The Impact of Learning and Overconfidence on Entrepreneurial Entry and Exit

Forthcoming, Organization Science

47 Pages Posted: 14 Mar 2018 Last revised: 10 May 2018

See all articles by John S. Chen

John S. Chen

University of Florida

David C. Croson

Michigan State University - Department of Economics; Wharton Financial Institutions Center

Daniel W. Elfenbein

Washington University in St. Louis - John M. Olin Business School

Hart E. Posen

University of Wisconsin-Madison

Date Written: April 23, 2018

Abstract

Empirical evidence suggests that entrepreneurs make mistakes: too many enter markets and, once there, persist too long. While scholars have largely settled on behavioral bias as the cause, we suggest that this consensus is premature. These mistakes may also arise from a process in which entrepreneurs continually learn about their prospects, and make entry and exit decisions from what they have learned. We develop a computational model of this process that connects pre- and post-entry learning and can be directed to analyze Bayesian rational or biased entrepreneurs. The model suggests that, to outside observers, rational entrepreneurs may appear overconfident, seem to take too long to exit, and exhibit a positive correlation between entry cost and persistence in the market. When examining confidence biases, the model suggests that entrepreneurs whose biases cause them to perform the worst post-entry will be most likely to enter, that pre-entry learning induces a positive correlation between distinct confidence biases among entrants, and that exit changes the prevalence of certain biases in the surviving population of entrants over time. Our study also speaks to recent work on pre-entry experience that documents the transfer of knowledge from parent to progeny firms, suggesting that, in addition to inheritance, differential performance may also be the result of heterogeneity in the length and quality of pre-entry learning during which an opportunity is assessed.

Keywords: earning, opportunity assessment, bias, overconfidence, entrepreneurship

JEL Classification: D21, M13, L26

Suggested Citation

Chen, John S. and Croson, David C. and Elfenbein, Daniel W. and Posen, Hart E., The Impact of Learning and Overconfidence on Entrepreneurial Entry and Exit (April 23, 2018). Forthcoming, Organization Science. Available at SSRN: https://ssrn.com/abstract=3140528 or http://dx.doi.org/10.2139/ssrn.3140528

John S. Chen

University of Florida ( email )

PO Box 117165, 201 Stuzin Hall
Gainesville, FL 32610-0496
United States

David C. Croson

Michigan State University - Department of Economics ( email )

East Lansing, MI 48824
United States
517-353-6938 (Phone)
517-432-1068 (Fax)

Wharton Financial Institutions Center ( email )

2306 Steinberg Hall-Dietrich Hall
3620 Locust Walk
Philadelphia, PA 19104
United States
214-768-4006 (Phone)
214-768-4099 (Fax)

Daniel W. Elfenbein (Contact Author)

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1156
St. Louis, MO 63130-4899
United States

HOME PAGE: http://www.elfenbein.net

Hart E. Posen

University of Wisconsin-Madison ( email )

Madison, WI
United States

HOME PAGE: http://bus.wisc.edu/faculty/hart-posen

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