Entrepreneurial Overconfidence and its Impact Upon Performance.

Abstract

A hubris theory of entrepreneurship suggests that financial forecasts are often informed by the use of heuristic methods prone to overconfidence. While overconfidence can be advantageous during the start-up phase, it is also linked to overoptimistic forecasts, non-optimal outcomes and firm failure. This paper uses a data set from 203 micro and small firms operating in North West Italy where overconfidence is measured as the difference between budget estimates and actual results for Earnings before Interest, Taxes, Depreciation, and Amortization (EBITDA), owners’ equity and borrowing costs. These measures are employed to identify the extent of overconfidence by entrepreneurs in their financial forecasts and to analyse any relationship between overconfidence and the characteristics of the entrepreneur and the firm. A further probit analysis is employed to investigate any association between overconfident financial forecasts and subsequent firm failure. The results are consistent with the hypotheses, suggesting that the majority of entrepreneurs are prone to overconfident budgetary forecasts that are directly associated with firm failure. Such overconfidence is mitigated by an entrepreneur’s level of educational attainment and the use of budgetary controls.