From Daniel Kahneman’s book “Thinking Fast and Slow”
Entrepreneurial Delusions.
- “The chances that a small business will survive for five years in the United States are about 35%. But the individuals who open such businesses do not believe that the statistics apply to them. A survey found that American entrepreneurs tend to believe they are in a promising line of business: their average estimate of the chances of success for “any business like yours” was 60%—almost double the true value. The bias was more glaring when people assessed the odds of their own venture. Fully 81% of the entrepreneurs put their personal odds of success at 7 out of 10 or higher, and 33% said their chance of failing was zero.” (p. 256)
- “I have had several occasions to ask founders and participants in innovative start-ups a question: To what extent will the outcome of your effort depend on what you do in your firm? This is evidently an easy question; the answer comes quickly and in my small sample it has never been less than 80%. Even when they are not sure they will succeed, these bold people think their fate is almost entirely in their own hands. They are surely wrong: the outcome of a start-up depends as much on the achievements of its competitors and on changes in the market as on its own efforts.” (p. 260)
“However, WYSIATI plays its part, and entrepreneurs naturally focus on what they know best—their plans and actions and the most immediate threats and opportunities, such as the availability of funding. They know less about their competitors and therefore find it natural to imagine a future in which the competition plays little part.” (p. 260) - “The direction of the bias is not surprising. If you interviewed someone who recently opened an Italian restaurant, you would not expect her to have underestimated her prospects for success or to have a poor view of her ability as a restaurateur. But you must wonder: Would she still have invested money and time if she had made a reasonable effort to learn the odds—or, if she did learn the odds (60% of new restaurants are out of business after three years), paid attention to them? The idea of adopting the outside view probably didn’t occur to her.” (p. 257)
- “Many years ago, my wife and I were on vacation on Vancouver Island, looking for a place to stay. We found an attractive but deserted motel on a little-traveled road in the middle of a forest. The owners were a charming young couple who needed little prompting to tell us their story. They had been schoolteachers in the province of Alberta; they had decided to change their life and used their life savings to buy this motel, which had been built a dozen years earlier. They told us without irony or self-consciousness that they had been able to buy it cheap, “because six or seven previous owners had failed to make a go of it.” They also told us about plans to seek a loan to make the establishment more attractive by building a restaurant next to it. They felt no need to explain why they expected to succeed where six or seven others had failed. A common thread of boldness and optimism links businesspeople, from motel owners to superstar CEOs.” (p. 258)
- Inventors can get advice from the Inventor’s Assistance Program. The Inventor’s Assistance Program will give the Inventor’s project a grade. A grade of a D or E means the project will fail.
So did the inventors give up when they received a D or E? Almost half of them kept going!
“However, 47% of them continued development efforts even after being told that their project was hopeless, and on average these persistent (or obstinate) individuals doubled their initial losses before giving up. Significantly, persistence after discouraging advice was relatively common among inventors who had a high score on a personality measure of optimism—on which inventors generally scored higher than the general population.” (p. 257)
“The evidence suggests that an optimistic bias plays a role—sometimes the dominant role—whenever individuals or institutions voluntarily take on significant risks. More often than not, risk takers underestimate the odds they face, and do not invest sufficient effort to find out what the odds are. Because they misread the risks, optimistic entrepreneurs often believe they are prudent, even when they are not.” (p. 256)
“When forecasting the outcomes of risky projects, executives too easily fall victim to the planning fallacy. In its grip, they make decisions based on delusional optimism rather than on a rational weighting of gains, losses, and probabilities. They overestimate benefits and underestimate costs. They spin scenarios of success while overlooking the potential for mistakes and miscalculations. As a result, they pursue initiatives that are unlikely to come in on budget or on time or to deliver the expected returns—or even to be completed. In this view, people often (but not always) take on risky projects because they are overly optimistic about the odds they face.” (p. 252)
“More generally, the financial benefits of self-employment are mediocre: given the same qualifications, people achieve higher average returns by selling their skills to employers than by setting out on their own. The evidence suggests that optimism is widespread, stubborn, and costly.” (p. 257)
“Organizations that take the word of overconfident experts can expect costly consequences. The study of CFOs showed that those who were most confident and optimistic about the S&P index were also overconfident and optimistic about the prospects of their own firm, which went on to take more risk than others.” (p. 262)
“Overconfidence also appears to be endemic in medicine. A study of patients who died in the ICU compared autopsy results with the diagnosis that physicians had provided while the patients were still alive. Physicians also reported their confidence. The result: “clinicians who were ‘completely certain’ of the diagnosis antemortem were wrong 40% of the time.” Here again, expert overconfidence is encouraged by their clients: “Generally, it is considered a weakness and a sign of vulnerability for clinicians to appear unsure. Confidence is valued over uncertainty and there is a prevailing censure against disclosing uncertainty to patients.” (p. 263)
“When they come together, the emotional, cognitive, and social factors that support exaggerated optimism are a heady brew, which sometimes leads people to take risks that they would avoid if they knew the odds. There is no evidence that risk takers in the economic domain have an unusual appetite for gambles on high stakes; they are merely less aware of risks than more timid people are. Dan Lovallo and I coined the phrase “bold forecasts and timid decisions” to describe the background of risk taking.” (p. 263)
“Psychologists have confirmed that most people genuinely believe that they are superior to most others on most desirable traits—they are willing to bet small amounts of money on these beliefs in the laboratory. In the market, of course, beliefs in one’s superiority have significant consequences.” (p. 258)
The chairman of Disney studios was asked why to so many studios release their movies on the same day like Independence Day or Memorial Day:
“Hubris, Hubris, if you only think about your own business, you think, “I’ve got a good story department, I’ve got a good marketing department, we’re going to go out and do this.” And you don’t think that everybody else is thinking the same way. In a given weekend in a year you’ll have five movies open, and there’s certainly not enough people to go around.” (p. 260)
“For a number of years, professors at Duke University conducted a survey in which the chief financial officers of large corporations estimated the returns of the Standard & Poor’s index over the following year. The Duke scholars collected 11,600 such forecasts and examined their accuracy. The conclusion was straightforward: financial officers of large corporations had no clue about the short-term future of the stock market; the correlation between their estimates and the true value was slightly less than zero!” (p. 261)
“The economists Ulrike Malmendier and Geoffrey Tate identified optimistic CEOs by the amount of company stock that they owned personally and observed that highly optimistic leaders took excessive risks. They assumed debt rather than issue equity and were more likely than others to “overpay for target companies and undertake value-destroying mergers.”” (p. 258)