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The impact of overconfidence bias on firm performance: an empirical analysis of S&P 1500 firms
In the context of public firms competing for profitable growth, there is abundant evidence that a high proportion of strategic decisions are value destructive. When managers make strategic decisions to position their firms for competitive advantage, they do so in a context of uncertainty and, in so...
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| Format: | Thesis |
| Language: | English |
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Graduate School of Business (GSB)
2025
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| Summary: | In the context of public firms competing for profitable growth, there is abundant evidence that a high proportion of strategic decisions are value destructive. When managers make strategic decisions to position their firms for competitive advantage, they do so in a context of uncertainty and, in so doing, they apply heuristics or intuition, which makes them vulnerable to cognitive biases. We focused on overconfidence bias and its impact on firm performance. Overconfidence is considered to manifest in three distinct forms, namely overestimation, overprecision, and overplacement. While there are numerous gaps and conflicts in the literature, the most notable issues are conflicting results on the overall impact of overestimation, a paucity of studies on the impact of overprecision, and a focus on the overconfidence of the CEO, rather than on the management team making the strategic decisions. Our review of theory and empirical studies led us to hypothesise a negative relationship between firm performance and overestimation, and a positive relationship with overprecision. We examined the impact of overestimation and overprecision by analysing the performance of the largest public firms, excluding financial services, in the United States over the period 2009 to 2019. We measured firm performance using industry-adjusted return on assets. We derived proxies for overestimation and overprecision from management earnings guidance. Since strategic decisions play out over various time horizons, we considered one to five-year lags between our treatment and dependent variables. We estimated our panel data using a year and firm fixed-effects model. We found support for our hypotheses with a sizeable effect size and statistical significance. We also considered the combined impact of overestimation and overprecision and found that the “specific pessimist” management teams, those that express the greatest underestimation (negative overestimation) and the greatest overprecision, deliver the best firm performance. In contrast, the “vague optimist” management teams deliver the worst firm performance. Our theoretical contribution enriches the debate on the overall impact of group-level overestimation and overprecision on firm performance. Our findings also have practical implications in corporate governance, investment strategies, and the recruitment and promotion of senior executives |
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