Overconfidence and Excess Entry: An Experimental Approach

Psychological studies show that most people are overconfident about their own relative abilities, and unreasonably optimistic about their futures (e.g. Shelly E. Taylor and J.D. Brown, 1988; Neil D. Weinstein, 1980). When assessing their position in a distribution of peers on almost any positive trait-- like driving ability (Ola Svenson, 1981 ), income prospects, or longevity-- a vast majority of people say they are above the average, although of course, only half can be (if the trait is symmetrically distributed). This paper explores whether optimistic biases could plausibly and predictably influence economic behavior in one particular setting-- entry into competitive games or markets. Many empirical studies show that most new businesses fail within a few years. For example, using plant level data from the U.S. Census of Manufacturers spanning 1963-1982, Timothy Dunne et al. (1988) estimated that 61.5 percent of all entrants exited within five years and 79.6 percent exited within 10 years. Most of these exits are failures (see also Dunne et al., 1989a, 1989b; D. Shapiro and R.S. Khemani, 1987).

[1]  Ido Erev,et al.  Equilibrium Play in Large Group Market Entry Games , 1998 .

[2]  C. Koopmans.  Van zacht naar hard: milieueffecten in kosten-batenanalyses , 1987 .

[3]  Michael Waldman,et al.  Systematic Errors and the Theory of Natural Selection , 1994 .

[4]  J. W. Hutchinson,et al.  Knowledge Calibration: What Consumers Know and What They Think They Know , 2000 .

[5]  G. Loewenstein,et al.  Behavioral Law and Economics: Explaining Bargaining Impasse: The Role of Self-serving Biases , 1997 .

[6]  E. Maccoby,et al.  The Psychology of Sex Differences , 1974 .

[7]  Robert A. Miller.  Job Matching and Occupational Choice , 1984, Journal of Political Economy.

[8]  Shelley E. Taylor,et al.  Illusion and well-being: a social psychological perspective on mental health. , 1988, Psychological bulletin.

[9]  Mark J. Roberts,et al.  Patterns of Firm Entry and Exit in U.S. Manufacturing Industries , 1988 .

[10]  N. Weinstein.  Unrealistic optimism about future life events , 1980 .

[11]  Douglas W. Allen,et al.  Risk Preferences and the Economics of Contracts , 1995 .

[12]  A. Tversky,et al.  Intuitive Prediction: Biases and Corrective Procedures , 1982 .

[13]  D. Dunning,et al.  Ambiguity and self-evaluation: the role of idiosyncratic trait definitions in self-serving assessments of ability , 1989 .

[14]  John R. Baldwin,et al.  The Dynamics of Industrial Competition , 1995 .

[15]  R. Roll,et al.  The Hubris Hypothesis of Corporate Takeovers , 1986 .

[16]  George Gamow,et al.  One, Two, Three...Infinity: Facts and Speculations of Science , 1947 .

[17]  Daniel Kahneman,et al.  EXPERIMENTAL ECONOMICS: A PSYCHOLOGICAL PERSPECTIVE , 1988 .

[18]  Joyce E. Berg,et al.  Controlling Preferences for Lotteries on Units of Experimental Exchange , 1986 .

[19]  Amnon Rapoport,et al.  Individual strategies in a market entry game , 1995 .

[20]  Reinhard Selten,et al.  Bounded rational behavior in experimental games and markets : proceedings of the Fourth Conference on Experimental Economics, Bielefeld, West Germany, September 21-25, 1986 , 1988 .

[21]  D. Kahneman,et al.  Timid choices and bold forecasts: a cognitive perspective on risk taking , 1993 .

[22]  Amnon Rapoport,et al.  Coordination in market entry games with symmetric players , 1995 .

[23]  O. Svenson.  ARE WE ALL LESS RISKY AND MORE SKILLFUL THAN OUR FELLOW DRIVERS , 1981 .

[24]  R. Selten,et al.  Money Does Not Induce Risk Neutral Behavior, but Binary Lotteries Do even Worse , 1999 .

[25]  J. March,et al.  Managerial perspectives on risk and risk taking , 1987 .

[26]  Dan Lovallo,et al.  Rational Entrepreneurs or Optimistic Martyrs? Some Considerations on Technological Regimes, Corporate Entries, and the Evolutionary Role of Decision Biases , 1997 .

[27]  Colin Camerer.  Individual Decision Making , 2020, The Handbook of Experimental Economics.