Managerial Optimism in a Competitive Market

Research has shown that many managers and entrepreneurs tend to be optimistic and are inclined to believe that negative shocks happen to them less frequently than to others. However, there is also evidence suggesting that such optimism is often inaccurate in reality and managerial optimism can lead to the failure of a company. We develop a game‐theoretic model to investigate the impact of managerial optimism on firms’ performance in a competitive market. Our analysis shows that a manager's optimism about demand can increase the firm's profit. Moreover, only one firm having managerial optimism can be win–win for both firms in a duopoly, because it can increase the level of product quality differentiation between the firms, alleviating price competition. However, if both firms have optimistic managers, the benefit of increased differentiation disappears, and firms are weakly worse off, compared with the case of both firms having realistic managers. Our research suggests that a firm should hire a realistic manager when managerial optimism is already pervasive in a competitive market.