Abstract
We analyse the effect of behavioural biases on entrepreneurs’ decisions to insure their firms against different kinds of corporate risks. We use a large sample of 2,295 Italian small and medium enterprises (SMEs), finding that they under-insure themselves. Since SMEs should insure more – in proportion – compared to bigger companies, analysing the reasons for this underinsurance is relevant to improve entrepreneurs’ decisions and help their firms, but also from a policy-making point of view. We link corporate insurance choices with the entrepreneurs’ personal characteristics and behavioral traits as well as with their households’ financial choices. Our methodology uses stepwise regressions to discern which variables are statistically significant. In our results, we find that entrepreneurs not only underinsure their firms but also themselves, thus exposing themselves, their firms and their families to high idiosyncratic risk. We find that these suboptimal decisions are affected by behavioural biases such as overconfidence, over optimism, risk misperceptions, and stubbornness, even though in a not straightforward manner. We measure both the overall effect on the number of insurances underwritten and on the specific type of insurance contract. In general, we find that relatively bigger firms do buy more insurance, and that trust in insurance companies is a key driver to insurance purchasing, as well as the estimated probability of suffering damages in the future. In contrast, entrepreneurs do underwrite fewer insurance contracts if their firms caused or suffered damages in the past, but also if they possess personal insurances, thus treating them as substitutes for firm insurance. Since SMEs represent a very important part not only of the Italian economy but also of the economy of many other countries, analyzing their insurance-related decisions is relevant because understanding the determinants that may lead entrepreneurs to mitigate the risks they face is beneficial not only for them and their firms but also for the economy as a whole.
Highlights
We analyse the effect of entrepreneurs’ personal characteristics and behavioral biases on the choice of underinsuring their companies against different kinds of risks
We find a significant relationship with risk misperceptions due to over-optimism, and overconfidence, even if in a not straightforward manner, as we detail in our discussion of the results we find in the econometric analysis
Entrepreneurs should be rational decision-makers when it comes to their businesses, and they should always act in the best interest of their companies
Summary
We analyse the effect of entrepreneurs’ personal characteristics and behavioral biases on the choice of underinsuring their companies against different kinds of risks. For SMEs, firm value typically constitutes a large portion of the owner’s wealth, thereby exposing SMEs entrepreneurs to a large idiosyncratic and often uninsured risk Both theoretical and empirical studies show that underinsurance leads entrepreneurs to invest less than optimally, thereby foregoing profit opportunities and ending up with a lower return on equity. We have information on entrepreneurs’ behavioural biases (such as ambiguity aversion, degree of overconfidence and over-optimism, regret aversion, etcetera), and on entrepreneurs’ families, such as overall household wealth and its composition, degree of diversification, personal insurance contracts, etcetera These unique features of the dataset allow us to link information on entrepreneurs and their families with the ones on their firms, analyzing the relationships between risks born by these three distinct entities, and of potential spillover effects between them
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