Narrative and Numbers: The Value of Stories in Business (Columbia Business School Publishing)

by Aswath Damodaran

the extent of the overpricing will vary, depending on the following factors: 1. The degree of overconfidence: The greater the overconfidence exhibited by entrepreneurs and investors in their own products and investment abilities, the greater the overpricing. While both groups are predisposed to overconfidence, that overconfidence tends to increase with success in the market. Not surprisingly, therefore, the longer a market boom lasts in a business space, the larger the overpricing will tend to get in that space. In fact, you can make a reasonable argument that overpricing will increase in markets where you have more experienced VCs and serial entrepreneurs, since experience often adds to overconfidence. 2. The size of the market: As the target market gets bigger, it is far more likely that it will attract more entrants, and if you add in the overconfidence they bring to the game, the collective overpricing will increase. 3. Uncertainty: The more uncertainty there is about business models and the capacity to convert them into end revenues, the more overconfidence will skew the numbers, leading to greater overpricing in the market. 4. Winner-take-all markets: The overpricing will be much greater in markets in which there are global networking benefits (i.e., growth feeds on itself) and winners can walk away with dominant market shares. Since the payoff to success is greater in these markets, misestimating the probability of success will ha...