Swinging for the Fences: Strategic Risk Taking in Entrepreneurship

Abstract

Traditional entrepreneurship research holds that a role of entrepreneurs is to bear risk and that entrepreneurs are risk seeking, or at least less risk averse than others. Using a tournament model we show that, due to competitive effects, even risk-neutral entrepreneurs appear to be risk seeking and will take on significant levels of risk. To explain this we introduce the concept of strategic risk, which we define as rational risk taking that arises due to competition. We show that the traditional view may have it backwards: we do not observe risky behavior because entrepreneurs have a taste for risk, but rather the structure of some markets induces rational strategic risk taking, and it is the presence of risk and uncertainty that allows entrepreneurship to exist. The model predicts that industries with higher uncertainty and riskier strategies available to entrepreneurs will have higher levels of entrepreneurial entry. We offer an alternative explanation to why radical innovations disproportionately come from small entrepreneurial firms, and why certain industries are more innovative than others.

Keywords: Entrepreneurship, Innovation, Risk-Taking

JEL Classification: D21, C70, M13, L10, O30