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Confidence Quotient
Wharton study finds entrepreneurial cockiness as a spur for startups.
As humorist Dave Barry has observed, most people are sure that they're above average drivers.
So it is, too, with entrepreneurs and their perception of their business acumen, says Brian Wu, a Wharton doctoral student in management. They exhibit an excessive confidence in their own abilities, and that overconfidence prompts them to launch startups in the face of long odds of success, according to a study by Wu and co-author Anne Marie Knott, a professor at the University of Maryland, titled "Entrepreneurial Risk and Market Entry."
With a nod to another humorist, Wu jokingly attributes his and Knott's finding to the "Lake Wobegon effect." Lake Wobegon, of course, is the fictional Minnesota hamlet created by Garrison Keillor. In the town, Keillor quips, "the women are strong, the men are good looking and all the children are above average."
For Wu and Knott, the hard-thumping heart of capitalism resides not in Silicon Valley, but in this mythical little place in the northern lake country.
Many people assume that entrepreneurs are risk takers in the conventional sense, Wu points out in a conversation. That is, they're more willing than most folks to sacrifice safe jobs and personal savings to start new companies because they're sure that the market will embrace their product or service. Or, put another way, they seek out risk in the face of uncertain demand and thus uncertain returns on their time and money.
But ample research has shown that entrepreneurs aren't any different from other folks in their appetite for market risk. "The empirical literature has consistently found that entrepreneurs' risk profiles seem to be indistinguishable from those of wage earners," Wu and Knott write.
That left Wu and Knott with a puzzle. If entrepreneurs aren't any hungrier for risk, as it's conventionally understood, how do you explain the fact that they're willing to strike out on their own and start new ventures? After all, the economic dangers they face aren't puny. As Wu notes, most new businesses failed within their first few years.
For Wu, the answer springs from basic human nature: People are vain and, in at least some dimension of their personality, tend to believe they're not like everybody else. They think — you guessed it — that they're above average. "It's a human tendency," Wu says. And it's no less true in China, Wu's home country, than the United States, he says.
You see manifestations of this phenomenon every day. CEOs and professional athletes push for higher compensation despite subpar performance. More than half of U.S. states claim that their students score above national averages on standardized tests. And everybody thinks the other guy was at fault when they get cut off in traffic.
Trouble is, instincts about human nature don't satisfy the rigorous standards for academic research. Scholars can't just say that they suspect that they know why people behave in a particular way. They have to prove it.
To support their theory, Wu and Knott turned to the banking industry. A lot of people don't consider banking as entrepreneurial. After all, few business clichés are as enduring as the one about bankers leaving at noon on Friday to play golf.
In fact, since deregulation during the '80s and '90s, banking has shown just the sort of "creative destruction" that famed economist Joseph Schumpeter identified as the hallmark of an entrepreneurial economy. Big banks such as Bank of America and Citigroup have gobbled up competitors across the nation. And their acquisitions have created voids that have been filled with the birth of smaller, regionally focused companies catering to small businesses.
A prominent example of this phenomenon has been the state of North Carolina, home to Bank of America and Wachovia, two of the nation's largest banks. There, waves of consolidation have been followed by flurries of small-bank formation.
In one locally famous case, a bank executive named Mike Patterson found himself without a top-level job after his bank, Peoples in Rocky Mount, N.C., merged with its cross-town rival, Planters, to form Centura. Patterson, therefore, left to start his own bank, called Triangle. Within a few years, Centura and Triangle merged, and Patterson became chairman of the new bank.
Federal regulators keep comprehensive records of bank formations, mergers, acquisitions and closures, giving Wu and Knott a laboratory to test their ideas. They built a statistical model and then ran the bank data through it. The results appeared to bear out their hypothesis. They found that, "While entrepreneurs are risk-averse in the classic sense of preferring a certain payment to an uncertain payment with equivalent expected value, their overconfidence predisposes them to bear economic risk under a given set of circumstances."
This is the story of Wharton alums featured in Get it Started! such as Jon Huntsman, Michele Peluso & Tracey Weber and Robert Goergen. Huntsman of Huntsman Corp beat back bankruptcy at an age when others were retiring. Weber and Peluso of Travelocity nurtured their employees and company through the devastating days after the 9/11 tragedy. Goergen left a lucrative position in private equity to take on an ailing candle manufacturer. Each of these individuals plunged ahead, figuring they could do a better job than their competitors.
In other words, they showed exactly the sort of overconfidence that Wu and Knott believe distinguishes an entrepreneur.
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