adopt what Kahneman and Lovallo refer to as the “outsideview”42 and objectively evaluate the precision of their judgment, but it can alsoimprove the efficiency and accuracy of their future decisions.

Portray an Image of Confidence

Speaking frequently, volunteering to speak first, talking with a factual tone,providing the first answer to problems, and adopting a calm demeanor are allthings that are natural signals of confidence. The benefits of confidence come pri-marily through its display to others. The implication is that acting confident isbeneficial. It is indeed most useful when that confidence can increase the dedica-tion of customers, investors, voters, or employees. But given the risks associatedwith false displays, leaders should avoid making claims of confidence on whichthey cannot deliver. The best and most persuasive claims of confidence are those



that are backed up by substance. When your claims are informed by data and con-sultation with outsiders, you not only will appear persuasive, but you will makemore accurate predictions and be less likely to suffer the consequences of poorcalibration.

Research has demonstrated that the mere experience of power makes peopleexcessively certain in the accuracy of their judgment and reduces their likelihoodof listening to others’ advice.43 By instituting systems of checks and balances whereone’s predictions must be approved by others before the predictions are made public,people can reduce the likelihood of becoming exposed as an overconfident advisorwho 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-levelexecutives who are particularly prone to experiencing the confidence-enhancingeffects of power.

Conclusion

Overconfidence in one’s private beliefs can produce risky actions that lead toeconomically disastrous outcomes. However, the display of confidence can also behelpful for gaining status, influence, and support. Recent research has uncoveredsome of the situations in which we are particularly prone to overconfidence. Fortu-nately, this research also suggests some practices that managers may adopt in aneffort to improve their decisions. By strategically conveying confidence to others,making an effort to collect performance data, and making a conscious effort to cali-brate their beliefs, managers can leverage the benefits of confidence without sub-jecting their organizations to the pitfalls of overconfidence.

Notes

1. Michael Lewis, Boomerang (New York, NY: W.W. Norton, 2011), p. 22.2. S. Plous, The Psychology of Judgment and Decision Making (New York, NY: McGraw-Hill, 1993),

p. 217.3. Linda Babcock, George Loewenstein, Samuel Issacharoff, and Colin Camerer, “Biased Judgments

of Fairness in Bargaining,” The American Economic Review, 85/5 (December 1995): 1337-1343.4. T. Odean, “Do Investors Trade Too Much?” American Economic Review, 89/5 (December 1999):

1279-1298.5. W.F. DeBondt and R.H. Thaler, “Financial Decision-Making in Markets and Firms: A Behavioral

Perspective,” in R.A. Jarrow, V. Maksimovic, and W.T. Ziemba, eds., Finance: Handbooks in Oper-ations Research and Management Science (Amsterdam: Elsevier, 1995), p. 389.

6. Erik Hoelzl and Aldo Rustichini, “Overconfident: Do You Put Your Money on It?” The EconomicJournal, 115/503 (April 2005): 305-318.

7. Don A. Moore and P.J. Healy, “The Trouble with Overconfidence,” Psychological Review, 115/2(2008): 502-517.

8. Daylian M. Cain, Don A. Moore, and Uriel Haran, “Making Sense of Overconfidence in MarketEntry,” Strategic Management Journal (forthcoming 2012).

9. Odean, op. cit.10. Brad M. Barber and Terrance Odean, “Trading Is Hazardous to YourWealth: The Common Stock

Investment Performance of Individual Investors,” The Journal of Finance, 55/2 (April 2000):773-806.

11. Ulrike Malmendier and Geoffrey Tate, “Who Makes Acquisitions? CEO Overconfidence andthe Market’s Reaction,” Journal of Financial Economics, 89/1 (July 2008): 20-43.

12. Mark Simon and Susan M. Houghton, “The Relationship between Overconfidence and theIntroduction of Risky Products: Evidence from a Field Study,” The Academy of Management Journal,46/2 (April 2003): 139-149.



13. Rita Gunther McGrath, “Failing by Design,” Harvard Business Review, 89/4 (April 2011): 76-83.14. Stephen Shankland, “Top Google Execs: $1 Salary, No Bonus, No Options,” CNET News, March

25, 2009, <http://news.cnet.com/8301-1023_3-10204209-93.html>.15. Manju Puri and David T. Robinson, “Optimism and Economic Choice,” Journal of Financial

Economics, 86/1 (October 2007): 71-99.16. DavidGoldman, “10BigDot.ComFlops,”2010,<http://money.cnn.com/galleries/2010/technology/

1003/gallery.dot_com_busts/index.html>.17. Linda Himelstein and Gerry Khermouch, “Commentary: Webvan Left the Basics on the Shelf,”

BusinessWeek, July 22, 2001, <www.businessweek.com/stories/2001-07-22/commentary-webvan-left-the-basics-on-the-shelf>.

18. Philipp Koellinger, Maria Minniti, and Christian Schade, “‘I Think I Can, I Think I Can’: Over-confidence and Entrepreneurial Behavior,” Journal of Economic Psychology, 28/4 (2007): 502-527.

19. Don A. Moore and Daylian M. Cain, “Overconfidence and Underconfidence: When and WhyPeople Underestimate (and Overestimate) the Competition,” Organizational Behavior and HumanDecision Processes, 103/2 (July 2007): 197-213.

