Risk Aversion or Risk Management?: How Measuresof Risk Aversion Affect Firm Entry and Firm Survival

The link between measured risk aversion and the decision to become an entrepreneur iswell established, but the link between risk preferences and entrepreneurial success is not.Standard theoretical models of occupational choice under uncertainty imply a positivecorrelation between an individual’s degree of risk aversion and the expected return froman entrepreneurial venture at the time of entry. Because the expected return is the riskneutral equivalent value, a higher expected return implies a higher survival probability,and so more risk averse entrepreneurs should survive more frequently than their lessrisk averse counterparts. We test that prediction using successive entry cohorts of youngentrepreneurs in the National Longitudinal Survey of Youth 1979 (NLSY79). Theempirical results soundly reject the prediction: the most successful entrepreneurs are theleast risk averse. This surprising finding calls into question the interpretation ofcommon measures of risk aversion as measures of taste for risk. Instead, measured riskattitudes perform as if they are indicators of entrepreneurial ability– the least risk averseare apparently those who can best assess and manage risks. Indeed, our interpretation isconsistent with the work of recent experimental studies that find that the less risk aversehave higher cognitive ability.[...]