Entrepreneurial overconfidence and SME financing decisions

This study examines the effect of entrepreneurial under- and overconfidence on small and medium-sized enterprises’ (SMEs) external financing decisions and outcomes. In addition to the conventional wisdom that overconfidence leads to suboptimal financing decisions and higher financing costs, we contend that moderate overconfidence induces entrepreneurs to commit costly efforts, which is seen as a favorable signal by financiers. We test this trade-off hypothesis using a large sample of UK SMEs and a novel measure of overconfidence. We find significant nonlinear relationships between overconfidence and alternative measures of financial demand and supply. Specifically, we show that mildly overconfident entrepreneurs are less likely to receive the loans applied for than both unconfident and extremely overconfident ones