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Rationality, Overconfidence and Leadership

This paper examines the process by which individuals get selected to be leaders and the attributes of leaders. It develops a model in which managers of a priori unknown ability are being judged relative to each other to determine who should be appointed the leader of the group. Managers are making unobservable choices about the payoff distributions of the projects they manage, and their abilities are being (noisily) inferred ex post from observed project outcomes. We have three main results. First, all managers choose higher levels of project risks when they are competing for leadership. Second, an overconfident manager - one who underestimates his project risk - has a higher probability of being chosen as the leader than an otherwise identical rational manager. Third, an overconfident leader may be better for the firm's shareholders than a rational leader. Numerous implications of the analysis for real-world leadership behavior, new product development, relation of risk-taking to firm size and organization culture are discussed.