Overconfidence and Illusion of Control
Management Decision Making
Dr. Natalia Karelaia
05 – Overconfidence and Illusion of
Control
Overconfidence
• Overconfidence in skill: o 80% of people say they are in the top 30% of safe drivers; o 80% of entrepreneurs believe that their chances of success are at least 70%.
• Overconfidence in prediction: Too narrow prediction intervals.
• Meta-Knowledge: Confucius test: How much do you think you know?
• Conviction is blinding: It is easy to forget one’s fallibility (in judgment). o “Convictions are more dangerous enemies of truth than lies.” -- F.
Nietzsche
• Be cautious when someone else seems very confident. Their confidence may not mean much…
• Overconfidence has its costs. o E.g., underestimated risk, missed deadlines, overrun budgets, overpaid acquisitions, excessive trading.
• Decide prudently but act boldly: o Be realistic when making predictions and decisions. o Be confident when implementing your decisions and trying to convince others.
Cognitive dissonance
• We feel psychologically uncomfortable when facing facts that are contrary to our existing knowledge, beliefs, habits, and tastes. To decrease dissonance, we come up with ad hoc rationalizations to save cherished ideas – by distorting new evidence – or rejecting it outright.
• We are motivated not so much to be right. Instead, we are motivated to believe we are right.
Competitor neglect
• When considering market-entry decisions people pay disproportionate attention to their own internal characteristics and little to those of competitors or the external market in general.
Illusion of control
• We tend to exaggerate the degree of control we have over events, discounting the role of chance.
Remedies for Overconfidence
• Monitor and actively seek feedback. Avoid rationalizing failures.
• Link incentives to accuracy (accountability).
• To avoid anchoring, start with several estimates, not one.
• Get forecasts from multiple people working independently.
• Take
Dr. Natalia Karelaia
05 – Overconfidence and Illusion of
Control
Overconfidence
• Overconfidence in skill: o 80% of people say they are in the top 30% of safe drivers; o 80% of entrepreneurs believe that their chances of success are at least 70%.
• Overconfidence in prediction: Too narrow prediction intervals.
• Meta-Knowledge: Confucius test: How much do you think you know?
• Conviction is blinding: It is easy to forget one’s fallibility (in judgment). o “Convictions are more dangerous enemies of truth than lies.” -- F.
Nietzsche
• Be cautious when someone else seems very confident. Their confidence may not mean much…
• Overconfidence has its costs. o E.g., underestimated risk, missed deadlines, overrun budgets, overpaid acquisitions, excessive trading.
• Decide prudently but act boldly: o Be realistic when making predictions and decisions. o Be confident when implementing your decisions and trying to convince others.
Cognitive dissonance
• We feel psychologically uncomfortable when facing facts that are contrary to our existing knowledge, beliefs, habits, and tastes. To decrease dissonance, we come up with ad hoc rationalizations to save cherished ideas – by distorting new evidence – or rejecting it outright.
• We are motivated not so much to be right. Instead, we are motivated to believe we are right.
Competitor neglect
• When considering market-entry decisions people pay disproportionate attention to their own internal characteristics and little to those of competitors or the external market in general.
Illusion of control
• We tend to exaggerate the degree of control we have over events, discounting the role of chance.
Remedies for Overconfidence
• Monitor and actively seek feedback. Avoid rationalizing failures.
• Link incentives to accuracy (accountability).
• To avoid anchoring, start with several estimates, not one.
• Get forecasts from multiple people working independently.
• Take