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Wharton Prof. Gavin Cassar says opportunity cost predicts entrepreneurs' goals.
Not all entrepreneurial ambitions are created equal.
From the earliest stages of their ventures entrepreneurs have different aspirations. Some are content to form "lifestyle companies" that give them independence and just enough of an income to pay their bills. Others envision creating the next Microsoft or Wal-Mart.
Gavin Cassar, an associate professor of accounting at the Wharton School who studies entrepreneurs, wanted to know what distinguished the two groups. What qualities, he wondered, might predict whether a fledgling entrepreneur would strive to create a modest venture or a massive one.
Sure, an obvious answer would be that some folks are simply more ambitious than others. But that explanation, in effect, just restates the question. Cassar wanted to understand why people's entrepreneurial ambitions differ. He suspected that the answer lay in their education or their wealth—or as researchers term them, human and financial capital.
A long-term survey of startup entrepreneurs led him to related, but different, explanations. He found that income and level of managerial experience foretold entrepreneurial ambitions. What mattered wasn't how many years of schooling someone had or how much money he had in his brokerage account, but the amount he was used to earning and the size of his current staff. In other words, entrepreneurs who sacrificed more in terms of current income and stature expected to create more of both with their new ventures.
Economists have a term for the price paid for not pursuing an entrepreneurial idea: they call it "opportunity cost," and it denotes the value of the things you forsake when you pursue one path over another. Cassar found that, with entrepreneurs, opportunity cost was the best gauge of the scope of their goals. The bigger the opportunity cost, the bigger the ambition.
Understand that he wasn't examining how big these entrepreneurs' firms became, just how big they hoped they would become. He wasn't seeking a way to predict firms' success, but rather a window into the entrepreneurial mindset.
Often, economic studies focus solely on numbers and ignore the people behind them and their non-monetary preferences. Yet at the same time, psychological studies tend to downplay, even ignore, economic explanations. Cassar tried to blend the tools of economics and psychology to create a picture of fledgling entrepreneurs.
Part
of his reason for doing that was his interest in the emerging field of
research on cognitive biases and shortcuts. Studies of decision-making,
for example, have found that people often forget why they chose one path
over another or unconsciously recast their memories in light of subsequent
experience.
Entrepreneurs
also tend to change their estimation of their abilities based on the evolution
of their circumstances, Cassar points out. "In general, entrepreneurs
tend to think that their abilities are better than average," he says. "But
when ventures fail, if you ask them to rate their abilities then, they say
that they're just the same as everyone else. And most interesting, they
say that that's what they'd thought before they started
their ventures."
Cassar's interest in the effect of biases on decision-making grew out of his earlier career as an accountant. In his native Australia, he'd worked in a construction firm. Once in grad school, he came to realize that the decision-making theories and methods he was being taught differed from the realities of the construction industry. "When you look at how decisions are made, you find they're very different from a rational, systematic process," he says.
In particular, he recalls his old firm's decision to undertake two major construction projects. The company made financial projections for both, as most firms would in that situation. Based on its projections, it plunged ahead.
Cassar left the firm, and about a year and a half later, it filed for bankruptcy. The liquidators asked him to return to help work through the mess. That let him review the financial records and minutes from meetings. What he learned surprised him.
"All the indicators on the management accounting system were accurate—there were a lot of downward indicators—but you had the managers who were responsible saying stuff like, ‘Maybe it'll reverse in two months,' or ‘It's a timing issue. It'll resolve itself.' But it never did. For psychological or self-interested reasons, they were ignoring the obvious signals. And as a result, they didn't take actions to correct the problems.
"That made me realize that you can have a good accounting system and still make bad decisions. I've always believed that people can take information and make rational choices. But then you look at a situation like that and you think maybe there's something to the psychologists' side. That's one of the things that got me interested in how entrepreneurs really make their decisions and whether accounting and information systems can improve them."
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