Trickle-Down Overconfidence: The Impact of Customer Overconfidence on Supplier Firms

Abstract

Economic research has long focused on how individual behavioral biases can create spillover effects. In this paper, we consider why CEO overconfidence impacts other firms in the supply chain. Using data on supplier-customer relationships, we examine how suppliers respond to overconfident customers. We find that suppliers to overconfident customers increase their relationship-specific investment compared to suppliers paired with non-overconfident customers. The effect, however, is attenuated when the customer firms exhibit high-levels of riskiness. We further find no evidence that suppliers become overconfident themselves in response to overconfident customers. These results suggest that increases in supplier investment are not driven by overconfidence spilling over to suppliers. Instead, it appears that increases in supplier investment are driven by a rational response to an expected increase in demand from overconfident customers.