For Love of Ambiguity Entrepreneurs Kiss Toads That Will Never Become Princes

RESEARCH BY CEDRIC GUTIERREZ SUGGESTS THAT OVERCONFIDENCE AND THE ATTRACTION FOR CHALLENGES PERCEIVED AS DEPENDING ON ONE'S SKILLS CAN PUSH ENTREPRENEURS AND MANAGERS TO ENTER TOO MANY MARKETS, OFTEN WITH NEGATIVE CONSEQUENCES

Market entry is at the heart of entrepreneurial activity, but it often proves to be a bad decision. Close to 75% of those who choose careers in entrepreneurship would have been better off as wage workers, almost 80% of angel investors never recoup their money, and more than four corporate mergers out of five fail to achieve the expected revenue synergies. Warren Buffett famously stated: “Managers [are] apparently mesmerized by […]   the story about the frog-kissing princess. Remembering her success, they pay dearly for the right to kiss corporate toads, expecting wondrous transfigurations… We have observed many kisses but very few miracles.”
 
Research by Cédric Gutierrez (Bocconi University) with Thomas Åstebro and Tomasz Obloj (both HEC Paris) published in Organization Science disentangles the role of two behavioral drivers that make entrepreneurs and managers so eager to kiss toads: overconfidence (the belief that chances of success are higher than what they are) and positive attitudes toward ambiguity.
 
Market entry decisions are inherently ambiguous—that is, the distribution of the probability over events (in this case, success or failure) is unknown, and decision makers must rely on subjective estimates. Moreover, the ambiguity and the associated payoff are likely to be perceived by decision makers as related to their own skills, often in comparison with rivals. In contrast, a chance-based game like roulette is risky but not ambiguous as player know the chances, for instance, of a “red” or a “black” outcome. Its results, furthermore, do not depend on the player’s skills.
 
In an experiment with 227 subjects, the authors manipulated participants’ confidence in order to evaluate its effect on the decision to enter skill- or chance-based games. As expected, overconfidence played an important role in the decision to enter ambiguous, skill-based games.  What is more, the study highlights the prominent relevance of the relatively under-studied preference for ambiguity. Overall, the study finds that decision makers are ambiguity seeking when they face a decision to enter an ambiguous, skill-based market. In other words, when the outcomes of a market are unknown and related to one’s own performance, people tend to be more willing to bet than when they have precise information about their chances of success.
 
“In our experiment, we find that this preference for ambiguity accounts for 36% of the differential in entry between chance-based and skill-based markets.” Prof. Gutierrez says. “This is comparable to the typical long-run economic penalty from choosing entrepreneurship. For example, prior work documents the discounted net present value of earnings at 35% lower for the median entrepreneur working for ten years compared with similar wage earners.”
 
Cédric Gutierrez, Thomas Åstebro and Tomasz Obloj, “The Impact of Overconfidence and Ambiguity Attitude on Market Entry”, in Organization Science, Vol. 31, No. 2, 2020, DOI: 10.1287/orsc.2019.1300.

by Fabio Todesco