The Laughing Cavalier (detail), Frans Hals, 1624. (Source: The Wallace Collection, London)
Ideas for Leaders #246

Reasons to Be Cheerful: Positivity Linked to Profitability

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Key Concept

Over-optimism in business is often seen as a bad thing, associated with recklessness and corporate ‘buccaneering’. New research, however, challenges this view. ‘Against-the-odds’ positivity can, it seems, motivate managers to work harder and propel them towards high performance targets.

Idea Summary

It is important to draw a distinction between over-confidence and over-optimism in business. The former can be seen as a pejorative term, linked to arrogance and hubris, and the latter as more ‘neutral’.

Over-confident managers underestimate the risks of their decisions; over-optimistic ones are biased towards larger growth projections than the figures suggest. So is over-optimism a good or a bad thing for companies?

Recent empirical research — some of the first to study over-optimism in a managerial context — suggests there’s good reason to be positive about positive thinking. It not only confirms the difference between over-confidence and over-optimism but also suggests the latter leads — in the short- or mid-term at least — to better performance and revenue growth.

The researchers isolated and measured over-optimism by comparing North American companies’ quarterly earnings forecasts against their eventual performance and analysts’ predictions. They also measured the frequency of optimistic language in company press releases.

The results show a correlation between ‘bullish’ forecasts and better-than-expected performance. They also show a ‘virtuous circle’ of optimism and growth: the correlation persisted as past wins made managers feel more positive about the next quarter.

It seems that optimism about the future leads to higher levels of personal investment in a task and the kind of momentum that ‘gets the job done’ — and that the successes of the optimistic manager can breed success.

Over-optimism is not, according to the research, a cognitive bias or, necessarily, a natural predisposition or personality trait. Instead, it’s something that emerges dynamically in a rational framework.

There are caveats, though. The ‘virtuous circle’ can be broken as ‘dynamically optimistic’ managers tend to burn out. The effect of over-optimism was seen to dwindle after about four quarters.

Why does optimism lessen with time? One explanation is ‘expectation inflation’. There comes a point when the over-optimistic manager finds it impossible to exceed their own expectations and so becomes more cautious ‘next time round’. In general, managers tend towards optimism in the absence of a good reason not to. But experience can have a dampening effect. 

Business Application

How do you make sure managers don’t cross the line between over-optimism and ‘over-reach’? How do you rein over-confidence in but sustain positive thinking? Gilles Hilary, one of the researchers, suggests there are a couple of practical steps companies can take:

  • Writing clauses into contracts that discourage forecasts that deviate too greatly from the facts and maths.
  • Setting ambitious targets tied to incentives. (This could encourage over-confident managers to work hard to achieve their objectives and persuade them to take a more measured approach when those objectives aren’t achieved and they don’t get paid. In other words, it could create a ‘win-win’ for companies.)

Ultimately, however, the answer might be to make sure the culture of the company is more conducive to optimism. If people feel over-confidence is a behavioural norm in the organization, and they’ll be rewarded for it, they’ll be more likely to display it; if they feel they’ll be ‘punished’ for failing to meet their own high standards and/or exceed their personal expectations, they’ll be more likely to retreat to pessimism and perform ‘sub-optimally’.

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Authors

Institutions

Source

Idea conceived

  • June 2013

Idea posted

  • October 2013

DOI number

10.13007/246

Subject

Real Time Analytics