Also, after thinking about it, I think it could be quite challenging to show that my theory about small organizations being more productive than large ones is accurate. Imagine that you picked a few hundred companies of under 100 employees and over 1,000 employees that survived for five years and studied them. You might find that the 100 employee firms were generally better investments, but perhaps it is a question of “nowhere to go but up” more than my theorized improved efficiency in small organizations. Trying to segregate the effects might be very difficult indeed…

Well to some extent I’m already doing this. I’m in business and I operate the way I said, and I encourage others in my organization to do so. I’m not filthy rich yet, so it clearly doesn’t overwhelm negative effects like spending too much time commenting on blogs during the workday But I’m confident that I’ve seen some return from doing this on a careful basis. I don’t eliminate people for overconfidence, I try to probe them to see if I can get them to understand the underlying probability with some discussion. If they can’t folllow me at all and we theoretically share expertise, I have to assume that they are less bright than I might otherwise believe.

I would guess that *some* level of overconfidence does represent an equilibrium strategy for both sides, but my bet is that the average person errs by trusting this signal too much, and I absolutely put that into practice.

BTW, Perry about VC returns: Even though I think you’re probably right about VC returns, I’m not quite so willing to buy the “people put lots of money in them so they must get fabulous returns” logic. Hedge funds have gotten huge amounts of money in the last decade too, and there isn’t much evidence that they outperform more typical investments on a risk adjusted basis after you account for their hefty fees. I also believe (based on fairly anecdotal evidence) that there’s a large and persistent difference between the returns of the best VCs and that of typical VCs.

Douglas: I don’t have any statistics at hand. I’ve been told that repeatedly by people that I trust, but I don’t myself have the numbers. The people in question are quite well informed (such as Victor Niederhoffer) but they might be mistaken or I might be misinterpreting their information. However, given the amount of money that has flooded the VC world over the decades, I can only assume that they have some reasonably good story to tell about potential return.

cite?
My impression is that the ROI on VC is secret.

Enhancement of risk acceptance can be valuable for a business if there are other factors which cause risk-aversion. One such factor is a perception by managers that the penalties for a failed project are much greater than the rewards for a successful one. This also manifests in the case of a manager with many subordinates; he would prefer a greater degree of risk-taking among them, since successes by one will balance a failure by another, but the subordinates themselves don’t benefit from such balance.

If businesses have biases that make them risk-averse, countering biases that promote risk will be beneficial. This relates somewhat to the posting on seen vs unseen biases, although in this case I’m not sure that any are seen much more clearly than others.

The examples above come from Kahneman and Lovallo, chapter 22 of
http://print.google.com/print?id=P5GsREMbUmAC&oi=fnd&pg=PA1&sig=nZ3y4LHNfAsrlxMfZDSt3cbSCOs

My hypothesis is this: large organizations naturally tend towards mismanagement and inefficiency, but are held in check by competition. The tendency towards mismanagement comes from a sort of “Gresham’s Law” of managers — bad managers, or at least mediocre ones, drive out good ones over the long term. In small organizations, the people that succeed tend to be the ones that add the most value to the organization, but over long periods, it becomes much harder to see the impact of individual employees and managers on the overall productivity of the organization, so the value individuals add becomes harder to judge. Once this point is crossed, the people that succeed best are the ones that are most skilled at political infighting and self promotion and not at adding value. They are sort of like a cancer — in the body, cells that mutate and disobey their programming and look after their own needs ahead of the needs of the whole organism do very well for their genetic line for a brief time, and similarly, managers that place their own needs ahead of those of the company but evade the “corporate immune system” do quite well for themselves for a while. Ultimately, however, cancers kill organisms if they are not kept in check. Similarly, all commercial organizations still need to be at least as efficient as competitors to survive, so this tendency towards “defecting” managers is kept at least modestly at bay. My supposition is that there is a dynamic equilibrium between these two tendencies, though of course almost all companies ultimately fail, whether after six months or one hundred fifty years.

Naively, one would assume that startups would rarely succeed because existing organizations generally have large pools of money, expertise, etc., and could easily enter in to most new areas of business on their own and take advantage of profit opportunities presented by them. I think one advantage startup companies have is that, when they are still quite small, their productivity can be much higher. This is for several closely related reasons that are the converse of the “corporate cancer” issue I just mentioned. In a small organization it is harder to hide whether or not your role is important to the success of the entire venture. In a small organization, the founders have enormous incentives to cut deadweight quickly, and have a good visibility into the activities and thus the productivity of all members of the organization. Of course, some new ventures are poorly run, but in a tight capital/small size situation such ventures die quite quickly, so the ones that survive tend to be quite aggressive and streamlined, and are often far more profitable for their owners than investments in larger organizations — the return on investments in venture capital has traditionally far outstripped the return on investments in larger companies, and I think this may be part of the reason.

My guess is that the critical point happens when the organizational size crosses the Dunbar Number — you go quite quickly from a group where everyone knows what everyone does and thus can directly judge competence and productivity to a size where everyone has to rely on proxies for competence and productivity, and, in the long run, skill in looking good wins over skill in being good. Then, of course, at some point enough people are just “looking good” and not enough are being good, and the organization fails.

I emphasize that this model is based largely on guesses and intuitive conclusions based on watching companies, not on good statistical data. (Well, all except the return from venture investing.) It would be interesting to devise experiments to test my hypotheses but until then they should be regarded with significant skepticism.

As a last point, you ask “could you run a more profitable business by deviating and rewarding non-optimistic non-yes-men people” — my answer is (as I said) on some level yes, but I’ll also note that it is in an important respect “no”. It is “no” in the sense that I don’t think most organizations can be reformed very well any more than aircraft can be repaired in flight very well. It is much easier to start over with new people than it is to fix the dynamics of an existing group. Your question implicitly assumes that an organization that has hit this sort of “management cancer” could somehow choose to reform itself but I’m not sure that is possible. The creative destruction of the markets means this isn’t a problem for society — truly hidebound companies will eventually die and others will replace them — but it is a problem for the owners of the hidebound companies. Perhaps, though, there is nothing to be done about it. (I certainly can’t offer any magic bullet that would work.)

I would say things slightly differently. I would say that optimism about management goals (i.e. yes-man behavior) is rewarded, even when such optimism is unwarranted, and pessimism and “negativity” (even when realistic) is punished. Part of this may be a question of managers rewarding people who tell them what they want to hear, and part of this may be a bias (which appears to be rather widespread) towards optimistic people in the workplace.

Overconfidence seems like a subset of optimism, while a realistic take on possible failure modes is, I suspect, an instance of a viewpoint that is viewed as “negative”.

However, my personal “study” of this is entirely anecdotal and based on informal observation. I do not know if it is correct, and I caution that I was making commentary rather than pretending to have a scientifically demonstrated viewpoint.

That said, an interesting experiment would be to put together some test of people’s attitudes towards “optimistic” and “pessimistic” viewpoints in a working context…