Overconfident Innovation

Some sorts of overconfidence benefit the world:

This paper uses … [a] measure of overconfidence, based on CEO stock-option exercise, to study the relationship between a CEO’s “revealed beliefs” about future performance and standard measures of corporate innovation. … The model predicts that overconfident CEOs, who underestimate the probability of failure, are more likely to pursue innovation, and that this effect is larger in more competitive industries. We test these predictions on a panel of large publicly traded firms for the years 1980 to 1994. We find a robust positive association between overconfidence and citation-weighted patent counts in both cross-sectional and fixed-effect models. This effect is larger in more competitive industries. Our results suggest that overconfident CEOs are more likely to take their firms in a new technological direction. (more)

Added 8JunePostrel on John Nye:

Professor Nye argued that the wins and the losses probably don’t cancel out. Even the biggest winners don’t make enough money personally to cover the losses of all the individuals who went into businesses that failed. … The lucky-fools theory suggests, then, that Victorian Britain’s economy was successful but stagnant not because investors were irrationally afraid of risks but because they were all too mature and calculating. They didn’t tolerate the foolish chances that a vital economy requires.

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  • Jayson Virissimo

    This is the kind of thing that leads me to believe that “overcoming bias” is largely an exercise in self-sabotage. Just because we don’t know why we have a bias doesn’t mean that it is useless (or that it should be overcome). It might even be the case that the elimination of one bias leads to becoming more biased in another domain. This could happen when we have multiple biases that check each other and keep any one bias from becoming dangerous.

  • Diim

    If you swap CEOs for medical researchers, this represents a strong argument for continued high spending in medicine. It’s a field where the direct marginal returns are poor, but of all the places to spend money I think life extension is something society has implicitly agreed to be worth it. I agree with your paradigm explaining why we spend too much on health care, but much of what we call waste is not really wasted in a more meta sense. So, cut subsidies to consumers and providers but not too much because those subsidies help fund the innovation in the system.

  • I can’t access the article right away. Do they explain why they think this shows under-estimation of the probability of failure, rather than a greater discounting of the future? Could be that these CEOs were more bold and daring in the face of an accurately estimated probability of failure.

  • Perhaps these “over confident” CEO’s understand that you “fail your way to success” and that your knowledge and experience grow as much with failure as it does with success. An innovator understands that each failure gets you that much closer to success. That is probably why you find them in competitive industries where the need for change is critical.

  • Catfish

    Exactly what I suspected.

  • For even more innovation, move away from competition entirely. As popularized by Alfie Kohn, the best psychological research the subject shows competition to reduce creativity and originality. In cooperative environment, people feel more comfortable taking the sort of risks that lead to outstanding outcomes.

  • Is this necessarily a good thing? There can certainly be “too much” innovation. Although, due to positive externalities, this is probably serendipitously socially beneficial. How many other ways does this exist (in which someone’s mistaken view of private benefits causes them to move to a more socially efficient level).

  • Pingback: Tweets that mention Overconfident Innovation" -interesting, objective perspective on innovation -- Topsy.com()

  • Jayson, yes there is much we don’t understand, but it seems unlikely that all our apparent biases are actually perfect behavior.

    Dlim, directed attempts at innovation are much more likely to be socially useful than randomly doing too much because no one seems to mind the waste.

    Karl, the issue in this case is who has to pay for the failures that teach these CEOs.

    Summer, so why don’t you start a company where you don’t make your employees compete, and then reap all that creativity?

    Henry, yes there can be too much innovation, but usually there isn’t.

    • Dee

      Is this result really suprising? Sure, CEOs that underestimate the probability of failure will take more risks in general than CEOs that correctly or overestimate the probability of failure, includuing the risks associated with technological innovation. It’s probably better for the economy or society in general to underestimate rather than overestimate risk though, provided you don’t do it too much.

      Diim, I don’t think the majority of waste in the health care system comes from spending on medical R&D but on unnecessary procedures and medications at the “consumer” level. Although I do think that medical innovation dollars are being spent in suboptiomal areas (i.e. drugs that lower blood pressure or cholesterol–thus enabling unhealthy lifestyle choices–rather than research into new vaccines).

