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Abstract We show that managerial overconfidence can be a rational response to the economic and institutional environment, rather than a personal trait. A manager, whose contract may not be renewed upon poor performance relative to his peers, chooses risky projects in the firm. This may result in more than half of the managers rationally estimating their abilities to be better than average. Although there can be underconfident managers in equilibrium, it is never the case that more than half of them estimate their abilities to be below average in any equilibrium.
