In the market, of course, belief in one's superiority has significant consequences. Leaders of large businesses sometimes make huge bets in expensive mergers and acquisitions, acting on the mistaken belief that they can manage the assets of another company better than its current owners do. The stock market commonly responds by downgrading the value of the acquiring firm, because experience has shown that such efforts fail more often than they succeed. Misguided acquisitions have been explained by a "hubris hypothesis": The executives of the acquiring firm are simply less competent than they think they are.
Risk Takers
The economists Ulrike Malmendier and Geoffrey Tate identified optimistic chief executive officers by the amount of company stock that they owned personally and observed that highly optimistic leaders took excessive risks. They assumed debt rather than issue equity and were more likely to "overpay for target companies and undertake value-destroying mergers." Remarkably, the stock of the acquiring company suffered substantially more in mergers if the CEO was overly optimistic by the authors' measure. The market is apparently able to identify overconfident CEOs.
This observation exonerates the CEOs from one accusation even as it convicts them of another: The leaders of enterprises who make unsound bets don't do so because they are betting with other people's money. On the contrary, they take greater risks when they personally have more at stake. The damage caused by overconfident CEOs is compounded when the business press anoints them as celebrities; the evidence indicates that prestigious awards to the CEO are costly to stockholders.
The authors write, "We find that firms with award-winning CEOs subsequently underperform, in terms both of stock and of operating performance. At the same time, as CEO compensation increases, CEOs spend more time on activities such as writing books and sitting on outside boards, and they are more likely to engage in earnings management."
I have had several occasions to ask founders and participants in innovative startups this question: To what extent will the outcome of your effort depend on what you do in your company? The answer comes quickly, and in my small sample it has never been less than 80 percent. Even when they are not sure they will succeed, these bold people think their fate is almost entirely in their own hands. They know less about their competitors and find it natural to imagine a future in which the competition plays little part.
Competition Neglect
Colin Camerer, who coined the concept of competition neglect, illustrated it with a quote from a chairman of Disney Studios. Asked why so many big-budget movies are released on the same holidays, he said, "Hubris. Hubris. If you only think about your own business, you think, 'I've got a good story department, I've got a good marketing department' ... and you don't think that everybody else is thinking the same way." The competition isn't part of the decision. In other words, a difficult question has been replaced by an easier one.
This is a kind of dodge we all make, without even noticing. We use fast, intuitive thinking -- System 1 thinking -- whenever possible, and switch over to more deliberate and effortful System 2 thinking only when we truly recognize that the problem at hand isn't an easy one.
The question that studio executives needed to answer is this: Considering what others will do, how many people will see our film? The question they did consider is simpler and refers to knowledge that is most easily available to them: Do we have a good film and a good organization to market it?