Risk Propensity and Financial Returns to Entrepreneurship

Abstract

Entrepreneurship is often associated with risk taking, but the financial implications of entrepreneurs' risk propensity remain elusive. Conflicting predictions arise from two schools of theories: on the one hand, more risk- tolerant entrepreneurs may demand higher returns for self-selection into risk- taking; on the other, boundedly rational entrepreneurs may overestimate their ability, and risk aversion protects them from taking on unprofitable projects. Drawing on a novel dataset from China, I show that households guided by more risk-tolerant individuals were more likely to enter into entrepreneurship. Entrepreneurs' risk propensity is generally not strongly related to business scale or performance, except that the very risk-tolerant ones tend to have more employees, lower revenue and lower profit. The findings are robust to propensity score matching. Furthermore, to disentangle risk propensity from overconfidence, I then conduct an experiment where both traits are explicitly measured. The effect of risk propensity remains robust to controlling for the level of confidence. In summary, this paper highlight the negative consequences of entrepreneurs indulging in undisciplined risk-taking.