Professional Documents
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Are Individuals Entering Self-Employment
Are Individuals Entering Self-Employment
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Cross-sectional differences in overoptimism
Table 3 reports a series of regressions reporting
differences in expectations of venture operation
and operating overoptimism. Given the bounds
on the dependent variables, the assumptions that
underlie the error distributions of ordinary least
squares are not appropriate; consequently, I use
generalized method of moments (GMM).
15
For
descriptive purposes, the rst three columns report
the coefcients from models predicting the expec-
tations of operation by nascent entrepreneurs.
These regressions are analogous to empirical
research that has examined entrepreneurial expec-
tations without considering ex post outcomes.
Reporting both the nascent entrepreneurs likeli-
hood of success and the bias associated with their
expectations allows comparison between those
behaviors or attributes that are associated with
positive expectations and those that are associ-
ated with overly optimistic expectations. Requiring
nonmissing values for all independent variables
reduced the analysis to 368 observations. The coef-
cient on formal business planning is 8.42 (p <
0.001), suggesting that undertaking this activity
signicantly increases the nascent entrepreneurs
expectation of operation by 8.42 percent. How-
ever, whether formal planning is associated with
overoptimism is determinant on how planning is
associated with subsequent venture operation.
Examining variations in operational overopti-
mism reveals that the coefcient on formal busi-
ness planning for observed overoptimism is consis-
tently negative and insignicant. Therefore, while
formal business plan preparation increases the
expectation that the venturing activity will lead
to an operating venture, such preparation is not
associated with overly optimistic expectations, as
planning is also positively associated with the
likelihood that the nascent activity will become
an operating venture. The coefcients on capital
inputs and money received are negative, suggest-
ing that individuals whose nascent activities have
purchased signicant capital inputs for the venture
or who have received money have a lower bias in
their expectations of venture operation than those
who do not. However, while this bias is lower,
15
Regression techniques that incorporate censored dependent
variables, such as Tobit regression, are not appropriate, as the
assumptions of self-selection and censorship that underlie these
models are not present for the dependent variables investigated
in this study (Maddala, 1983; Wooldridge, 2003: 553).
Copyright 2010 John Wiley & Sons, Ltd. Strat. Mgmt. J., 31: 822840 (2010)
DOI: 10.1002/smj
832 G. Cassar
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Copyright 2010 John Wiley & Sons, Ltd. Strat. Mgmt. J., 31: 822840 (2010)
DOI: 10.1002/smj
Nascent Entrepreneurial Expectations 833
individuals who have undertaken these activities
still appear to exhibit overoptimism. Overall, the
evidence presented for operational overoptimism
does not support either Hypothesis 2a or Hypoth-
esis 2b.
Table 4 presents the GMM regression analysis
for those ventures that achieved operation for one
year or more. Given the relatively small number of
observations available for both sales and employ-
ment, formal business planning and nancial pro-
jections are included in separate models to avoid
harmful multicolinearity (Kennedy, 2003).
16,17
Model 1 shows that formal business planning
is not associated with sales overoptimism. How-
ever, in Model 2, it is observed that the prepa-
ration of projected nancial statements leads to
overly optimistic forecasts in regard to venture
sales (p < 0.01). This result is consistent with the
inside view exacerbating overoptimism in expec-
tations. In particular, the undertaking of nancial
projections encourages the nascent entrepreneur to
adopt an inside view in regard to the nancial per-
formance of the venture, resulting in overly opti-
mistic nancial expectations. This result is consis-
tent with Hypothesis 2b. Further, the above associ-
ation is invariant to the inclusion of venture orga-
nizing activities in the full model presented in the
third column. The results from Model 3 also show
that nascent entrepreneurs whose ventures have
received money from the sales of goods or ser-
vices have signicantly less overoptimism in their
sales expectations. This demonstrates the benet of
actually making sales in improving the rationality
of nancial sales expectations.
18
16
The condition index is advocated to be the best indicator
of multicolinearity and is calculated as the square root of the
ratio of the largest to the smallest characteristic root of XX
(Belsley 1991; Kennedy 2003). The condition index on the
full models presented in Table 4 with the inclusion of both
formal business planning and nancial projections was above
25, which is suggestive of harmful colinearity (Belsley, Kuh,
and Welsch, 1980). An explanation for the greater colinearity
observed in these models, beyond the reduction in sample size,
is the stronger correlation between formal business planning and
nancial projections for the subsample of ventures that achieved
operation for one year or more.
