Overconfidence and Decision Making

This assignment delves into the complex relationship between overconfidence and decision-making. It examines how sociological and psychological factors contribute to overconfidence and explores situations where it is more prevalent. The analysis focuses on the link between power and overconfidence, considering whether powerful individuals are more susceptible to overconfident decisions or if pre-existing power experiences foster this trait. Five baseline experiments are discussed, each providing evidence for the psychological impact of power on decision-making.

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Assessment 2, Individual Assignment
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Table of Contents
Introduction......................................................................................................................................2
Article Summary..............................................................................................................................2
Article analysis- Analyse each article..............................................................................................4
Article comparison...........................................................................................................................6
Discussion........................................................................................................................................6
Works Cited.....................................................................................................................................7

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Introduction
Overconfidence is not just a fundamental psychological trait rather it can be considered as a
well-established bias. In this case the subjective confidence of a person seems to be reliably
higher than the objective accuracy of their judgements. However, there are other definitions of
overconfidence as well. Author defines overconfidence as the overestimation of a person’s actual
performance or over precision in depicting the unwarranted certainty regarding the accuracy of
the beliefs of a person. The emergence of overconfidence and its impact over the decision
making processes has widely been discussed. Extensive research works have been conducted on
the basis of the impact of overconfidence in the context of financial, business or corporate
decision making. More specifically overconfidence can be considered as the behavioural bias
which is most willingly researched by the academicians who are working in the field of
economics. In other words the “better than the average effect” which is simply the tendency of
individuals to overestimate their expertise and capabilities relative to a reference group gives rise
to direct likelihoods in the context of decision making. This assignment will solely focus on
analysing three relevant journal articles which are broadly based on the impact of overconfidence
on decision making. Primarily it will present summary of the three articles followed by a detailed
analysis of those individual articles. Finally each of the articles will be compared and contrasted
with respect to the other, for instance their similarities or difference will be discussed.
Afterwards a discussion section will be there where the relevant understanding developed
through reading these papers will be discussed and then certain recommendations will be
provided.
Article Summary
This paper considers overconfidence as an effect which is named as “better than average effect”
and this compels people to assume that believe that their skills and capabilities are over and
above the average level. The paper will focus on developing an experimental paradigm through
which a distinction could be made between the two potentially possible clarifications for the
effect; these are specifically overconfidence and rational information processing (Merkle &
Weber, 2011). In order to do so an experiment has been conducted. The participants of the
experiment were asked to enumerate their relative position within the populace through stating

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their distribution of complete trust. However, the findings of the paper portray the fact that
people holds specific beliefs regarding their capabilities in inexplicably different fields or genres
which are sometimes inconsistent with the rational information processing. These people have
depicted considerably high over-placement at both the individual level as well as the aggregate
level. Henceforth, the paper comes into a concluding fact that overconfidence cannot only be
regarded as a simple trait of overconfidence rather it is a result of a psychological bias (Merkle &
Weber, 2011).
In the second paper emphasises over the impacts of overconfidence over the incentive contracts
in the context of a moral hazard framework. It has been observed that the overconfidence of an
agent can impose certain conflicting impacts on the equilibrium contract. On one side of the
spectrum, an overconfident or optimistic agent may value the success-contingent payments
disproportionately and hence prefers incentives which are high-powered (De la Rosa, 2011). On
the other end of the spectrum, when the involved agent overestimates the degree to which his or
her actions can affect the outcomes, whereas the low-powered incentives are adequate to
persuade any given level of effort. On an added notion, when an agent is soberly overconfident,
the effect stated latter dominates. This is because in such a case the agent bears less risk there are
gains in efficiency gains which is stemming from the his or her overconfidence (De la Rosa,
2011). Again when the agent is extremely overconfident, the former effect will dominate and
then the agent will get exposed to a great amount of risk. At that point of time any gains will be
generated only through risk sharing under disagreement. The findings of the paper depicts that a
rise in the level of overconfidence or optimism raises the implemented effort in equilibrium.
This paper is constructed on the basis of five experiments which strictly exhibit the fact that
previous experience of possessing power certainly leads towards overconfident decision making.
The study will make use of different instantiations of power that includes an episodic recall task
(in experiments 1-3), a measure of power which is related to work (in experiment 4) and
assigning of high and low power role (experiment 5) as well as the power produced
overconfident decisions which gave rise to significant monetary loses on the part of the powerful
(Fast et al., 2012). The findings of the paper clearly depict the fact that the presence of power
plays an important role in generating these tendencies of decision making. Primarily, the sense of
power not the mood influences the link between overconfidence and power (experiment 3).

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Secondarily, the linkage between the overconfidence and power was detached when power not
accessible to the powerful as well as when the powerful was made to feel incompatible in their
genre of power (Fast et al., 2012). These findings portrays that when the presence of objective
power makes the people feel subjectively powerful then it gives rise to overconfident decision
making.
Article analysis- Analyse each article
As the first paper specifies that in a recent academic literature the notion of overconfidence has
been challenged as this was only analysed in the domain of economics and psychology
previously. They criticised the use of conventional methodology while explaining the better than
average effect. The authors who raised the argument also showed the fact that in a simple
signalling framework; the processing of rational information will lead to the results which were
previously considered as the evidence of overconfidence (Merkle & Weber, 2011). Now in order
to overcome the criticisms posed by these authors the current research work is based on a
strategic guideline which will be able to indicate the existence of real overconfidence. This will
be done through the improving the previous research methodology.
The researchers observed that there are many different sets of opinions which are able to
providee the same result whenever they are aggregated. However, in this context the Bayesian
posteriors and the actual overconfidence are typically same. Therefore in order to fetch more
detailed beliefs of the participants regarding different domains which were previously associated
with overconfidence, underconfidence and overoptimism the authors had designed two different
experiments (Merkle & Weber, 2011). Along a quantile scale the self-evaluation were performed
that elaborated the ability distribution compared with a peer group. In accordance with this scale
the participants provided the estimates which in turn represent their subjective probability of
falling into each of the skill quantile. This extended valuation of the test allowed the researchers
to re-verify whether the results were in accordance with the rational information processing or
not.
The results obtained from the test depicted that there exists substantial amount of overconfidence
in the belief distribution of the participants of the experiment (Merkle & Weber, 2011). Most of
the people found that their probability of falling in the high quantile in higher. Moreover,

