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. This study 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. Some possible explanations for the high rate of business failure are reviewed. The hypothesis that business failure is a result of managers acting on the optimism about relative skill they exhibit in surveys is considered. The findings are consistent with the prediction that overconfidence leads to excessive business entry.

Policy implications 
Individuals may prefer performance based incentives schemes more often than standard theory predicts, regardless of their skill-level compared to their competitors.
Camerer, C., & Lovallo, D., 1999. 'Overconfidence and Excess Entry: An Experimental Approach'. American Economic Review, pages 306-318.