Entrepreneurs are not unusually risk tolerant; rather, they are overconfident.

http://www.businessweek.com/smallbiz/content/feb2005/sb2005021_6109_sb013.htm

by amichail • 17 years ago

46 21 17 years ago

amichail• 17 years ago

And maybe the reason they tend to be young is that those who are older have a more realistic assessment of their abilities due to extensive experience?

knightinblue• 17 years ago

Not to mention responsibilities. As a 24 yr old guy, if I put everything on the line and lose - big deal, I can wipe the slate clean and start over. My 34 yr old brother with a wife, 3 kids and a mortgage can't take the same risk as easily as I would.

sho• 17 years ago

Well, not to criticise your bro, but that's the life he signed up for. He willingly took on those responsibilities.

It's not generally thought of as a risk, but he definitely took one - by locking himself into multiple, multi-decade commitments he tossed the dice on continuing to be perfectly satisfied with his current lot, and there would be a lot of pain if he was wrong. After all, what is commitment phobia other than a special type of risk aversion?

trjordan• 17 years ago

Except that they don't tend to be young:

http://gigaom.com/2009/06/18/the-young-entrepreneur-stereoty...

lionheart• 17 years ago

I think sometimes you need a little overconfidence.

After all, used to be taking even financial risks could get you killed very easily. Nowadays, what's the worst that can happen? You end up broke and living at your parents until you're 25.

Take the risk. It's worth it. Not enough people are taking them.

puzzle-out• 17 years ago

Agree that you need a little overconfidence sometimes. But perhaps the fact that there are more support systems around (move back in with parents, social benefit), means that we as a generation never grow comfortable with risk in the first place, and thus can never be truly confident with it.

edawerd• 17 years ago

I don't really have the numbers to back it up, but I think if you compute the expected value of starting a venture, the numbers will show you that you that taking the risk is not worth it (vs. getting a normal salaried job), since most ventures fail.

With that stated, I think that entrepreneur overconfidence is a features and not a bug. The fact that entrepreneurs are overconfident may, in most instances, be to their detriment, but it also will engender great breakthroughs that have huge payoffs and make society much better. Without overconfidence, this wouldn't even be possible.

colins_pride• 17 years ago

Expected utility is probably a more appropriate gauge for these decisions, rather than expected value

grandalf2• 17 years ago

Maybe everyone else is underconfident... Who's to say what the optimal amount of confidence is. Tenured academics? Non-entrepreneurs? Salaried lifers in big firms?

randomwalker• 17 years ago

I don't think you understood the article. Overconfidence is a well-defined and measurable term, a systematic tendency to estimate one's future performance in excess of expectation. In one widely quoted study, 95% of a cohort of MIT students expected to graduate in the top half of the class. (That might well be apocryphal, but it serves to illustrate the point just the same.) It also illustrates the point that while you may not always be able to determine that an individual is overconfident, you can point to a group and say that its members are overconfident on average.

This is completely unrelated to the question of whether or not overconfidence is a good thing. For example, there are studies showing that students who are slightly overconfident -- but not too much -- improve the most in the long term. (Not able to find a link right now, unfortunately.) As another commenter pointed out, the consequences of failure have changed dramatically (for the better) in recent times. In my opinion, a lot more people should be taking up entrepreneurship than the current levels.

grandalf2• 17 years ago

The point in your second paragraph was the point I was trying to make :)

wheels• 17 years ago

To make the subtlety more clear -- I think that over-confidence could have three slightly divergent definitions:

- Too much confidence to accurately predict personal outcomes

- So much of the first that it becomes harmful

- So much of the first that it deviates significantly from the norm

As I recall, most people fall into the first, and I presume the article is suggesting that entrepreneurs are the third.

tdavis• 17 years ago

As an entrepreneur, I disagree. If anything, I'm under-confident. I give pretty much every other developer (and designer) the benefit of the doubt that they're better than me. I just make websites; it's not kernel hacking or compilers, you know.

And it isn't unusual risk tolerance. You know what's really risky? Depending on a salary to pay your mortgage. Having kids. From my perspective, multi-decade obligations are risky. Compromise is risky. Making my own way is the only risk-free thing I can do in a society which exists to remove its own free will.

