A Theory of Entrepreneurial Overconfidence, Effort, and Firm Outcomes
Journal of Entrepreneurial Finance, 2015, Vol. 17, No. 1, pp. 1-27
29 Pages Posted: 29 Sep 2014 Last revised: 17 Mar 2015
Date Written: September 27, 2014
Abstract
We present a theory of entrepreneurial behavior that explores the relationship between overconfidence and successful firm outcomes, such as acquisition or IPO. In our model, increasing overconfidence produces two conflicting effects on the probability of a successful outcome: it not only induces an entrepreneur to increase the riskiness of a venture (which lowers the likelihood of successful exit), but also drives higher entrepreneurial effort, increasing likelihood of a successful exit. Due to this conflict, a kinked or U-shaped relationship may exist between overconfidence and positive outcomes. Furthermore, our model suggests that increased outside equity mitigates the effects of overconfidence.
Keywords: Overconfidence, Entrepreneurship, Cognitive Bias, IPO, Mergers & Acquisitions, Effort
JEL Classification: G32, G34, L26, M13
Suggested Citation: Suggested Citation