Influences on an Entrepreneur's Perceived Risk: The Role of Magnitude, Likelihood, and Risk Propensity

ABSTRACT This study makes a contribution to the existing literature on entrepreneurial risk perception. A model is developed and tested to capture how entrepreneurs perceive the risk associated with new business ventures. Two variables are examined to assess the entrepreneur's perception of the "magnitude" of risk, and another variable captures the "likelihood" of loss associated with the new business. The individual's prior disposition, referred to here as "risk propensity," is tested for influence on the magnitude and likelihood factors. The research results confirm the roles of the likelihood of losing money on a new venture and the size of the potential loss in determining how much risk the entrepreneur perceives in a new venture. These research findings suggest that in order to reduce perceived risk among perspective entrepreneurs, two issues must be addressed. First, it is important to provide information that assures the entrepreneur that issues that can adversely affect the outcome of the new business venture have adequate contingency plans. Second, raising and allocating capital in stages, rather than the entire amount up front, will reduce the perceived risk in the eyes of the entrepreneur. INTRODUCTION The literature on entrepreneurial risky decision-making has evolved dramatically over the last decade. Early studies on entrepreneurship evoked the premise that entrepreneurs were de facto risk seekers who pursued business opportunities others deemed too risky. More recently, cognitive differences involving biases and heuristics have been shown to affect the perception, rather than the propensity, of entrepreneurs in assessing the risk of new business ventures (Palich and Bagby 1995; Simon, Houghton and Aquino 1999). The role of risk in entrepreneurship is important to study not only at the individual level to find ways to create risk reduction strategies, but also at a macro level in understanding similarities and differences across cultures or economies. Variances in both management style (Bjerke 2000) and operational strategy (Sum, Kow, and Chen 2004) among entrepreneurs from different cultures and nations have been recognized. Considering risk perceptions, Asian entrepreneurs are generally considered to be more risk-averse than entrepreneurs in Western nations (Bjerke 2000). Some research does suggest, however, that entrepreneurs share certain inherent traits despite differences in culture and nationality (McGrath and MacMillan 1992). While some aspects of risk perception may be part of the predisposition of the individual or influenced by the culture, the environmental context of the economy may also play a role. Tan (2002) for example, found that mainland Chinese exhibited a higher level of willingness to take risks than Chinese Americans or Caucasian Americans. He posited that they need to take a higher level of risk when starting a new venture due to the harsh governmental restraints they face. The research stream of risk perception in entrepreneurs, its antecedents, and its consequences continues to develop. Classic decision theory has been the starting point for researchers in identifying and validating direct influences on perceived risk. The venture related variables likelihood and magnitude - have emerged as important influences on the perception of the risk in a new venture. Likelihood of loss is defined as the probability that a new venture's financial outcome will be less than expected. Magnitude of loss refers to the absolute and relative amount of wealth loss that would result from the new venture failing. Likelihood of loss as a factor influencing new venture risk is most firmly supported in the classic decision theory and economics literature, while magnitude of loss became apparent in research specifically focused on business decision-making (March and Shapira 1987). The individual entrepreneur's inclination to take risks has also been identified as an influence on risk perception. …