Risk balanced skills and entrepreneurship

Authors: Chihmao Hsieh Simon C Parker C Mirjam van Praag

Publish Date: 2016/07/26

Volume: 48, Issue: 2, Pages: 287-302

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Abstract

This paper proposes that risk aversion encourages individuals to invest in balanced skill profiles making them more likely to become entrepreneurs By not taking this possible linkage into account previous research has underestimated the impacts of both risk aversion and balanced skills on the likelihood individuals choose entrepreneurship Data on Dutch university graduates provide an illustration supporting our contention We raise the possibility that even riskaverse people might be suited to entrepreneurship and it may also help explain why prior research has generated somewhat mixed evidence about the effects of risk aversion on selection into entrepreneurshipTwo of the most influential theories of individual selection into entrepreneurship are based on the concepts of risk aversion RA Kihlstrom and Laffont 1979 and balanced skills BS Lazear 2005 Specifically if entrepreneurship is a more risky occupation than paid employment and if individuals vary in their aversion to risk then it follows that the least riskaverse people are most likely to become the entrepreneurs Kihlstrom and Laffont 1979 Moreover because entrepreneurship requires expertise in a variety of roles while paid employment rewards specialists people with balanced skills are most likely to become entrepreneurs as well Lazear 2005Despite the prominence and continued influence of the RA and BS theories the evidence for them is decidedly mixed For example many psychologybased studies have failed to detect any difference between entrepreneurs and nonentrepreneurs in terms of their risk attitudes Brockhaus 1980 Shaver and Scott 1991 Metaanalyses of risk aversion and entrepreneurial selection have also generated conflicting results Stewart and Roth 2001 Miner and Raju 2004 with Miner and Raju 2004 concluding that the available evidence about the validity of the RA theory is inconclusive Economicsbased studies have also generated mixed findings Astebro et al 2012 While some research suggests that entrepreneurs are indeed typically less riskaverse than employees Cramer et al 2002 Ekelund et al 2005 Ahn 2010 Brown et al 2011 others have reported insignificant differences between these groups Barsky et al 1997 Parker 2008 Still others have found an association between risk aversion and entrepreneurial entry Simons and Astebro 2010 a nonmonotonic relationship between risk aversion and the entrepreneur’s work commitment Elston et al 2005 and a dependency of the relationship between risk aversion and entrepreneurship on other factors such as education Polkovnichenko 2002 And while several studies have measured balanced skills in terms of the number of prior job roles and have generated evidence consistent with the BS theory Lazear 2005 Wagner 2006 Hartog et al 2010 Astebro and Thompson 2011 the robustness of these results has been called into question Silva 2007While RA and BS remain popular and influential theories not least because of their persuasive and attractive internal logics their lack of clear empirical support raises several troubling questions For example does the inconclusive evidence about the role of risk aversion mean that any differences of this sort do not actually affect occupational choice perhaps because other factors dominate this choice or because paid employment is also risky Parker 1997 Likewise have the estimates of skill balance been weakened by using a flawed proxy namely the number of prior job roles—or are they actually a mirage masquerading as hardtomeasure personal abilities Silva 2007 Hartog et al 2010 or preferences such as a ‘taste for variety’ Astebro and Thompson 2011 Lacking answers to these questions our knowledge about reasons why people become entrepreneurs is bound to remain limitedThis paper proposes a different argument which may shed light on this issue Previous work has indeed examined the effects of both risk aversion and skill balance on the entrepreneurial entry decision but treating them as independent variables eg Lazear 2005 672 We instead propose that balanced skills and risk aversion are not independent and should be studied and examined empirically in tandem Given evidence that riskaverse actors like to diversify their human capital eg Amihud and Lev 1981 one might expect highly specialized employees to be left with few competitive options if returns from specialism suddenly become less valuable in fastchanging uncertain environments Abernathy and Wayne 1974 Then riskaverse individuals who fear the loss of flexibility associated with highly specialized human capital may respond by diversifying their human capital investments As a result riskaverse people could ironically end up acquiring exactly the balanced skill sets which are especially conducive to entrepreneurshipAs well as being of interest in its own right the possibility that risk aversion and balanced skills are positively related implies as we go on to show that empirical studies which have ignored this interdependence hitherto might have underestimated both of their impacts on entrepreneurial selection In principle this point might help to explain the mixed body of evidence pertaining to the RA and BS theoriesThe paper makes the following contributions First it extends our theoretical understanding of entrepreneurship as an occupational choice by proposing a novel association between the two hitherto separate concepts of risk aversion and balanced skills Our simple formulation extends the theory of BS from a certain environment as in Lazear 2005 to a risky one Risk is present in both occupations and the acquisition of balanced skills is treated as a choice variable in our theory rather than being taken as given as in Lazear 2005

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