Perhaps some people are confusing "overconfidence" with a lack of belief in absolutes like "failure", "success", and "mistakes".

julien• 17 years ago

I fully agree with that. As an entrepreneur as well, I will definetly that I am very very under-confident.

I love this saying : "Everybody knew it was impossible, then an idiot came and did it". I feel like an idiot : I don't know anything and I doubt everything; starting with myself.

terpua• 17 years ago

Sounds like Atlas Shrugged 2.0 and a much shorter quote from John Galt.

pmichaud• 17 years ago

First, the few rich guys that I know (north of $10m) are shitheads. Not that they are personally offensive, or even necessarily morally bankrupt. Instead they are willing to ask for asinine things from people who should rightly be offended by the request. They try to make deals that favor them without regard to the interests of the other person, and it turns out to be a winning strategy because they'll get rejected over and over, but in the 10 or 20% of cases where they win, they get ridiculously good deals.

That tendency to ask for too much could be seen as a type of over confidence, but it's also a riskier strategy on average.

Then, these people are almost indifferent to the details of whatever deal they've made. They will make a deal that is exactly what it needs to be to get signed, but which is utterly impossible to deliver. They don't care: "it'll work out."

That's another form of over confidence: the belief that impossible things will work out well enough. It also turns out to be true enough to get someone into the multimillionaire range. One has to be a little more careful to break much higher than that, but it's a good starting strategy. And again, it's a risk to make a deal you might not be able to deliver on.

I didn't read the paper, but I know that dissertations necessarily have to be very limited, so they tend to be simplistic when they are original research, so I wonder:

1) Who was in the entrepreneur group? Successful serial entrepreneurs, or just some undergrad kids in the entrepreneur club?

2) How risk measured? A little psychological battery designed to measure general risk-taking won't capture the mindset of a person who does shaky deals. Is it risky to do try for a deal that'll probably fall through and you probably can't deliver on, or is it safer to do lots of quick and dirty deals so the volume makes up for the instability? How could this paper have measured that?

If anyone has access to this database, let us know the answers: http://mansci.journal.informs.org/cgi/content/abstract/52/9/...

pie• 17 years ago

I just wanted to say your comment about brazenly-illogical-yet-effective (i.e. "assholish") business mannerisms rings true to my own experience and some of the characters I have encountered (and, unfortunately, worked for as well). There are many different ways to make a buck.

kirse• 17 years ago

They try to make deals that favor them without regard to the interests of the other person

I don't see how exactly this makes one a "shithead" though. Don't you always try to get the best deal for yourself first and then if the other person doesn't budge you compromise a bit? I pretty much always start out with any deal ridiculously in my favor because you don't lose anything if the other person rejects it...

My rule is typically "make an offer that is just before the point of being offensive and then compromise from there if the deal is needed." That way you can usually reach a "midpoint" that is still mostly on your favorable side of the deal.

I'm not a multi-millionaire, but I'll call ya in 10 years and let you know if I am ;)

wooster3• 17 years ago

See my comment elsewhere in the thread, but the paper can be found here: http://ideas.repec.org/p/sba/wpaper/05bwmk.html

wooster3• 17 years ago

The paper is here: http://ideas.repec.org/p/sba/wpaper/05bwmk.html

He's generalizing from banking industry data from 1984-1997, which seems like a tenuous proposition. Recent events suggest the risk in the banking industry was not properly understood during that period.

Further, when examining risk tolerance, it might be good idea to look at an industry where expected returns can't be accurately forecast in advance. Banking seems like an exception to the rule here.

There are a couple of subtle misdirections in the paper. In one place he says: "This risk of failure is considerable. Approximately 10% of all firms in the United States fail each year (U.S. Small Business Administration 1999)." Actually, the risk of failure of banking institutions is in Table 3, which he doesn't textually mention is 1%.

He also mentions "Furthermore, even though the banking is one of the oldest industries, it has been growing at 6.5% rate over the past ten years (roughly three times GDP growth)." which is irrelevant as it's over a different time period than his data and analysis. Further, the chart he inserts directly after this sentence shows a decreasing rate of entry over his studied period. Also, notice the numbers: this whole paper is premised on the entry of between 50 and 400 new companies per year.

wooster3• 17 years ago

"risk of failure" -> "rate of failure", of course.

Entrepreneurs are not unusually risk tolerant; rather, they are overconfident.

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