      • Jayson Virissimo

        Robin, I’m not saying that are biases are perfect behavior at all. What I was getting at is that, on the margin, “debiasing” might make one more biased, not less.

    • “Who pays?” …. Acknowledged.

      Effective CEO’s [but usually other C level firewalls like COO’s & CIO’s] accommodate some “trial and error” within their budget for these adventures. They usually take a portfolio approach to innovation across projects and project managers. The goo dones know how to bury early stage innovation within their budgets too.

      As entrepreneurs outside the Corporate world learn, the issue with the spend is not how big it is, it is how smart and adaptive it is. Incrementalism works.

      And as any good banker knows, keep away from a borrower [ie. CEO] that wants a “bet the company” innovation. In that case, it is often the agent betting the principal’s money, not their own.

  • Because I both lack capital and abhor capitalism. I would rather struggle for a new cooperative social system than work within the existing structures.

  • Tracy W

    Summerspeak – if your hypothesis was true that moving away from capitalism increases creativity, then how come this study found that the competitiveness of the industry mattered, in that more competitive industries had more innovative CEOs? Of course correlation is not causation, but a lack of correlation does imply a lack of causation.
    And do you have any data about creativity in capitalist systems compared with creativity in non-capitalist ones?

  • For the record, there have been examples of productivity increasing in companies in which they moved toward a cooperative rather than competitive environment within the workplace. If, by some bizarre twist of fate, I became a capitalist, I would use that model.

    The psychological research I refer to deals with primarily with children in the educational setting. It’s certainly possible things function differently on the grand scale. Unfortunately, we’re not yet able to conduct such large experiments.

    But what does “more competitive” even mean in this context? It all looks awfully competitive from where I’m standing. Most if not all of the CEOs in question presumably when through the typically hierarchical, status-based school system dominant today. I doubt the supposed less competitive industries employ anything like a healthful cooperative environment. As such, that comparison is not a good test.

    • John Maxwell IV

      Summerspeaker, it’s hard to take someone seriously when they say that overthrowing the capitalist system and replacing it with communes would be easier than starting a successful company with a culture of cooperation.

      If you’re so sure that your model works, prototype it on a small scale and show it to other people. Working examples are far more convincing than protests and theorizing.

      “I doubt the supposed less competitive industries employ anything like a healthful cooperative environment.” OK, then this represents an opportunity for you to start a cooperative company, make a ton of money, and spend it promoting your cause! What are you waiting for?

      I have a really hard time understanding how some people think.

      • Though this may come as a shock you, revolutionary anarchist agitation requires no initial capital investment or special skills. You don’t have to take out loans. You don’t have to sign any papers. You don’t have to know how to start and manage a business. Moreover, starting a cooperative company for profit within broader capitalist/competitive framework conflicts with my ideals.

      • John Maxwell IV

        Has it occurred to you that the marketplace of ideas about how society should work is a very competitive marketplace? By proselytizing your views about how society should work, you are competing! Sure, the aim of the competition is to see who can serve society best–but that is also the basis on which conscientious corporations compete! I’m suggesting that you form a conscientious corporation, which seems just as compatible with your ideals as what you’re doing right now.

        Do you have a hard time signing papers or acquiring new skills?

      • Nick Tarleton

        Sure, the aim of the competition is to see who can serve society best–but that is also the basis on which conscientious corporations compete!

        Well, except for rent-seeking.

  • John Maxwell IV

    OK, but who says we need more innovation?

    My old economics professor did consulting on the side, and he said that whenever company executives started talking about “strategic” assets, hard analysis went out the window. Also, I vaguely remember reading somewhere that companies don’t milk their cash cows as long as they should to profit-maximize before moving on to the hot new thing.

    And it seems pretty clear to me that corporate profit-maximizing correlates well with customers getting satisfied. The most useless kind of corporation is the one that makes a product no one wants to buy.