Made to my measure

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Your research focuses on the phenomenon of overconfidence. Is it a condition that is widespread?

Peter Schwardmann: Yes, it is. Many people believe that they are better – more intelligent, attractive, affable – than they really are. An influential set of studies on the topic was published in the 1970s. For example, some 90% of participants answered the question ‘Are you among the top 50% of the drivers in this room?’ in the affirmative. Obviously, some of them overestimated their driving skills! The same is true of other capabilities, and of the positive qualities that people attribute to themselves. Of course, individuals differ in this respect. Some people tend toward pessimism and see themselves as less accomplished than they actually are. Moreover, studies also suggest that women are more realistic in this respect than men. But on average, we tend to err on the side of overconfidence rather than self-deprecation.

How does one study overconfidence?

Schwardmann: Overconfidence is a positive misjudgment of one’s abilities and potential. In order to study it, an objective measure of individual performance is required. We can then ask whether a person’s own estimate is optimistic, realistic, or pessimistic relative to that measure. For example, participants in one of our most recent studies took an intelligence test, and were asked to judge their own performance relative to that of others. We then compared their self-assessments with their actual performance in the test. The question we asked them was: “What is the probability that you are among the top two performers in a random group of four?” On average, 60% of all participants assumed that they were in the upper half.

What was the overall result of the experiment?

Schwardmann: We wanted to know why people overestimate themselves. Two hypotheses have been proposed to account for the phenomenon. One is that an excessively positive self-image makes us happier. The other argues that it is useful trait in the context of social interactions. We set out to test the second hypothesis. And indeed, our study shows that having a high opinion of one’s self makes one more persuasive in situations in which it is important to convince others.

How did you test the hypothesis?

Schwardmann: After taking the IQ test, our subjects were interviewed by an interlocutor, whose task it was to identify the best participants, who would then win cash prizes. Crucially, not all subjects knew about the interviews. We found those subjects that were informed that they would be called upon to convince others believed that they had done better in the IQ test than their rivals. In other words, the fact that they expected to have the opportunity to impress others boosted their self-confidence. We can also show that higher confidence in turn helped subjects to give a more convincing performance. Moreover, this self-assurance was expressed not only in the statements they made. It was also evident in nonverbal signals. Thus, our experiment shows how effective self-confidence can be in persuasion, and that we sometimes self-deceive into higher confidence for this reason.

So in this situation, your experimental subjects were not consciously exaggerating, they really believed themselves to be better at the set task?

Schwardmann: Subjects earned money for correctly guessing their performance and their initial assessments were completely private. So it is likely that the overconfidence we see in these assessments represents a sincere belief.

If overestimating one’s abilities is highly advantageous, do these people view their lives as a succession of self-fulfilling prophecies?

Schwardmann: In the context of a professional career that may well be the case. To be successful in many professions, it is useful to convince others, and self-confidence helps one to do so. This probably explains why individuals with very high levels of self-confidence are disproportionately successful in sectors in which competition is especially tough, and where conventional performance indicators do not always provide clear pointers as to the true quality of the work done. It is quite likely that this applies not only to CEOs in management, but also to politicians. Conversely, even extremely self-confident, high-flying managers and politicians can suddenly find themselves in situations in which a single bad decision is enough to bring them down to earth.

Are such blunders what really aroused your interest in the role of overconfidence in economics?

Schwardmann: Yes, because bad decisions can have wide-ranging economic consequences. One study suggests that overconfident CEOs have a greater tendency to persist in pursuing unprofitable mergers, thus running the risk of losing millions of dollars. If economists can gain a better understanding of how and why these misjudgments occur, we can integrate them into our models, thus making our models more realistic.

If decisions made by overconfident CEOs can damage the businesses they run – would it not be better to have more cautious and reflective individuals at the helm?

Schwardmann: That‘s an important question! Though it is probably hard to speak to this based on a laboratory experiment.

Does overconfidence play a role in spheres other than business and politics?

Schwardmann: Definitely. Quite a lot of data on the costs of overconfidence and excessive optimism is available. For example, there is evidence that brokers in financial markets regard their own predictions of future trends as far more precise than they actually are – and they lose lots of money as a result. Psychologist Danny Kahnemann, a Nobel Laureate, once said that if he had a magic wand, he would use it to make overconfidence disappear. Kahnemann was thinking about the costs of overconfidence. Doctors who stick to false diagnoses, entrepreneurs that place too much faith in the potential of their projects, students who choose courses that are unsuitable for them because they misjudge their own abilities. All these decisions run the risk of costing time and money. We hope that our work can help explain why people so often take an overoptimistic view of things, given that this has real costs.

Do you have other work in this area?

Schwardmann: At the moment we are testing the hypothesis that humans developed their capacity for overconfidence because it helps them to deceive others in a large field experiment with people who participate in debating contests. These individuals have made a hobby of the art of converting others to their point of view. The effect here is similar to our IQ-test design. Once participants were assigned to one or the other side of an issue, their expectations and judgments began to shift in the direction most favorable for their line of argumentation.

Can one conclude from this that we all create our own image of the world, our own reality?

Schwardmann: There are certainly powerful forces that pull us away from a realistic assessment of the world around us. As we observe the world we are consciously or unconsciously on the lookout for pleasurable or profitable interpretations of what we see. But of course of capacity to self-deceive is not unconstrained: our beliefs have to be somewhat plausible.

As an economist, how then do you respond to your own findings in relation to the role of overconfidence in the business world?

Schwardmann: Behavioral economists study deviations from the standard model of economics, which postulates that individuals always act rationally in pursuit of their own interests. Deviations are usually interpreted as the result of either biases or personal preferences. Overconfidence is often viewed as a bias or something that leads to bad decisions. Our work shows that overconfidence can serve an important function to the individual and may well be an optimal response to the environment in which persuasion is important.

Dr. Peter Schwardmann is a staff researcher in the Seminar for Economic Theory at LMU.