Nurturing overconfidence: The relationship between leader power, overconfidence and firm performance

Abstract

This paper analyzes the relationship between leader power and overconfidence in the corporate context. Building on psychology research, we postulate that by activating self-serving cognition and illusion of control, the amount of power allocated to the leader of an organization positively influences the probability that he/she will exhibit overconfident beliefs. Using various measures of both formal and symbolic leader power we provide corroborating evidence for such endogeneous - power-based - origin of leader overconfidence. Then, we develop an empirical framework that allows to test the endogeneity-free effects of leader overconfidence on firm performance. Namely, we use a propensity score matching technique to construct a sample of reasonable counterfactuals (i.e., leaders in similar power-allocation conditions who do not exhibit overconfidence). As a result, we provide dissenting evidence about the effects of overconfidence, showing an economically and statistically significant positive influence of overconfidence on firm performance.