The positive role of overconfidence and Optimism in Investment Policy Abstract managers with those of rational managers. We reach the surprising conclusion that managE We use a simple capital budgeting problem to contrast the decisions of overconfident, optimis overconfidence and optimism can increase the value of the firm. Risk-averse rational managers will postpone the decision to exercise real options longer than is in the best interest of shareholders Overconfident managers underestimate the risk of potential projects and are therefore less likely t postpone the decision to undertake. Optimistic managers, too, undertake projects quickly. Thus moderately overconfident or optimistic managers make decisions that are in the better interest of shareholders than do rational managers. Overly overconfident or optimistic managers may be too eager to undertake projects. This tendency can sometimes be controlled by increasing hurdle rates for risky projects. While compensation contracts that increase the convexity of manager payoffs can be used to realign the decisions of a rational manager with those of shareholders, it is less expensive to simply hire a moderately overconfident manager. The gains from overconfidence and optimism will at times be sufficient that shareholders actually prefer an overconfident, optimistic manager with less ability to a rational manager with greater ability JEL classification codes: G31 L21The Positive Role of Overconfidence and Optimism in Investment Policy Abstract We use a simple capital budgeting problem to contrast the decisions of overconfident, optimistic managers with those of rational managers. We reach the surprising conclusion that managerial overconfidence and optimism can increase the value of the firm. Risk-averse rational managers will postpone the decision to exercise real options longer than is in the best interest of shareholders. Overconfident managers underestimate the risk of potential projects and are therefore less likely to postpone the decision to undertake. Optimistic managers, too, undertake projects quickly. Thus moderately overconfident or optimistic managers make decisions that are in the better interest of shareholders than do rational managers. Overly overconfident or optimistic managers may be too eager to undertake projects. This tendency can sometimes be controlled by increasing hurdle rates for risky projects. While compensation contracts that increase the convexity of manager payoffs can be used to realign the decisions of a rational manager with those of shareholders, it is less expensive to simply hire a moderately overconfident manager. The gains from overconfidence and optimism will at times be sufficient that shareholders actually prefer an overconfident, optimistic manager with less ability to a rational manager with greater ability. JEL classification codes: G31, L21