How too much confidence can benefit entrepreneurs

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Researchers have created a computational model to interpret decision-making, learning, and experiences that result in entrepreneurs’ success and failure in market entry and exit.

In short, they distilled the traits that lead an entrepreneur to get into, or out of, the startup business.

Innovations come and go. Entrepreneurs fail and move on. Researchers have spent decades empirically analyzing the process and people behind such startups and shutdowns, relative to confidence or overconfidence. But too much of that scholarship “(mis)attributed” mistakes to individual behavioral bias, according to a new study outlining the model.

‘Toxic’ traits

Of the many equations used in their model, the researchers came across the surprising result that certain combinations of personality biases, which coauthor Daniel Elfenbein says often seem “absolutely toxic,” turn out almost to the benefit of entrepreneurs.

One such equation: overconfidence + overreaction to information gathered = near-optimal results.

“My view is that most people do tend to overreact to the latest news,” says Elfenbein, an associate professor of strategy in the Olin Business School at Washington University in St. Louis.

“That’s what I’ve seen in my own laboratory work. It makes me actually think, if that’s the case, to be a little overconfident at the start might be a pretty good thing—at a population level. The idea that every bias is a defect may well be wrong,” he says.

The model took into account pre-entry learning, a vital aspect that might prove a stronger component than even the ongoing learning throughout the experience. Such groundwork can explain some patterns of success and failure, and may help to overcome some combinations of behavior bias quickly and others more slowly, the researchers found.

“Context changes the skill set of entrepreneurs,” he says, “and this paper highlights the fact that maybe context shapes the opportunity assessment of entrepreneurs.

“We started tackling stuff that’s invisible: What happens before entering the marketplace,” he adds.

One key finding: “The worst entrepreneurs still enter,” Elfenbein says. “These are the people who are both overly optimistic about their chances and learn too slowly, because they are overprecise in their beliefs. Not only are they overconfident about their prospects for profitability, but they are overconfident about what they know. So the entrepreneurs who destroy the most value are most likely to enter, nevertheless.”

How bad is bias?

Another important takeaway from their computational model, Elfenbein says, is the combination of biases that actually prove to be innocuous, such as entrepreneurs who are slightly overconfident/overoptimistic or overreact to new information.

“In our simulation, if you’re more likely to start, but quick to pull the plug, that works almost as well as if you’re perfectly calculating the odds at every point in time,” he says. “Even if you react too quickly to the information that you get, those gut-feel people will do theoretically just as well as the folks who are hyper-rational about it.”

Their computational model likely holds more significance as an academic platform from which to conduct further study, though Elfenbein notes that it could benefit the angel investors and venture capitalists funding innovations based on entrepreneurs.

“Often, we make an assumption that bias is bad,” says Elfenbein.

“This is a process study,” Elfenbein says. “It helps us to better understand confidence and overconfidence in the context of entrepreneurship. And it is intended to address questions that firm founders, angel investors and venture capitalists care about, including how we can focus on mitigating failures with the right approach.”

Their model offers the field of study three new facets:

  • It unifies theoretical frameworks for understanding empirical regularities heretofore considered individually.
  • It provides complementary perspective to strategy research.
  • It predicts bias—such as confidence, precision, and such—and the effects of bias on business.

“You’ve got Vince Lombardi, who says quitters never win and winners never quit. Then I’ve got this other poster on my wall that says if you never quit and you never win, then you’re an idiot,” Elfenbein says.

“There are a lot of entrepreneurs in that space, ‘We haven’t succeeded yet,’ and they need to think about these sets of issues. There are other people in the space who say, ‘We haven’t really started to try yet, but when we start to try, how will we know what success looks like and what failure looks like?’ Our view is, they’ll probably be better business people for it. Part of that is behind the entrepreneurial mantra, ‘Fail fast, fall often.'”

Elfenbein and Hart Posen of the University of Wisconsin first struck upon this course of study while together at the Darden-Cambridge Judged Entrepreneurship Conference in London in 2015. Over dinner in Cambridge’s Christ’s College dining hall, they decided to put a team together to emphasize their scholarly strengths.

“We felt that the entrepreneurship literature had over-attributed patterns of behavior to overconfidence, that it hadn’t sufficiently described what overconfidence meant, and that it ignored a lot of interesting stuff happens before a business is launched,” Elfenbein says.

The study appears in Organization Science.

Additional coauthors are from the University of Florida and Michigan State University.

Source: Washington University in St. Louis