20. Timothy Dunne, Mark J. Roberts, and Larry Samuelson, “Patterns of Firm Entry and Exit inU.S. Manufacturing Industries,” The RAND Journal of Economics, 19/4 (Winter 1988): 495-515.

21. Paul D. Windschitl, Justin Kruger, and Ericka Nus Simms, “The Influence of Egocentrism andFocalism on People’s Optimism in Competitions: When What Affects Us Equally Affects MeMore,” Journal of Personality and Social Psychology, 85/3 (September 2003): 389-408.

22. Rick Newman, “How Obama Can Win Back Small Business,” US News, June 29, 2012, <www.usnews.com/news/blogs/rick-newman/2012/06/29/how-obama-can-win-back-small-business>.

23. Don A. Moore, “The Unexpected Benefits of Final Deadlines in Negotiation,” Journal of Experi-mental Social Psychology, 40/1 (January 2004): 121-27.

24. Colin Camerer andDan Lovallo, “Overconfidence and Excess Entry: An Experimental Approach,”The American Economic Review, 89/1 (March 1999): 306-318.

25. Chip Heath and Amos Tversky, “Preference and Belief: Ambiguity and Competence in Choiceunder Uncertainty,” Journal of Risk and Uncertainty, 4/1 (January 1991): 5-28.

26. Cain, Moore, and Haran, op. cit.27. Bill Vlasic, “Chosing Its Own Path, Ford Stayed Independent,” New York Times, April 9, 2009,

<www.nytimes.com/2009/04/09/business/09ford.html?_r=1&ref=alanrmulally>.28. Windschitl, Kruger, and Simms, op. cit.29. Gavin J. Kilduff, Hillary Anger Elfenbein, and Barry M. Staw, “The Psychology of Rivalry:

A Relationally Dependent Analysis of Competition,” Academy of Management Journal, 53/5(October 2010): 943-969.

30. Justin Kruger and David Dunning, “Unskilled and Unaware of It: How Difficulties in Recogniz-ing One’s Own Incompetence Lead to Inflated Self-Assessments,” Journal of Personality andSocial Psychology, 77/6 (December 1999): 1121-1134.

31. David Eil and Justin M. Rao, “The Good News-Bad News Effect: Asymmetric Processing of Objec-tive Information About Yourself,” American Economic Journal: Microeconomics, 3/2 (2011): 114-138.

32. Cameron Anderson and Gavin J. Kilduff, “Why Do Dominant Personalities Attain Influence inFace-to-Face Groups? The Competence-Signaling Effects of Trait Dominance,” Journal of Person-ality and Social Psychology, 96/2 (2009): 491-503.

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.

34. Jessica A. Kennedy, Cameron Anderson, and Don A. Moore, “Social Reactions to Overconfi-dence: Do the Costs Outweight the Benefits?” unpublished manuscript, 2012.

35. Gary Charness, Aldo Rustichini, and Jeroen van de Ven, “Overconfidence, Self-Esteem, andStrategic Deterrence,” unpublished manuscript, 2011.

36. Robert X. Cringely, “Have You Heard the One About Apple’s Data Center?” <www.cringely.com/2011/06/have-you-heard-the-one-about-apples-data-center/>.

37. Elizabeth R. Tenney, Robert J. MacCoun, Barbara A. Spellman, and Reid Hastie, “CalibrationTrumps Confidence as a Basis for Witness Credibility,” Psychological Science, 18/1 (January2007): 46-50.

38. Sunita Sah, Don A. Moore, and Robert J. MacCoun, “Cheap Talk and Credibility: The Conse-quences of Confidence and Accuracy on Advisor Credibility and Persuasiveness,” unpublishedmanuscript, 2010.

39. Joseph R. Radzevick and Don A. Moore, “Competing to Be Certain (But Wrong): MarketDynamics and Excessive Confidence in Judgment,” Management Science, 57/1 (January 2011):93-106.



40. Elizabeth R. Tenney, Barbara A. Spellman, and Robert J. MacCoun, “The Benefits of KnowingWhat You Know (and What You Don’t): How Calibration Affects Credibility,” Journal of Exper-imental Social Psychology, 44/5 (2008): 1368-1375.

41. Francesca Gino, Zachariah Sharek, and Don A. Moore, “Keeping the Illusion of Control UnderControl: Ceilings, Floors, and Imperfect Calibration,” Organizational Behavior and Human Deci-sion Processes, 114/2 (March 2011): 104-114.

42. Daniel Kahneman and Dan Lovallo, “Timid Choices and Bold Forecasts: A Cognitive Perspec-tive 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 DetrimentalEffects of Power on Confidence, Advice Taking, and Accuracy,” Organizational Behavior andHuman Decision Processes, 116/2 (November 2011): 272-285.

California Management Review, Vol. 55, No. 2, pp. 5–23. ISSN 0008-1256, eISSN 2162-8564. © 2013 byThe Regents of the University of California. All rights reserved. Request permission to photocopy orreproduce article content at the University of California Press’s Rights and Permissions website athttp://www.ucpressjournals.com/reprintinfo.asp. DOI: 10.1525/cmr.2013.55.2.5.



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