Entrepreneurial overconfidence and SME financing decisions

This study examines the effect of entrepreneurial under-and-overconfidence on SMEs’ access to external finance. Besides the conventional wisdom that overconfidence leads to sub-optimal financing decisions and higher financing costs, we contend that moderate overconfidence induces entrepreneurs to commit costly effort, 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 non-linear relationships between overconfidence and alternative access to finance measures. Specifically, we show that mildly overconfident entrepreneurs are less likely to be credit rationed than both unconfident and extremely overconfident ones.