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The Positive Effects of Biased Self-Perceptions in Firms

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  • Simon Gervais
  • Itay Goldstein

Abstract

We study a firm in which the marginal productivity of agents' effort increases with the effort of others. We show that the presence of an agent who overestimates his marginal productivity may make all agents better off, including the biased agent himself. This Pareto improvement is obtained even when compensation contracts are set endogenously to maximize firm value. We show that the presence of a leader improves coordination, but self-perception biases can never be Pareto-improving when they affect the leader. Self-perception biases are also shown to affect job assignments within firms and the likelihood and value of mergers. Copyright 2007, Oxford University Press.

Suggested Citation

  • Simon Gervais & Itay Goldstein, 2007. "The Positive Effects of Biased Self-Perceptions in Firms," Review of Finance, European Finance Association, vol. 11(3), pages 453-496.
  • Handle: RePEc:oup:revfin:v:11:y:2007:i:3:p:453-496
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