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Summary:

Entrepreneurs are subject to many of the same biases that cause people to persist with their investments, and don’t necessarily behave to always maximize outcomes when presented with lucrative new opportunities, a new study says.

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photo: Thinkstock

Whether in gambling or relationships, many people have the feeling that they just need to stick with their chosen course of action if they’ve already invested blood, sweat, and dollars in it. Would-be entrepreneurs are also taught to be persistent, a quality that is often highly praised by both fellows entrepreneurs and the press. Therefore it’s not surprising that entrepreneurs are subject to many of the same biases that cause people to persist with their investments, and don’t necessarily behave to always maximize outcomes when presented with lucrative new opportunities, a new study says.

The sunk cost fallacy is the nearly automatic psychology that causes you to stick with losing bets rather than jump ship. A strategy to combat this fallacy — mentally focusing on the potential gains of cutting and running rather than the losses — was outlined last week in The Atlantic. Persistence, an important quality in entrepreneurs, can also be amplified by self-justification or normative pressures to stick with in-progress endeavors, according to researchers at Oregon State and Utah State universities. They surveyed 135 (mostly male, middle-aged) high-tech entrepreneurs in the U.S. and found that the entrepreneurs don’t always pursue decisions that would maximize utility if it requires giving up a current business venture.

Thinkstock

Thinkstock

Like mere mortals, entrepreneurs are also motivated in their decision-making to maximize potential financial and non-financial benefits (value) given the likelihood of achieving those benefits (expectancy). Entrepreneurs also have a host of other factors to consider, like their past startup experience, the size of their current business, potential psychological, social, and financial switching costs, and whether starting a new business meshes with their personal principles of autonomy and risk-averseness, for example. When it comes to leaving their current business and starting a new one, however, it turns out that the way expectancy and value play into the decision isn’t straightforward.

Here’s how the survey worked, in the researchers’ own words:

“The participants were asked to rate the likelihood that they would pursue a series of hypothetical entrepreneurial opportunities. Each hypothetical opportunity was presented as a comparison with the participant’s current business across four criteria: value of financial returns, likelihood of finan­cial returns, value of non-financial benefits, and the likelihood of non-financial benefits”

To test the effects of expectancy and value on entrepreneurs’ persistence with their existing business, the researchers set different prior conditions: in some cases the entrepreneurs would have the resources to continue with their current business as well as start a new one, while in others they had to choose between staying with the old business or launching a new one. These two conditions resulted in unexpected behaviors.

If the potential value of the current business was higher than that of the alternative, or if probability of success was higher for the current than the alternative, entrepreneurs tended to discount potential highly successful or financially rewarding outcomes associated with the hypothetical new business venture. That is, expectancy and value weren’t simply additive factors that predicted whether entrepreneurs would spring for a new business opportunity.

There are a number of factors that could be at play here beyond just money. The researchers also looked at the size of the company (entrepreneurs were more likely to leave bigger firms) and past startup experience, which could help entrepreneurs better evaluate the market (over 80 percent of those surveyed had previous startups under their belt). Uncertainty (as opposed to risk) may also play a role, with entrepreneurs opting to stick with their existing venture where some amount of uncertainty may already have been eliminated.

Of course, an online survey is no match for the real world, where entrepreneurs would have much more information and time to guide their business decisions. But if entrepreneurs can self-diagnose and recognize tendencies for overconfidence, counterfactual thinking, and a drive to avoid uncertainty, they can potentially maximize their returns and generate some kickass businesses in the process.

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