The Curse of Overconfidence

If ever there was a poster child for the perils of entrepreneurial overconfidence, Theranos founder Elizabeth Holmes would have to be it. Despite clear evidence that her company’s “revolutionary” blood-testing technology did not work, she kept pushing it, racking up investments from the likes of Henry Kissinger and Rupert Murdoch, confident that everything would be fine. It wasn’t, of course, and Holmes is now facing 11 years in prison for defrauding investors.  

It is a cautionary, albeit extreme, tale of what can happen when bravado gets the better of an entrepreneur. But it should not be taken as a complete dismissal of confidence as a necessary trait when starting a business, says Elspeth Murray, director of the Centre for Business Venturing and CIBC Faculty Fellow in Entrepreneurship at Smith School of Business. “You have to be confident, or you would never take the plunge.”    

The problem is when confidence becomes the whole story, Murray explains. “Yes, you need to be confident, but really successful entrepreneurs have a whole bunch of other things that they do to bolster that confidence over time and become more and more confident that it will work out.” 

Murray points to Jennifer Hyman and Jennifer Fleiss as prime examples. Back in 2009, the two Harvard Business School graduates were sure that a business model based on people renting expensive designer clothing would work. But they were also adamant about testing the assumptions that their confidence was based upon. That kind of discipline, says Murray, is one reason why Rent the Runway took off and is still a thriving enterprise.

The big lesson here is that if you are just running on a tank brimming with confidence, you may sputter and stall. “Over time, it can make you myopic,” she says. “Your focus becomes narrowed so that you’re just thinking about one set of signals to tell you whether or not things are going well. And so what you consider to be the noise is actually the signal. This is probably what happened to Elizabeth Holmes.”  

Three ways to overconfidence 

The research on overconfidence and entrepreneurship has grown exponentially over the past few decades. Much of it focuses on three types of overconfidence: overprecision, overestimation and overplacement. 

Overprecision refers to excessive certainty regarding the accuracy of your beliefs. Overestimation involves overemphasizing your actual ability, performance, level of control or chance of success. Overplacement is the exaggerated belief that you are better than others.      

Interestingly, however, the growth in research has not led to a consensus on whether overconfidence is good or bad. Some studies claim overconfidence allows entrepreneurs to make effective decisions, while others seem to show it leads to biased decision-making. One paper suggests overconfidence can lead to higher innovativeness, while an earlier paper proposes the opposite.  

The researchers behind a study from last year say there could be several reasons for this disagreement. For one, some studies treat the three types of overconfidence as the same, neglecting the fact that they have different psychological origins and are characterized by different underlying processes. Another reason could be that prior research has not really looked at the impacts of overconfidence on different phases of the entrepreneurial process. It could be that overconfidence impacts the pre-launch, launch and post-launch phases in different ways.  

To tease out these issues, the researchers did a meta-analysis of 62 studies published between 1993 and 2021. Surprisingly, they found that the only overtly negative effect of overconfidence tended to happen during the post-launch phase. And here it was usually only when entrepreneurs displayed overprecision — putting too much stock in the accuracy of their beliefs.    

“I think what this really shows is that over time some ‘overconfident’ entrepreneurs can lose the ability to really deal in the facts of the situation,” says Murray. “You’ve had so many trials and tribulations that you’ve created this false sense of reality around you. It’s what happened to the BlackBerry founders. They were so narrowly focused, had blinders on, and stopped paying attention to the Apples of the world.”    

How to keep confidence in check 

So how do entrepreneurs rip off those blinders of overconfidence, or at least not fall victim to overprecision? Murray has some ideas. 

The classic rational approach is to set clear milestones for how things should progress. These could be factors such as a certain amount of market uptake for a product or a certain amount of money raised by specific dates. If the milestones are not reached, that could be a sign to re-assess, says Murray.  

But the problem, she adds, is that entrepreneurs are often told to persist. So if a milestone is not reached, an entrepreneur’s overconfidence might kick into overdrive and cue them to keep pushing rather than face reality.  

This is why Murray also recommends that entrepreneurs surround themselves with a couple of key advisers. These people should not be friends or family, but they should be there from the beginning of the venture to create trust and credibility. 

“As a very successful entrepreneur once told me,” says Murray, “these are people who will tap you on the shoulder and tell you to dismount when the horse is dead. It’s very difficult to know when the horse you’re riding is dead because we’re told to persist, so having those trusted advisers is so important.” 

Third, Murray says that entrepreneurs need to bake “radical candour” into the DNA of their business. In other words, they should make full and frank discussions about the venture a normal part of operations. 

And that includes being radically frank about when it is time to call it quits and what failure can mean, she says. 

“Oftentimes people will persist and be overconfident because of this thing we call ‘failure’. So reframing what failure actually looks like can be helpful. Let’s say you’ve tested a bunch of assumptions, you’ve raised some seed capital, but your experiments tell you it’s not going to work. It’s okay to pull the plug. That is intelligent failure. As opposed to the Theranos issue where the technology didn’t work.”    

To add to your reading list, Elspeth Murray recommends Losing the Signal: The Untold Story Behind the Extraordinary Rise and Spectacular Fall of BlackBerry, by Jacquie McNish and (Smith alum) Sean Silcoff, as well as Radical Candor: Be a Kick-Ass Boss Without Losing Your Humanity, by Kim Scott.