It pays to be pessimistic

3 October 2018

Man with hands in the air

Optimistic thinking is leading people to set up businesses that have no realistic prospect of financial success according to new research from the University of Bath, Cardiff University and the London School of Economics and Political Science.

The study, which tracked individuals as they move from paid employment to setting up their own business venture, goes some way to explaining why only fifty percent of businesses in the UK survive their first five years.

Researchers found that business owners with above average optimism earned 30 percent less than those with below average optimism, and substantially less than they would have earned if they had remained an employee.

Published in the European Economic Review, the study explores the financial consequences of becoming an entrepreneur for optimists - people with a tendency to overestimate their chances of doing well and underestimate their probability of failure.

Doomed to fail

Man obscured by shadow

Despite entrepreneurs earning on average less, working longer hours and bearing more risk than their counterparts in paid employment, optimists are more likely than most to mistakenly think they have found a good business opportunity and that they have what it takes to exploit it successfully.

Realists and pessimists are less likely to proceed with unpromising entrepreneurial ventures.

Studies consistently report that about 80 percent of the population have an overly optimistic outlook.

This can increase ambition and persistence, encourage others to cooperate, and generally enhance performance. Ominously though, basing choices on faulty assessments also leads to participation in activities doomed to fail.

In 2016, according to the Office of National Statistics, 414,000 businesses were set up in the UK, against 328,000 business failures in the same year.

A growing proportion of the UK workforce

Dr Chris Dawson, Associate Professor in Business Economics at the University of Bath’s School of Management, said: “Our results suggest that too many people are starting business ventures, at least as far as personal returns are concerned.

“As a society we celebrate optimism and entrepreneurial thinking but when the two combine it pays to take a reality check. Every episode of the BBC’s Dragon’s Den provides examples of such thinking. Pessimism may not generally be seen as a desirable trait but it does protect people from taking on poor entrepreneurial projects.”

Andrew Henley, Professor of Entrepreneurship and Economics at Cardiff Business School, added: “The evidence strongly implies that would-be entrepreneurs need to think and plan carefully before launching a new business venture.

“The self-employed are often ignored by policy-makers and yet form a growing proportion of the UK workforce...”

Andrew Henley

“Carefully designed support is needed to ensure people considering entry into self-employment, do so from a position of cautious and reasoned assessment of their chances of success, particularly in the current challenging business environment.”

Professor Andrew Henley, Professor of Entrepreneurship and Economics, Director of Research Engagement and Impact

Professor David de Meza, in the LSE Department of Management, added: “Governments frequently talk about the role of entrepreneurs in creating economic growth, but there is a downside.

“The personal and societal fall-out of failed businesses shouldn’t be underestimated, which is exactly what optimists do. Policy-makers should not encourage the wrong sort of start-up.”

The study analysed 18 years of data from the British Household Panel Survey – a major longitudinal study – recording optimism as a bias in forecasting personal financial outcomes when subjects are still in paid employment, and its subsequent effects on entrepreneurial returns.

Access the full study – ‘Curb Your Enthusiasm: Optimistic Entrepreneurs Earn Less’ – in the European Economic Review.

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