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interestingly, the unskilled exhibits depicted overconfidence. However, the research work also
found the fact that the theoretical criticisms as posed by the previous researchers have only
certain practical values regarding overconfidence research.
The standard model of principle-agent has been used widely to determine the incentive structure
in different organisations. It thoroughly provides a detailed overview of the forces that give form
to the incentive contracts on basis of the assumption of full rationality (De la Rosa, 2011). There
are many instances that people are often overconfident about their future prospects and ability.
This is the behavioural characteristic that seems important regarding the agency problem. The
paper aims to enumerate the impact of overconfidence of the agents in a moral hazard model,
significantly its influence over the equilibrium contract.
Overconfidence of agents may give rise to conflicting results within the equilibrium contract. On
one hand, if the agent is overconfident, a lower amount of compensation is sufficient to bring any
level of effort rather compared to the effort which is cost-effective. This is referred to as
“Incentive Effect of overconfidence”; it thrusts the equilibrium contract towards low-powered
incentives. In the other end, when the salesman is overconfident confident enough he or she will
certainly overestimate the probability of the sale, at this point of time he or she will find a high
commissioned contract of incentive more lucrative than a realistic agent would (De la Rosa,
2011). This is because the owner will believe that she will have to pay the commission more
frequently. At that point it will seem that hiring a person with high powered incentive and lower
base salary is more attractive, this is termed as the Wager Effect of overconfidence. Interestingly
the findings of the paper depicts that overconfidence of the agents can be beneficial if measures
in terms of efficiency (De la Rosa, 2011).
The third paper is solely concerned about the fact that though overconfidence among the
powerful have always remained a widely discussed issue, lesser focus in given over the
psychological and sociological factors which gives rise to the overconfidence. The research work
will try to examine this relationship between the sociological and psychological factors with the
occurrence of overconfidence. This will not only focus on the factors that give rise to
overconfidence but also explore when it is more likely to take place (Fast et al., 2012). The
substitute explanations of the existence of overconfidence within the powerful will also be
examined in this research. It may be a case that the overconfident individuals are more attracted

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towards power and are more likely to achieve a high-powered position. If this is the case then
promoting only those who does not have a tendency towards overconfidence would certainly
help to resolve the problem. On the other hand, when a person has pre-existing experience of
possessing power it may give rise to overconfidence which will in turn make it difficult to tame
relationship between overconfidence and power (Fast et al., 2012). This paper has broadly
examined why when and how the emergence of power will lead to overconfidence. In order to do
so the researchers have conducted five baseline experiments and these experiments were so
designed that the findings of an experiment substantiates the findings of the other experiment.
The experiments conducted revealed the fact that psychologically experiencing power can lead to
the overconfident decision making.
Article comparison
The key similarity between all the three articles is that all of them are based on the emergence of
overconfidence and its impact on decision making process. All the researchers have tried to
establish the fact that overconfidence is not only a psychological trait; rather there are certain
other factors as well which gives rise to this overconfidence. It is also a matter of fact that all the
articles analysed in the assignment clearly depict that overconfidence may lead to wrong
decision making. If this decision is regarding the economy or the financial aspects of an
organisation it may harm the core interests of the firm adversely. On the contrary sometimes
overconfident decision may also benefit the organisation as well.
However, from the primary viewpoint there are huge dissimilarities among the research works.
The first article traces out the key reason behind the emergence of overconfidence, while the
second one approaches on overconfidence through the traditional principle agent framework. The
third, article also explains overconfidence in the light of pre-existing experience of possessing
power. This means that the third article states if a person has experience of possessing power he
or she will be more likely to be overconfident. Hence it can be said that although the research
works stated above are concentrated on the same factor, each of them has tried to approach it
from different perspectives.

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Discussion
After analysing and reviewing all the articles it can be clearly said that all of them are based on
rational assumptions. The findings are quite plausible which are obtained on the basis of the
calculations and analysis. Hence it is quite evident that these research works are very well
written and based on logically established calculations. However, as all of the articles are based
on overconfidence, on a recommendation note it can be said that people should not always base
their decisions under the influence of overconfidence. Though it may sound contradictory but it
is necessary to mention that sometimes overconfident decisions may also sound beneficial for the
decision maker, though it is quite rare.
Works Cited
De la Rosa, L.E., 2011. Overconfidence and moral hazard. Games and Economic Behavior,
73(2), pp.429-51.
Fast, N.J., Sivanathan, N., Mayer, N.D. & Galinsky, A.D.., 2012. Power and overconfident
decision-making. Organizational behavior and human decision processes, 117(2), pp.249-60.
Merkle, C. & Weber, M.., 2011. True overconfidence: The inability of rational information
processing to account for apparent overconfidence. Organizational Behavior and Human
Decision Processes, 116(2), pp.262-71.