17
An example of the reduction in sample size for the tests
reported in Table 4 is provided for the sales overoptimism tests.
Of the initial sample of 386, only 321 respondents provided
their expectation of total sales for the rst full year of operation.
Subsequent actual sales information was obtained from 93 of
these respondents in follow-up phone interviews, of which only
50 respondents provided actual sales specically from the rst
year of operation.
18
To investigate the possibility that reported overoptimism
in sales was driven by pressure placed on entrepreneurs by
Interestingly, for employment, the relationship
between overoptimism and nancial projections is
no longer found, with the coefcients on Mod-
els 5 and 6 actually being negative and insignif-
icant. A possible explanation for the difference
between sales and employment is that nancial
projections are the monetary representation of the
nancial outcomes of intended behavior. There-
fore, the nexus between sales and nancial out-
comes is more direct than the nexus between
employment and nancial outcomes. For exam-
ple, additional employment may be associated
with increased scale, which may represent larger
nancial returns, but it may also bring increased
costs, which are associated with lower nancial
returns to the entrepreneur. In comparison, sales
are specically modeled in nancial projections,
and greater sales are directly associated with posi-
tive outcomes for the entrepreneur. Therefore, even
though both sales and employment expectations
were highly positively correlated in the sample
( = 0.49, p < 0.001), the undertaking of nan-
cial projections may have different implications for
the beliefs of nascent entrepreneurs in regard to
sales and employment.
DISCUSSION
Implications for theory and practice
The study ndings are of interest for several
reasons. First, it is the rst study to provide
longitudinal evidence of the rationality of indi-
viduals expectations during the venture evalua-
tion process. The advantage of the longitudinal
approach is that it elicits expectations of nascent
entrepreneurs and compares them to observed out-
comes, thereby overcoming methodological con-
cerns of extant research evaluating the expectations
of decision makers. Extant research has demon-
strated that individuals who are optimistic about
their life expectancy or those who have higher self-
efcacy are more likely to be an entrepreneur than
investors to facilitate investment, both the sales expectations
and overoptimism of sales were compared for those who had
asked nancial institutions and other people for funding and
those who had not. There were no signicant differences between
these two groups (t = 1.02, p = 0.31) and (t = 0.32, p = 0.75),
suggesting that this concern was not driving the presence of
overoptimism. It should also be noted that given the survey is
condential, there should be no incentive on the entrepreneurs
to articially inate their reported expectation to satisfy outside
stakeholders.
Copyright 2010 John Wiley & Sons, Ltd. Strat. Mgmt. J., 31: 822840 (2010)
DOI: 10.1002/smj
834 G. Cassar
T
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Copyright 2010 John Wiley & Sons, Ltd. Strat. Mgmt. J., 31: 822840 (2010)
DOI: 10.1002/smj
Nascent Entrepreneurial Expectations 835
to be in career employment (Puri and Robinson,
2007; Zhao, Seibert, and Hills, 2005). Similarly,
extant research has found that individuals who are
overcondent in the certainty of their knowledge
in that they overestimate the correctness or pre-
cision of their beliefs in answering challenging
questions or predicting the future, are more likely
to be entrepreneurs and more likely to undertake
product introductions that are pioneering or risky
(Busenitz and Barney, 1997; Forbes, 2005; Simon
and Houghton, 2003). However, these research
approaches cannot answer whether, or to what
extent, individuals entering venturing are overly
optimistic in regard to the venturing activities they
undertake, as this can only be achieved through
comparing ex ante expectations with ex post out-
comes. The magnitude of overoptimism observed
is substantial with nascent entrepreneurs on aver-
age overestimating the likelihood of venture oper-
ation by 33.2 percent. By providing specic evi-
dence demonstrating that individuals entering ven-
turing overestimate the benets from undertaking
nascent activity and subsequent entrepreneurship,
this research contributes to the literature that seeks
understanding of the forces that underlie entry into
and persistence of entrepreneurial behavior.
Cooper et al. (1988) observed that individu-
als who recently became entrepreneurs reported
their odds of business success to be substantially
higher than historically observed and greater than
the odds of success for other similar businesses.
Given their research design, the authors posited
that these beliefs were caused by post-decisional
bolstering. In the current study setting, ex post
decision bolstering cannot be a cause of overop-
timism, as the expectations observed are elicited
before the venture is operational. The evidence
from this study cannot conrm or reject that bias
related to ex post decision bolstering is present in
entrepreneurs; however, it does suggest that the
presence of overoptimistic beliefs in entrepreneurs
is not contingent on the presence of ex post deci-
sion bolstering.
