Academic journal article Journal of Small Business Strategy

When It's Right to Be "Wrong": The Effects of Overconfidence and Planning on Product Performance in a Dynamic Environment

Academic journal article Journal of Small Business Strategy

When It's Right to Be "Wrong": The Effects of Overconfidence and Planning on Product Performance in a Dynamic Environment

Article excerpt

ABSTRACT

Some authors emphasize overconfidence may benefit managers by increasing decision-making efficiency, whereas others argue it results in serious errors. This study helps resolve the debate by examining the relationship between overconfidence and product performance, as well as testing whether planning might mediate the link. The study sampled 52 small computer companies that had decided to introduce a product. It examined the manager's overconfidence and planning when the product was launched and measured the product's performance 18 months later. We found that overconfidence decreased planning, planning decreased performance, and, as hypothesized, planning mediated the relationship between the two other variables. By examining the meditating role of planning, we were able to better identify the causal relationships and clarify the effects of overconfidence.

Keywords: overconfidence, planning, performance, small business, product introduction

INTRODUCTION

Seminal works (e.g., Blau & Schoenherr, 1971; Galbraith, 1977) suggest that managers in small businesses, as opposed to those in larger companies, may face different challenges and employ different processes when making strategic decisions. Often they have fewer resources and formal processes, making it more difficult to remove initial uncertainty when making strategic decisions (Simon, Houghton & Savelli, 2003). This uncertainty is multiplied when managers employ a strategy of introducing new products in dynamic environments (Simon & Houghton, 2003). Dynamic markets make it difficult for managers to use historical knowledge to inform current choices. It is, for example, difficult in dynamic environments to discern customer preference and which competitors will be relevant (e.g., Brown & Eisenhardt, 1997; Brinckmann, Grichnik, & Kapsa, 2010).

As explained by Heuer (1999), the mind is poorly "wired" to deal effectively with this inherent uncertainty. Therefore, when facing uncertain conditions, some managers deny it exists, exhibiting overconfidence (Busenitz & Barney, 1997; Simon & Houghton, 2003). Overconfidence occurs when one's certainty of specific facts exceeds the accuracy of his or her knowledge (Busenitz & Barney, 1997; Russo & Schoemaker, 1992). Specifically, scholars (e.g., D'Souza & Kemelgor, 2008; Liao, Welsch, & Stoica, 2008; McNamara & Bromiley, 1997; Simon & Houghton, 2003) have suggested that overconfidence is more likely to occur when coping with dynamic environments, ill-structured decisions, and introducing pioneering products, and it may be especially prevalent among smaller firms. Virtually every business study of overconfidence acknowledges that overconfidence may be beneficial by increasing decision-making efficiency (Hayward, Forster, Sarasvathy, & Fredrickson, 2010), but that it also could result in errors that are large, persistent and serious (Hayward, Shepherd, & Griffin, 2006). Yet, these contradictory implications have not been reconciled empirically, to date (e.g., Busenitz & Barney, 1997; Forbes, 2005). Some researchers maintain that the incorrect facts of overconfident managers hurt business performance because these managers rush to action and leapfrog classical decision formulation and implementation steps (Hayward et al., 2006). In particular, they argue that overconfidence may encourage the managers to ignore planning and start down a false path. And without planning, some assert, economic performance will suffer.

Other scholars, however, do not accept this negative view of overconfidence as universally applicable (Busenitz & Barney, 1997). While most accept that overconfidence may reduce planning, they believe that in certain circumstances, such as dynamic environments, planning is not useful. McGrath and MacMillan (1995), for example, argue that in dynamic environments, planning does not work because there is little data upon which to base projections. …

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