Box 3 : What is overconfidence?

Discussion of SME perceptions

The findings of the previous section could have different explanations. The conventional view is that SMEs lack skills or experience. This view is amply reflected in the desk study. Our analysis suggests that another reason contributes substantially to unsound financial management practices and behaviours: many of the interviewed entrepreneurs are overconfident about their professional standards. Their high opinion of their own record-keeping and financial management system is not supported by the facts.

Box 3 : What is overconfidence?

Overconfidence is a form of optimism that is not justified by objective facts. It underlies several behavioural biases that affect decision-making towards taking on excessive risk. ‘Excessive’ means that the actual risk is bigger than the intended risk-appetite. Indeed, the adage ‘biting off more than one can chew’ illustrates it well.

These are common types of the overconfidence bias: • Over Ranking refers to someone rating his or her own personal performance as higher than it actually is. The reality is that most people think of their own ability as above average. This leads entrepreneurs to taking on too much risk. • Relatedly, the desirability effect refers to someone overestimating the odds of an event simply because the outcome is desirable; commonly also known as “wishful thinking”. • Illusion of control bias occurs when people think they have control over a situation when in fact they do not. On average, people believe they have more control than they really do. Entrepreneurs who do not accurately assess their risks fail to put the required risk management in place. • Timing optimism refers to someone overestimating how quickly he or she can do work and underestimate how long it takes to get things done. Especially for complicated tasks, entrepreneurs constantly underestimate how long a project will take to complete; and this affects their customer and supplier relations as well as their finances (when an investment takes longer than anticipated to pay off). Illusion of control and timing optimism particularly affect entrepreneurs when their enterprise has been growing and they increasingly depend on delegated management. ‘Founder’s syndrome’ is fed by overconfidence. Governance rules are among others meant to mitigate these risks.9

We asked the entrepreneurs: - which strengths and weaknesses they see in their record keeping system; and - what they ’would like to do better/ be better at when it comes to the financial side of your business. Combining the answers to these two questions, almost half (30 out of 61) of all SMEs interviewed believe that they do not have any weaknesses nor any need for improvement at all. However, out of these SMEs: - 14 (46.7%) said that they do not or not always separate business and private accounts; - 10 had not hired a professional accountant; and - 18 characterized their record keeping system as only partly professional or only very basic.