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Entrepreneurial Risk and Market Entry

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  • Brian Wu
  • Anne Marie Knott
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    Abstract

    This paper attempts to reconcile the risk-bearing characterization of entrepreneurs with the stylized fact that entrepreneurs exhibit conventional risk aversion profiles. We propose that the disparity arises from confounding two distinct dimensions of uncertainty: demand uncertainty and ability uncertainty. We further propose that entrepreneurs will be risk averse with respect to demand uncertainty, yet “risk-seeking” (or overconfident) with respect to ability uncertainty. To examine this view we model the entrepreneur’s entry decision then test the model empirically. We find that entrepreneurs in aggregate behave as we predict. Accordingly, risk-averse entrepreneurs are willing to bear market risk when the degree of ability uncertainty is comparable to the degree of demand uncertainty. A potential market failure exists however in instances where there is a high degree of demand uncertainty, but low ability uncertainty. In those settings there may be insufficient entry, competition and innovation.

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    Paper provided by U.S. Small Business Administration, Office of Advocacy in its series The Office of Advocacy Small Business Working Papers with number 05bwmk.

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    Length: 30 pages
    Date of creation: 2005
    Date of revision:
    Handle: RePEc:sba:wpaper:05bwmk

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    1. Hellmann, Thomas F., 2002. "When Do Employees Become Entrepreneurs?," Research Papers 1770, Stanford University, Graduate School of Business.
    2. Richard J. Rosen, 1991. "Research and Development with Asymmetric Firm Sizes," RAND Journal of Economics, The RAND Corporation, vol. 22(3), pages 411-429, Autumn.
    3. Sarasvathy, D. K. & Simon, Herbert A. & Lave, Lester, 1998. "Perceiving and managing business risks: differences between entrepreneurs and bankers," Journal of Economic Behavior & Organization, Elsevier, vol. 33(2), pages 207-225, January.
    4. Loretta J. Mester, . "Efficiency in the Savings and Loan Industry," Rodney L. White Center for Financial Research Working Papers 26-92, Wharton School Rodney L. White Center for Financial Research.
    5. Benjamin E. Hermalin & Nancy E. Wallace, 1994. "The Determinants of Efficiency and Solvency in Savings and Loans," RAND Journal of Economics, The RAND Corporation, vol. 25(3), pages 361-381, Autumn.
    6. Timothy Dunne & Mark J. Roberts & Larry Samuelson, 1988. "Patterns of Firm Entry and Exit in U.S. Manufacturing Industries," RAND Journal of Economics, The RAND Corporation, vol. 19(4), pages 495-515, Winter.
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    13. S.A. Lippman & R.P. Rumelt, 1982. "Uncertain Imitability: An Analysis of Interfirm Differences in Efficiency under Competition," Bell Journal of Economics, The RAND Corporation, vol. 13(2), pages 418-438, Autumn.
    14. Richard H. Thaler & Eric J. Johnson, 1990. "Gambling with the House Money and Trying to Break Even: The Effects of Prior Outcomes on Risky Choice," Management Science, INFORMS, vol. 36(6), pages 643-660, June.
    15. Jovanovic, Boyan, 1982. "Selection and the Evolution of Industry," Econometrica, Econometric Society, vol. 50(3), pages 649-70, May.
    16. Mitchell A. Petersen & Raghuram G. Rajan, 2000. "Does Distance Still Matter? The Information Revolution in Small Business Lending," NBER Working Papers 7685, National Bureau of Economic Research, Inc.
    17. Palich, Leslie E. & Ray Bagby, D., 1995. "Using cognitive theory to explain entrepreneurial risk-taking: Challenging conventional wisdom," Journal of Business Venturing, Elsevier, vol. 10(6), pages 425-438, November.
    18. Colin Camerer & Dan Lovallo, 1999. "Overconfidence and Excess Entry: An Experimental Approach," American Economic Review, American Economic Association, vol. 89(1), pages 306-318, March.
    19. Henry Chesbrough & Richard S. Rosenbloom, 2002. "The role of the business model in capturing value from innovation: evidence from Xerox Corporation's technology spin-off companies," Industrial and Corporate Change, Oxford University Press, vol. 11(3), pages 529-555, June.
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