Overconfidence among entrepreneurs has been documented in the work of many researchers. In a sample of 2,994 entrepreneurs, 81% of them, approximately 2,450, believe that their chances of success are at least 70%. Of the sample, 33% believe in an absolute 100% chance of succeeding, while 75% of new businesses will fail shortly after inception or will not make it within the next 5 years.
Another research revealed that when entrepreneurs were asked a question related to whether cancer or heart disease is the leading cause of death, against other individuals, entrepreneurs present a level of confidence in their answers which was significantly higher than those of others while the number of correct results were equally dispersed.
Entrepreneurs frequently exhibit the tendency to underestimate the likelihood of unfavorable results to occur. The chances of a new venture to fail or the profit that a firm will earn, as also the reaction of the competition, have been underestimated because the entrepreneurs show overconfidence in their ability to prevent all unfavorable things to happen.
While the majority of managers are overconfident, entrepreneurs exhibited greater overconfidence than managers. This finding suggests that several launches of new ventures were the outcome of the overconfidence that entrepreneurs show. Equally, overconfidence could be to a degree responsible for the fairly high incidence of new venture failures, given that overconfident entrepreneurs are expected to overestimate their ability to make correct decisions in launching and developing their new businesses.
It follows that if entrepreneurs normally display overconfidence, also young entrepreneurs may possibly exhibit overconfidence when shaping their intention to start their own businesses.
Several studies suggested that the purpose to become self-employed has a high level of dependency on the individual’s feelings to independence, ownership, and risk. In other words, because of their perceptions, individuals may be encouraged to proceed with a new venture. Hence, a question arises as to whether entrepreneurial intensions are affected independently by overconfidence or whether overconfidence operates as a moderator of these entrepreneurial intentions.
Both instances, in my belief, work complementarily. The sense of independence, ownership, and risk may be facilitated by becoming self-employed, while in not exhibiting confidence about your own ability to succeed, the attempt will fail.
The level of confidence that individuals exhibit will perform as long as it becomes a conscious belief. According to Forbes, a distinction is made between overconfidence and self-efficacy. More specifically, Forbes clarifies overconfidence as a measure of accuracy of an individual’s ability, while entrepreneurial self-efficacy measures the individual’s perception of their abilities. Such distinction suggests that overconfidence becomes a subconscious phenomenon, whereas entrepreneurial self-efficacy evolves into a consciously held belief. In addition, Forbes claims that an individual’s entrepreneurial self-efficacy varies to different levels of over-inflated opinions about their abilities. In such cases, the more over-inflated opinion, the higher the probability for individuals to demonstrate overconfidence in their abilities. Based on that, several entrepreneurs, with past business successes, will inevitably turn out to be more overconfident because their self-efficacy level is very high. Thus, overconfidence seems to act as an independent variable that holds the relationship between entrepreneurial self-efficacy and entrepreneurial intentions.
Overconfidence replaces lack of information by overestimating ability. It can be observed that the more difficult the task, the greater the chance of overconfidence to kick in and increase. On top of that, individuals that successfully completed tasks in the past experience an increase in their confidence regardless if this confidence is justified or not. From a point onward, individuals tend to disregard the information or the risks associated to a task and are based solely on their over-inflated ability, which is built up on past incidents which might not have been always successful.
When entrepreneurs are overconfident, they exhibit the tendency to follow their own information, down-weighting the publicly available information or ignoring the complete lack of any information whatsoever. The rest of the individuals that observe such behavior tend to believe that entrepreneurs are fearless of risk or that they have a higher level of risk tolerance. Such perception existed for many years and mainly was considered to be one of the distinct characteristics of entrepreneurs. A study by researchers provided contrary information to that belief. More specifically, it was observed that entrepreneurs are more cautious than most of us think. In several cases, entrepreneurs appeared to be more risk averse than the average, without though being discouraged in undertaking new ventures and obviously risk. Such a finding seems contradicting but actually is not. The explanation to that is based on the perception that entrepreneurs place to risk. The majority of individuals identify risk as the level of uncertainty of something to happen or not; therefore, the greater the uncertainty, the greater the risk. Entrepreneurs set different dimensions for uncertainty, which allow them to proceed with tasks, which for the majority of individuals appear very uncertain.
Entrepreneurs believe that uncertainty has two dimensions, one is the well-known market uncertainty (systemic risk) and the other is the uncertainty regarding ability. Like the majority of people, entrepreneurs dislike risk but, on the other hand, place great value on their ability. The appreciation of their ability comes in and compensates for the market risk; thus, any new venture becomes less risky and possibly more appealing.
Such findings imply that, as long as there is a great appreciation in the ability of the entrepreneurs, no venture is risky enough to discourage them. Conversely, if a high degree of uncertainty exists regarding ability, entrepreneurs will avoid entering in such ventures because their perceived lack of ability will never overcome the systemic risk.
It appears then that the volume of information which could reveal the level of uncertainty in a venture somehow becomes insignificant. Non-entrepreneurs try to be rational by supporting their decision not only on private but also on public information. Entrepreneurs do the same but place more weight on their own information which is the outcome of their ability and reduce the value of public information.
It is argued that overconfidence is something that characterizes human behavior in most cases. People tend to appreciate their knowledge highly even in cases where prior experience is contrary to that. The literature suggests that such overconfidence is something to be expected and most probably in cases where little information is available, but the impact of overconfidence on people’s behavior may differ depending on their perception about uncertainty.
Non-entrepreneurs exhibit overconfidence up to the limit on which the information is considered insufficient; therefore, the task in hand becomes uncertain. Entrepreneurs, on the other hand, exhibit similar overconfidence regardless of the available information. The driving force is the self-assessment of their skills and ability which appears to be unrelated to the level of information. Their ability is enough to compensate any lack of information. Clearly, when entrepreneurs over-assess their ability or believe that their ability will suffice to overcome objective difficulties, then the probability of failure increases significantly. Prior failures do not discourage them because part of overconfidence is isolating unfavorable results, thinking of them as out of the norm.
Entrepreneurs behave in a rational manner, contrary to what other individuals may think, under the influence of overconfidence which apparently characterizes human behavior. A question for further research that arises is when or under what circumstances is entrepreneurial ability not sufficient to overcome the risk in any new ventures.
About the Author
This article was written by Ioannis S Salamouris, an Assistant Professor of Finance at Hellenic American University (http://www.hauniv.us). In addition, Ioannis is the Director of the Office of Institutional Research and Assessment (OIRA) at the University. Ioannis is also the President of a Social Enterprise for Education and Lifelong Learning (http://www.knowl.gr). Last year, IS has become a Member of the Policy Committee of the Federation of Hellenic Associations of Young Entrepreneurs (http://www.esyne.gr).