Second, this study contributes to theory. I argue
that the use of plans and projections encourages
reection on the implementation of ones actions
through scenario representation, consistent with an
inside view to forecasting. Consequently, I con-
tribute by proposing that the use of plans and pro-
jections in themselves may affect decision maker
beliefs and forecasting biases. Additionally, by
using plans and projections, this is the rst study
to empirically investigate how the inside view can
affect expectations in a eld setting, thereby testing
the bounds of the theory and the signicance of its
hypothesized effect on expectations. While there is
evidence of the presence of such views in forecast-
ing behavior within a population generally, little
research has investigated differences of inside view
adoption and forecasting biases within sample in
similar settings (Buehler et al., 1994). For exam-
ple, while researchers conjecture that individuals
are generally too optimistic, it is unclear whether
those who adopt a more inside view to forecasting
are more likely to have forecasting biases.
Further, there is a lack of understanding about
how the inside view inuences expectations and
beliefs in eld settings, with the limited evidence
related to the inside view based on experimen-
tal settings. By using a eld design, I address
concerns that experimental designs may overstate
the presence of bias in decision making, given
their reliance on salient signals, lack of mean-
ingful incentives, or insufcient task orientation
(Schwarz, 1994). For example, it is difcult to
recreate with complete faithfulness the nature,
tasks, and environment that entrepreneurs expe-
rience during new venture creation. Therefore,
the experimental manipulation of nancial projec-
tions use may exaggerate the role of the inside
view, which may be limited by the contingencies
of daily life in entrepreneurial endeavor (Buehler
et al., 1997). Experiments that monitor subjects
over short temporal periods may also overstate the
inside views inuence, as its effect may dissipate
over the course of extensive, long-term projects
(Buehler et al., 1997). Further, incentivizing sub-
jects to complete tasks using nominal monetary
incentives may overstate the inside views inu-
ence on task completion given the greater eco-
nomic incentives that individuals face when cre-
ating an operating business (Camerer and Lovallo,
1999). This study demonstrates that differences in
management behaviors consistent with the inside
view appear to be an economically signicant
inuence on expectation formation and contribute
to understanding differences in forecast overopti-
mism in the eld.
Further, distinguishing between different types
of expectations revealed that nancial projections,
while being associated with overly optimistic sales
expectations, were not associated with overly opti-
mistic employment expectations. Such a nding
may be explained by the compatibility principle,
Copyright 2010 John Wiley & Sons, Ltd. Strat. Mgmt. J., 31: 822840 (2010)
DOI: 10.1002/smj
836 G. Cassar
which has been observed in experimental settings,
whereby the weight of any input component is
enhanced by its compatibility with the output. For
example, when subjects were asked to provide a
numerical output, such as a dollar amount, numer-
ical data had a greater impact on their response
than other data that was less compatible in con-
tent, scale, or display (Tversky, Sattath, and Slovic,
1988). As nancial projections are the monetary
representation of the outcomes of intended behav-
ior, they may be more likely to encourage reec-
tion on the causal events that lead to the nan-
cial outcomes. Further, employment outcomes are
more ambiguous in regard to the nancial per-
formance of a venture than are sales outcomes.
For example, greater sales and growth may lead
to greater need for the venture to employ more
people; however, more employees also represent
greater costs, thereby reducing the nancial returns
from the venture. In other words, the undertaking
of nancial projections is associated with overly
optimistic expectations for nancial outcomes, but
not necessarily for other outcomes. The varying
implications for the expectations of decision mak-
ers from different management behaviors high-
lights the importance of the context of the inside
view and the types of plans and projections used
in shaping expectations.
Third, the study provides empirical evidence for
differences in forecast overoptimism distinguish-
ing between ex ante beliefs and ex post outcomes.
In particular, the evidence suggests that formal
business planning by the nascent entrepreneur,
while being associated with a greater likelihood
that their nascent activity would lead to an oper-
ating venture, is not associated with overly opti-
mistic beliefs. The explanation for this nding
is that formal business planning also facilitates
venture formation, increasing the likelihood of
entrepreneurs completing the tasks required to
progress their nascent activity into an operating
business. The specic mechanism that planning
facilitates organizational creation may be through
focusing goal attainment and allowing individuals
to make faster decisions than with trial-and-error
learning (Delmar and Shane, 2003). Alternatively,
regardless of the specic strategies and goals set,
the presence of a formal plan may stimulate struc-
ture to animate and orientate individuals to act with
more intensity (Weick, 1995). This nding also
demonstrates the importance of research designs
to distinguish between those behaviors or attributes
that are associated with positive expectations from
those that are associated with unjustied or overly
optimistic expectations.
