Overconfidence and Optimism in Self-Employment

Abstract

Some have argued that entrepreneurs are more optimistic than non-entrepreneurs. A related theoretical perspective argues that entrepreneurs are more likely to suffer from various overconfidence biases. Prior research has often treated the two interchangeably. In this research I argue that optimism and overconfidence are correlated but conceptually distinct. Optimism is defined as the tendency or inclination to perceive, interpret, or construe an event or action as more likely to result in a favorable outcome irrespective of the objective probability of that outcome actually occurring or the abilities or attributes the individual marshals to bringing it to fruition. Overconfidence, on the other hand, is an excessive or unwarranted belief in one's own attributes or abilities-or that of some other social or economic actor(s)-to predict or bring about some outcome. Using data from all five waves of the National Education Longitudinal Survey ("NELS") I adjudicate between the two concepts as they relate to predicting self-employment status. I find that only overconfidence (both general and specific to earnings ability) has a positive impact on becoming self-employed. Importantly, both forms of overconfidence are measured 6 to 8 years prior to entry into self-employment, which minimizes the possibility of reverse causality. Controlling for intervening ownership expectations makes this all the more decisive. I conclude by providing some exploratory analyses of what drives overconfidence in earnings expectations, as well as some speculations regarding the causes of these findings.

Keywords: Entrepreneurship, self-employment, earnings, overconfidence, optimism, expectations

JEL Classification: J22, J23, J24, J31, A14, D01, D14