What is the best remedy for overconfident optimism? – Chapter 24

The planning fallacy is one of many manifestations of the optimistic bias. Many people view their attributes as more favorable than they probably are and consider their goals as more achievable than they probably are. Optimistic bias can be a risk as well as a blessing, which is why you should be cautious when you feel optimistic.

Some people are more optimistic than others. They are usually happy, popular and resilient. Optimists play a disproportionate role in shaping society. Their decisions have an impact on others: they are leaders, inventors, entrepreneurs. They seek challenges and take risks, are talented and lucky. Their successes and the admiration by others makes them even more confident. This description results into the following hypothesis: the most influential people are likely to be overconfident and optimistic, and take more risks than they are aware of. The evidence indicates that an optimistic bias causes institutions or people to take on risks.

The chances that a small company will survive for five years in the US are slightly over 33%. Someone who starts a company believes that these statistics do not apply to him/her. Research shows that American entrepreneurs are prone to believe that their company is something else: their estimated chance of success was almost twice as high: 60%. Would they still have invested time and money if they knew the odds? They never thought of the outside view.

One of the benefits of being an optimist is considered persistence when faced with obstacles. However, being persistent can be costly. Studies show how almost half of the people continue their project after being told it would not succeed. Their initial losses doubled.

According to psychologist, the majority of people genuinely believes that they are better than others, they would even bet money on it. This belief has significant consequences in the market. Misguided acquisitions by large businesses in the stock market are explained by the ‘hubris hypothesis’: leaders of acquiring firms are less competent than they think they are. The optimistic risk taking of entrepreneurs contributes to the economic dynamism of our capitalistic society, but also evoke policy issues. Should founders of small companies be financially supported by the government, when they are very likely to fail? There is no satisfying answer to this question.

Entrepreneurial optimism is not merely explained by wishful thinking, emotions and cognitive biases also play a significant role, especially the WYSIATI-rule of System 1. Focusing on the goal and neglecting relevant base rates can result into the planning fallacy. Focusing on the causal role of skill and neglecting the role of luck can result into the illusion of control. Focusing on what is known and neglect what is not known leads to overconfidence.

Many founders believe that the success of their company depends to a great extent on their effort. They think their fate is almost completely in their own hands. This is not true: the changes in the market and the achievements of competitors are just as important. Entrepreneurs focus on what they know: their plans, actions, opportunities and most immediate threats (WYSIATI). They usually know very little about their competitors. This is called the concept of competition neglect. Another manifestation of WYSIATI is overconfidence. When they estimate a quantity, they rely on information that comes to mind and form a coherent story in which it makes sense. The consequences can be costly. Overconfident experts are also overconfident about the prospects of their own company and willing to take more risks they should avoid. Ironically enough, companies and people reward misleading optimists more than they reward truth tellers.

Is there a remedy for overconfident optimism?

Overconfident optimism is very hard to overcome by training. Overconfidence is a immediate consequence of System 1-features that can be tamed but not eliminated. The biggest obstacle is that subjective confidence is determined by the coherence of the constructed story, not by the amount and quality of the supporting information. Organizations are better at taming optimism than individual people. The best remedy comes from Gary Klein and is called the ‘premortem’. When an organization is about to make an important decision, a group of individuals with relevant knowledge regarding the decision should gather for a brief session. They have to imagine being one year into the future: the outcome of the decision turned out to be extremely bad and write a brief history of what happened. The premortem overcomes the groupthink that influences a lot of teams once a decision is close to being made and it directs the imagination of knowledgeable individuals into an important direction.