More generally, the study ndings are of interest
to decision makers. While research has examined
the forecast accuracy of decision makers, there
is limited understanding of how particular behav-
iors inuence forecasting bias (Durand, 2003).
For example, there is little evidence on whether
commonly used management practices moderate
the level of biased or extreme prediction. Con-
sequently, this study provides an important link
between observed psychological bias and manage-
ment practices, namely nancial projections. This
documented relationship is particularly important,
given the fundamental role that nancial projec-
tions play in allowing decision makers to struc-
ture expectations and to cope with the future. The
evidence from this study suggests that the same
management activities that entrepreneurs rely on
to cope with uncertainty appear to be exacer-
bating individuals to hold overoptimistic expec-
tations. Acknowledging how management prac-
tices bias expectations may allow decision makers
to use organizational or decision-making controls
to reduce this inuence. For example, generat-
ing reasons why the planned outcome may not be
achieved, or consciously relating past experiences
to the forecasting task at hand, are approaches
individuals can take to reduce overly optimistic
or overcondent forecasts (Buehler et al., 1994;
Koriat, Lichtenstein, and Fischhoff, 1980). In a
group setting, the use of conict-based approaches
whereby members critique proposals and make
counter arguments may result in more realistic
expectations (Schweiger, Sandberg, and Ragan,
1986).
Another decision-making de-biasing technique
is adoption of the outside view. Through incor-
porating relevant information that decision makers
may otherwise neglect, the outside view should
avoid the overoptimistic tendencies from sce-
nario thinking (Kahneman and Lovallo, 1993;
Kahneman and Tversky, 1979). Specically, with
knowledge of the outcomes from similar pre-
vious endeavors, decision makers expectations
can be formed through evaluation of how their
present endeavor compares to previous endeav-
ors. Within this evaluation, decision makers should
also de-bias their expectations by factoring out
historically observed forecasting errors made by
similar endeavors and control for overoptimistic
Copyright 2010 John Wiley & Sons, Ltd. Strat. Mgmt. J., 31: 822840 (2010)
DOI: 10.1002/smj
Nascent Entrepreneurial Expectations 837
tendencies when comparing their endeavors future
performance to previous similar endeavors (Flyvb-
jerg, 2004; Lovallo and Kahneman, 2003). There-
fore, this study also has implications for nascent
entrepreneurs, as the ndings demonstrate a gen-
eral forecasting bias in those entering ventur-
ing. An awareness of the biased forecasting ten-
dencies of those in similar decision-making set-
tings may allow individuals considering future
entrepreneurial activity to incorporate knowledge
of overoptimism into future expectations. How-
ever, the benets of awareness may be tempered
by the tendency for decision makers to ignore such
warnings depending on the perceived uniqueness
of their venture opportunity.
Limitations and future research
The studys focus on individuals undertaking
nascent venture activity is a powerful setting in
which the inside view tendencies are heightened
given the uniqueness of the forecasting task and the
vested interest of the forecaster. Future research
could investigate the extent to which inside view
adoption, and the use of management practices
associated with the inside view, affects the expec-
tations of decision makers in settings beyond
nascent venturing activity. For example, in an
organizational setting, the use of groups and the
extent to which organizational controls are in place
to reduce overly optimistic expectations or pro-
vide forecasting discipline may reduce or exacer-
bate optimistic bias on the expectations of decision
makers (McNamara and Bromiley, 1997). Varia-
tions in the nature of the forecasting task, such as
the degree to which a forecast is unique or recur-
rent, and the extent to which the forecaster has a
vested interest in the prediction or outcome may
all inuence both forecasting bias and the inu-
ence of management behavior on forecasting bias.
Such empirical investigations of the inside view
may provide insight by testing the bounds of the-
ory to which the inside view is posited to inuence
expectations or exacerbate boldness in forecasting.
