Strategic and Natural Risk in Entrepreneurship: An Experimental Study

35 Pages Posted: 28 Apr 2016

See all articles by John Morgan

John Morgan

University of California, Berkeley - Economic Analysis & Policy Group

Henrik Orzen

University of Mannheim

Martin Sefton

University of Nottingham - School of Economics

Dana Sisak

Erasmus University Rotterdam (EUR) - Department of Economics; Tinbergen Institute

Date Written: Summer 2016

Abstract

We report on the results of experiments where participants choose between entrepreneurship and an outside option. Entrepreneurs enter a market and then make investment decisions to capture value. Payoffs depend on both strategic risk (i.e., the investments of other entrepreneurs) and natural risk (i.e., luck). Absent natural risk, participants endogenously sort themselves into entrepreneurial and safe types, and returns from the two paths converge. Adding natural risk fundamentally changes these conclusions: Here we observe excessive entry and excessive investment so that entrepreneurs earn systematically less than the outside option. These payoff differences persist even after many repetitions of the task. With a risky outside option, entry further increases and about one‐third of entrepreneurs adopt a passive strategy, investing little or nothing. Finally, we examine an environment where an individual must become an entrepreneur but chooses the stakes over which she will compete. Due to under‐entry and under‐investment in the high stakes setting, the returns gap grows to over 15 percentage points. A two‐factor model incorporating loss aversion and love of winning can rationalize these returns patterns.

Suggested Citation

Morgan, John and Orzen, Henrik and Sefton, Martin and Sisak, Dana, Strategic and Natural Risk in Entrepreneurship: An Experimental Study (Summer 2016). Journal of Economics & Management Strategy, Vol. 25, Issue 2, pp. 420-454, 2016. Available at SSRN: https://ssrn.com/abstract=2771437 or http://dx.doi.org/10.1111/jems.12140

John Morgan (Contact Author)

University of California, Berkeley - Economic Analysis & Policy Group ( email )

Berkeley, CA 94720
United States
510-642-2669 (Phone)
810-885-5959 (Fax)

HOME PAGE: http://faculty.haas.berkeley.edu/rjmorgan/

Henrik Orzen

University of Mannheim

Martin Sefton

University of Nottingham - School of Economics ( email )

University Park
Nottingham, NG7 2RD
United Kingdom

Dana Sisak

Erasmus University Rotterdam (EUR) - Department of Economics ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

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