Are Individuals Entering Self-Employment Overly Optimistic? An Empirical Test of Plans and Projections on Nascent Entrepreneur Expectations

Topics: Entrepreneurship, Bias, Business plan Pages: 40 (12863 words) Published: August 16, 2010
Strategic Management Journal
Strat. Mgmt. J., 31: 822–840 (2010) Published online EarlyView in Wiley InterScience ( DOI: 10.1002/smj.833 Received 18 January 2007; Final revision received 14 November 2009

The Wharton School, University of Pennsylvania, Philadelphia, Pennsylvania, U.S.A.

This research examines the rationality of the expectations of nascent entrepreneurs. Consistent with conjectures regarding entry into self-employment, I find substantial overoptimism in nascent entrepreneurs’ expectations, in that they overestimate the probability that their nascent activity will result in an operating venture. Further, for those ventures that achieve operation, individuals overestimate the expected future sales and employment. To explain variations in overoptimism, I posit that those individuals who adopt an inside view to forecasting through the use of plans and financial projections, will exhibit greater ex ante bias in their expectations. Consistent with the inside view causing overoptimism in expectations, I find that the preparation of projected financial statements results in more overly optimistic venture sale forecasts. Copyright  2010 John Wiley & Sons, Ltd.

Expectations of future returns from vocational activity underlie the choice of employment and trigger the decision to start a venture (Cassar, 2006; Shane and Venkataraman, 2000). Individuals, when choosing to invest their time and capital in nascent entrepreneurial activity, do so with an expectation of success, such as the probability of achieving an operating business. Expectations also underlie the subsequent actions of individuals through the venturing process, such as whether to continue in self-employment or how much additional time and capital to invest (Gimeno Keywords: expectations; financial projections; forecasting; nascent entrepreneur; overoptimism; planning; rationality

∗ Correspondence to: Gavin Cassar, The Wharton School, University of Pennsylvania, 1300 Steinberg Hall-Dietrich Hall, Philadelphia, PA 19104-6365, U.S.A. E-mail:

et al., 1997; McCarthy, Schoorman, and Cooper, 1993). Given the importance of expectations on individual behavior, there are consequences for individuals, their stakeholders, and the economy to making inaccurate or systematically biased predictions related to entrepreneurial choices. The rationality of nascent entrepreneurial expectations, that predictions of future outcomes related to venturing activity are made without bias, is often assumed when modeling entry into selfemployment and organizational creation (Evans and Jovanovic, 1989; Evans and Leighton, 1989). However, researchers acknowledge that individuals are bounded and open to potential influences that may lead them to have biased expectations (Kahneman and Lovallo, 1993; Kahneman and Tversky, 1973; Simon 1955). For example, there is substantial evidence that individuals generally have overly optimistic expectations, in that their expectations of specific future outcomes are more favorable than what eventually occurs (Weinstein,

Copyright  2010 John Wiley & Sons, Ltd.

Nascent Entrepreneurial Expectations
1980).1 The tendency of nascent and existing entrepreneurs to have overoptimistic expectations may explain why individuals enter and persist in self-employment even in the presence of lower returns from venturing (Camerer and Lovallo, 1999; Moskowitz and Vissing-Jorgensen, 2002). While there are conjectures as to the presence or magnitude of overoptimism in the expectations of those entering or continuing in self-employment, surprisingly, there is little evidence on the rationality of entrepreneurial expectations. Simply put, there is no research that has investigated how ex ante expectations of individuals entering...

References: Strat. Mgmt. J., 31: 822–840 (2010) DOI: 10.1002/smj
Strat. Mgmt. J., 31: 822–840 (2010) DOI: 10.1002/smj
Strat. Mgmt. J., 31: 822–840 (2010) DOI: 10.1002/smj
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