Many nancial intermediaries require ventures
to submit nancial projections in order to be eligi-
ble for nancing. Such behavior is considered good
business practice and not only provides potential
nanciers with information concerning the invest-
ment project, but also signals the competence and
quality of the management team. The empirical
ndings show that the act of preparing nancial
statements is associated with more overly opti-
mistic sales projections. Clearly, nancial inter-
mediaries and other stakeholders can undo any
bias by the preparers through due diligence or
superior knowledge (Cable and Shane, 1997). To
what extent outside stakeholders are susceptible to
potential biases in decision making is an interest-
ing question for future research. For example, how
does nancier condence and beliefs change as a
result of an entrepreneurs submission of formal
business plans or nancial projections, or direct
discussions with entrepreneurs? Experimental evi-
dence from other groups, such as venture capital-
ists and nancial analysts, suggests that they too
are susceptible to simple manipulations in the for-
mat of information, consistent with scenario think-
ing (Sedor, 2002; Zacharakis and Shepherd, 2001).
While the ndings presented here demonstrate
that nascent entrepreneurs are overly optimistic, it
is important to recognize that the population inves-
tigated in this study is distinct from those consid-
ered to be existing owners and managers of rms.
Extant evidence regarding the presence of overop-
timistic beliefs in entrepreneurs and managers in
established rms, which has utilized a longitudi-
nal design comparing ex ante expectations with
ex post realizations, has been limited and incon-
clusive (Ashworth, Johnson, and Conway, 1998;
Cassar and Gibson, 2007). Differences between
nascent entrepreneurs and other decision makers
may be a consequence of differences in ability,
forecasting process, and variations in the nature
of forecasting undertaken. The extent to which
entrepreneurs learn about their venture opportunity
during the operation of the rm through feedback
and the learning achieved from venturing experi-
ence that may improve their evaluations of expec-
tations related to future nascent activity could be
determined with longer time series data beyond the
scope of the PSED. These important questions are
left to future research.
The empirical analyses in regard to overopti-
mism in one-year sales and employment expecta-
tions were achieved with a relatively small sample
primarily because only those nascent entrepreneurs
who subsequently achieved an operating venture
were interviewed and completed the realizations
after one years operation were available for com-
parison. The attrition resulting from the low pro-
portion of nascent ventures that become operating
ventures and the nature of data collection can be
addressed in future research by starting with a
Copyright 2010 John Wiley & Sons, Ltd. Strat. Mgmt. J., 31: 822840 (2010)
DOI: 10.1002/smj
838 G. Cassar
greater number of respondents in the rst stage
of data collection. Importantly, even given the rel-
atively small sample, which reduces the power of
the empirical tests, the association between nan-
cial projections and overoptimistic nancial expec-
tations was observed.
CONCLUSION
This research examines the rationality of the expec-
tations of nascent entrepreneurs during new ven-
ture start-up. Consistent with conjectures regarding
entrepreneur entry, this study provides novel evi-
dence of substantial overoptimism in expectations,
in that nascent entrepreneurs overestimate the
probability of their nascent activity becoming an
operating venture. Further, nascent entrepreneurs
overestimate future one-year sales and employ-
ment of the venture, suggesting that they are overly
optimistic both in regard to the success of their
venturing activity and the actual performance of
their operating ventures.
Another novel contribution of this study is the
theoretical development and empirical support that
the use of plans and projections may have a non-
neutral effect on the expectations of decision mak-
ers. Thereby, this study demonstrates important
linkages between the psychological biases present
in nascent entrepreneurs forecasts and their use
of typical management activities. The adoption of
plans and scenarios, in particular nancial pro-
jections, signicantly exacerbates tendencies for
individuals to make nancial forecasts that are too
optimistic. This suggests that the same manage-
ment activities that are advocated by academics
and adopted by individuals to cope with the future
are associated with nascent entrepreneurs having
irrational expectations. Given the importance of
organizational creation and venture growth, and
the expectations that underlie them, the ndings
from this study have important implications for
both theory and practice.
ACKNOWLEDGEMENTS
The author thanks Justin Craig, Gary Dushnitsky,
Dean Shepherd, and participants from the 2007
Global Management Accounting Research Sympo-
sium for their insightful comments, and the support
of Sol C. Snider Entrepreneurial Research Center
and Wharton Entrepreneurial Programs. An ear-
lier version of this paper was presented at the
2006 Babson College Entrepreneurship Research
Conference. This research would not be possible
without the efforts of the Entrepreneurial Research
Consortium.
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Copyright 2010 John Wiley & Sons, Ltd. Strat. Mgmt. J., 31: 822840 (2010)
DOI: 10.1002/smj