Are Leaders Prone to Overconfidence?

Good structure triumphs over good intentions.

Posted Mar 01, 2021 | Reviewed by Hara Estroff Marano

The science of polling took a hit in 2016 when it forecast that Hillary Clinton would win over Donald Trump.  Did the science improve four years later? 

In 2020, polls indicated that Joe Biden would carry Ohio by four points, but Donald Trump won by 8.2 points. Polls predicted that Sara Gideon would defeat Maine’s incumbent Senator Susan Collins by 5-12 points.  But Susan Collins eventually defeated Ms. Gideon by 8 points. (Kotak & Moore, 2020)

Even allowing for a margin of error, scientists who do polling were overconfident.

Writing in his Wall Street Journal column “The Intelligent Investor,” Jason Zweig observed that individual investors borrowed to leverage trading is up 42 percent in 2021.  At the same time, a wary Federal Reserve is holding interest rates to near-zero to help avoid a major recession. (Zweig, 2021).  Could some investors be a bit overconfident?

Most of us like to think of ourselves as “rational,” even "cautiously rational." In this post, we will explore the gap between how we think of ourselves versus how we behave.

Classical economists talk about “economic man,” a supposedly rational being.  It is the foundation of much of economic thinking.  In 1957, however, Nobel Prize winner Herbert Simon proved that this traditional view was incomplete. He argued that human rationality is bounded.  (Bazerman & Moore, 2009).

Few of us like to think of our rationality as being “bounded,” and yet the research proves it to be the case.  For example, in 2011, Dov Paluch conducted research with 90 managers at a South African professional service firm.  He examined the tendency towards overconfidence as a function of sex, age, cognitive ability, and level of management.  He found that as one moves up the organizational hierarchy, people get overconfident.  The other variables were not statistically significant.

These findings provide a useful perspective for understanding the lack of success of mergers and acquisitions. In a 20-year period, the United States has spent over $3.4 trillion on 12,000 mergers.  And the result?  Shareholders of acquiring companies have lost $220 billion.  (Paluch, 2011).  Kusstatscher and Cooper state that 70 percent of M&As fail to achieve the goals of the acquiring company (2005).  

What’s to Be Done?

It can be predicted that every CEO proposing an acquisition to her Board of Directors knows these statistics.  It can also be predicted that each CEO feels that she/he is an exception.

These findings on overconfidence should give investors and board members a sense of urgency to ensure that Boards of Directors contain truly independent directors who have no personal or business ties to the CEO or other business interests that might conflict with judgment.  Having truly independent directors is critical in leadership succession of family-dominated business systems.  The reason is not that certain family members are “bad” people.  It is that all of us have bounded rationality. The higher up in the hierarchy, the more the tendency towards overconfidence.

For C-suite job candidates seeking to join a company, ask the CEO about the names of the independent directors and their backgrounds.  Were they selected because they belonged to the CEO’s golf club or because the company retained an independent search firm to find truly independent perspectives?  Use this information as important data in deciding whether to join the team.

Overcoming Overconfidence When Managing Your Team

We have met few leaders who would describe themselves as “overconfident.”  Indeed, most of the leaders we work with pride themselves on being “skeptical” and “data-driven.”  Like most of us, however,  they are susceptible to unjustified overconfidence.

When discussing issues with your team, we recommend you routinely assign one or more members of your team to the role of devil’s advocate.  Ask the appointed devil to come up with reasons why the team’s cherished plan should not be done.  In the absence of a specific assignment of devil’s advocate, your subordinates may not feel comfortable speaking up against your idea, for fear that you will call them negative and risk-averse.

Have the appointed devil lead the team into a discussion about scenario planning if the cherished plan fails.

Take time to create three levels of disaster: mild, moderate, severe.  Create plans for dealing with all three scenarios. 

Once the plan is formally approved, have all your team members take out their mobile devices and select a specific date and time one to two years into the future.  If the board has approved an acquisition,  have the members take their mobile devices and select a specific date three years into the future. The title of this meeting will be called Reviewing the X Decision:  What Worked, What Didn't Work, What Lessons Can Be Learned."

Do not assume you will be motivated 1-3 years from now to conduct such a review.  The chances are you will claim you are too busy to conduct such a meeting.  Place your trust in structure.  Motivation is an overrated concept.

Summary and Conclusions

Humans have a bias towards overconfidence.  And the higher in the organization, the more prone a person is to overconfidence.

The intervention strategy we suggest focuses not on changing human nature but structuring human systems to push back on our inherent overconfidence.

References

Bazerman, M. & Moore D. Judgement in Managerial Decision Making, New York: John Wiley & Sons, 2009.

Kotak, A. and Moore, D.  “The Polls are Overconfident, Just Like People.” Quartz, November 12, 2020. https://qz.com/1932176/why-the-polls-were-wrong-in-the-2020-election/

Kusstatscher, V. and Cooper C. Managing Emotions in Mergers and Acquisitions. London: Edward Elgar Publishing, 2005.

Paluch, D. Overconfidence Bias in Decision-making at Different Levels of Management.  Unpublished MBA Thesis submitted to the Gordon Institute of Business Science, University of Pretoria, 2011.

Zweig, J. “Why your wild trading ideas feel so right.” Wall Street Journal, B1, February 20-21, 2021