Innovation Diary: Entrepreneurs are right to be overly-optimistic – it’s the rest of us who have the problem
IF YOU’RE an optimistic sort, you may be more likely to live longer, feel less lonely, and be generally happier than those eternal pessimists who eke out their existences in constant worry. And it should come as little surprise that entrepreneurs are glass half-full types.
A 2004 study by Manju Puri and David Robinson of Duke University, for example, found that business owners are generally more optimistic than the rest of us (they think they’re going to live longer). This, in turn, is associated with specific economic decisions. Optimists (regardless of whether they are entrepreneurs) are more likely to love their job, are happier to work longer hours, and never want to retire. All very useful if you’re building a company.
Yet the link between optimism, entrepreneurship, and risk tolerance isn’t as straightforward as often assumed. Yes, entrepreneurs are more risk-loving than non-entrepreneurs. They tend to have non-diversified investment portfolios, for example. But Puri and Robinson found that the correlation between risk tolerance and optimism is quite low. In fact, they say, entrepreneurs are more often considerate, longer-term planners. This makes sense. Kaufmann Institute research shows most founders of US firms are middle-aged and 70 per cent are married.
But surely entrepreneurs are often over-confident, and surely this can be a problem? Unsurprisingly, entrepreneurs typically expect to be more successful than they really will be – why else would they bother? Of 2,994 entrepreneurs surveyed for a study in the 1980s, for example, 33 per cent thought they had a 100 per cent chance of success, yet 50 per cent of firms started today will be dead within five years. Some worry that this delusion is itself a problem. But is over-confidence really that bad?
In a fascinating recent research review, Ioannis Salamouris of the Hellenic American University argues that entrepreneurial over-confidence is entirely rational. His point is complex, but the thrust is that entrepreneurs typically have a different understanding of risk to non-entrepreneurs. While most people identify it simply as the level of uncertainty of something happening or not, entrepreneurs divide this into two. First is market uncertainty: the chance of interest rates going up, or a competitor moving in next door. Sensibly, they fear this as much as the next person. Second, however, is uncertainty of ability – and here, Salamouris argues, entrepreneurs are different from most, in having a greater belief in their capacity to win. They will be overconfident: by discounting past failures, or ignoring a lack of market information. But this doesn’t matter. In fact, he says, “the appreciation of their ability comes in and compensates for the market risk.”
If Salamouris is right (and you have to buy into several assumptions about the nature of entrepreneurship), optimism – even over-confidence – is one of entrepreneurs’ greatest assets. Indeed, it may be that it isn’t entrepreneurs with the problem.
Walter Frick of the Harvard Business Review has dug out a new working paper from Lund University in Sweden. Far from entrepreneurs being stupidly optimistic, it suggests, non-entrepreneurs are too negative about the future. The paper draws on 13 years of survey data, asking Swedish citizens whether the economy would improve in the next 12 months. The entrepreneurs were more positive (even controlling for age, gender, education and income). But they were also more accurate. In short, the authors write, “our evidence hereby challenges the prevailing argument that entrepreneurs are irrational in how they form their beliefs about the future. Rather, it is non-entrepreneurs who are more irrational, because their beliefs are overly pessimistic.”
Tom Welsh is business features editor at City PM @TWWelsh