Effect of Overconfidence on Cournot Competition in the Presence of Yield Uncertainty

Abstract

This study investigates the effects of overconfidence on a Cournot competition subject to yield uncertainty. We consider one of two firms to be overconfident, whereas the other is completely rational and derive the Nash equilibrium to compare with that when both firms are completely rational. Through this comparison and analysis, we establish that (i) the relationship between a firm's overconfidence and the likelihood of that firm developing a monopoly in the market is positive; (ii) a rational firm always suffers a loss because of its competitor's overconfidence in a Cournot competition; and (iii) an overconfident firm does not benefit constantly from its overconfidence, although overconfidence results in permanent, increased, and more aggressive market sharing in competitions.

Managerial overconfidence, overinvestment, and R&D spillover

“…Yu () showed that CEOs' overconfidence and overinvestment can become the equilibrium outcome and that equilibrium overconfidence and overinvestment exhibit an inverted U shape with respect to product market competition. Pu et al () investigated the effect of overconfidence on product market competition in the presence of random yield and derived proof of a positive relationship between a firm's overconfidence and the possibility that the firm monopolizes a product market. However, the existing literature regarding the behavior of CEOs' overconfidence ignores the spillover effect of investment.…”

Better innovators or more innovators? Managerial overconfidence and corporate R&D

“…As shown by behavioral finance, managers are not always rational and are exposed to biases such as anchoring, framing, loss aversion, optimism, and overconfidence. (Ainslie, ; De Bondt, Muradoglu, Shefrin, & Staikouras, ; Deshmukh, Goel, & Howe, ; Foxall, ; Hursh & Roma, ; Pu, Jin, & Han, ; Roa García, ). Furthermore, even if managers believe that their behavior is rational, their decisions can still be biased.…”

Confidence bias and advertising in imperfectly competitive markets

“…More recent studies use CEO bias, typically excessive confidence or aggressiveness, as a commitment device to potentially improve owner profit. For example, Englmaier (2010Englmaier ( , 2011 investigates the effect of CEO overoptimism on R&D activity in Cournot and Bertrand models; Englmaier and Reisinger (2014) and Schroeder, Tremblay, and Tremblay (2020) study the effect of the type of competition on CEO confidence bias and profit; and Pu, Jin, and Han (2017) address the effect of CEO overconfidence in the presence of yield uncertainty on profit in a Cournot setting. We view a CEO's bias regarding his or her marketing ability as a commitment device and explore the impact of the potential bias on advertising and profit.…”

“…Empirical studies include Ben‐David, Graham, and Harvey (2013); Malmendier and Tate (2005, 2008); Deshmukh, Goel, and Howe (2013); Schrand and Zechman (2012); Galasso and Simco (2011); Hirshleifer, Low, and Teoh (2012); Banerjee, Dai, Humphery‐Jenner, and Nanda (2015); Huang and Kisgen (2013); and Chen, Leung, Song, and Goergen (2019). For theoretical work, see Goel and Thakor (2008), Englmaier (2010, 2011), Englmaier and Reisinger (2014), Pu et al (2017), and Schroeder, Tremblay, and Tremblay (2020).…”