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Entrepreneurial Risk and Market Entry

The Wharton School, University of Pennsylvania, 2000 SH-DH, 3620 Locust Walk, Philadelphia, Pennsylvania 19104
Olin School of Business, Washington University, Campus Box 1133, One Brookings Drive, St. Louis, Missouri 63130-4899
wux{at}wharton.upenn.edu
knott{at}wustl.edu

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 "apparent risk seeking" (or overconfident) with respect to ability uncertainty. To examine this view, we construct a reduced-form model of the entrepreneur’s entry decision, which we aggregate to the market level, then test 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. Potential market failures exist in instances where there is a high demand uncertainty but low performance dispersion (insufficient entry), or low demand uncertainty but high performance dispersion (excess entry).

Key Words: entry; risk; entrepreneur; uncertainty; overconfidence
History: Received: September 2, 2004;