In conditions where there is any ambiguity in competence and performance (which is common in organizations), overconfident individuals will be perceived as more competent by others, and should attain higher levels of status, compared to individuals with more accurate self-perceptions of competence.This is because overconfident people send out more “competence cues”; they talk louder, have more confidence in their opinions, use more emphatic gestures, and all this is wrongly interpreted as signs of actual ability.
They established this experimentally. 104 students were asked to judge strangers’ personalities from their photos. They were then asked to estimate how they performed. The difference between these estimates and actual performance was used to measure over-confidence. The subjects were then paired together randomly on a similar task, after which subjects were asked to rate their partners’ ability. Overconfident individuals were indeed perceived as more competent than they really were.
The effect is significant. Each three percentage points of overconfidence lead to someone being perceived as one percentage point more able than they really were. So, for example, if an individual of median ability were to consider himself better than 80% of subjects, his partner would rank him better than 60%.
If a similar thing happens in organizations, then overconfident people are more likely to be promoted. And this could have positive feedback effects. Higher status will itself breed even more overconfidence (“I got the job so I must be good”). And if bosses employ like-minded subordinates, the result could be entire layers of management which are both over-confident and engaged in groupthink. The result will be that the organization takes excessive risks.
Does this sound like any (ex-)bank you might have heard of?
Now, you might object here that, over time, the overconfident, over-promoted individual will reveal his mediocre ability and so be stopped from getting the top job.
Not necessarily. One problem here is tail risk. Imagine two projects. One pays a certain 3% a year. The other has a 98% chance of paying 5% and a 2% chance of losing 100%. A rational risk-neutral individual would choose the safe prospect, because the risky prospect has a lower expected pay-off. However, the overconfident individual would under-rate the chance of loss and so choose the risky venture.
And here’s the thing. Over 10 years, this individual has a four-fifths chance of being “right” every year, and even over a 20-year period he has a two-thirds chance of being "right" every year. Over such a period, the overconfident boss’s reputation would grow - exacerbated, perhaps, by his employers and investors’ confirmation bias. And so he’d get a superstar salary.
As the book of Ecclesiastes has it (9:11):
The race is not to the swift, nor the battle to the strong, neither yet bread to the wise, nor yet riches to men of understanding, nor yet favour to men of skill; but time and chance happeneth to them all.It omitted to had, however, that chance happeneth to be biased.