But they tend to overestimate their income. The greater the optimism, the lower the earnings, writes David de Meza

de Meza, David

LSE Research Online

blogs.lse.ac.ukhttp://blogs.lse.ac.uk/businessreview/2015/10/02/self-employment-attracts-people-with-an-optimistic-personality/Self-employment attracts people with an optimistic personalityBearing in mind that only some 50 percent of businesses survive their first five years, what sort of person does ittake to start one? The answer: an optimist. Still, other answers are possible. The returns to success may be sogreat that the gamble is worthwhile, especially as the autonomy experienced by entrepreneurs is part of theattraction. So it is worth trying to pinpoint whether optimism is also a factor. By optimism, we mean systematicallybiased beliefs in the probability of doing well.In earlier work, some of us found that the self-employed are more likely tooverpredict their future income than are employees. This observation doesnot directly imply that the self-employed are intrinsic optimists or that their entrydecisions tend to be mistaken. The uncertainty of starting a business makes itharder to forecast earnings and easier to focus on the upside. Plus, havingmade the bold decision to become self-employed, it is tempting to justify thedecision by being confident of success. So the financial optimism of the self-employed may be an ex post phenomenon, created by the environment inwhich they operate rather than by an intrinsic disposition to defy the evidenceand expect the best. To investigate this, we look at whether the self-employedwere unusually optimistic when they were employees.The data comes from the Bristish Household Panel Study. This tracks, over 16years, individuals’ expectations concerning their personal finances in thecoming year and what they earned in the current year. The optimistic bias in theforecast errors is greater for employees who will become self-employed in the future than it is for those whoremain as employees for the whole period. On becoming self-employed, the optimistic bias increases even more.Optimism falls back when people cease to be self-employed, but it still exceeds that of the never self-employed.These findings suggest that self-employment does attract people with an optimistic personality as well asproviding an environment in which optimism flourishes.The height of the bars is a measure of optimism. Relative to the never self-employed, itshows the extent to which (middle column) the self-employed overestimate the chance ofbeing better off. The first column is their relative optimism before entering self-employment, and the last column the optimism of those who have left self-employment.These results matter because if people become self-employed as a result of false evaluations of their prospects,they are making mistakes, at least as far as their interests are concerned. Government policy to encouragebusinesses start-ups may, therefore, be misguided. It is true that there may be social benefits from newbusinesses. For example, through job creation, but it should also be noted that when start-ups fail they areresponsible for a great deal of job destruction.If the self-employed do tend to overestimate their financial returns and are thereby too ready to give up salariedwork, it follows that the more optimistic they are, the less they will earn. Our current research looks at thisquestion. It does seem to be true that measuring optimism prior to becoming self-employed and controlling forearnings as an employee, greater optimism is associated with lower earnings. Setting up a business is not theonly rash activity that optimists enter into. According to our measure, married optimists are more likely to divorce!♠♠♠This post is based on the article “Entrepreneurship: Cause and Consequence of Financial Optimism” by G.Reza Arabsheibani, Christopher Dawson, David de Meza and Andrew Henley, in the Journal of Economics andManagement Strategy (2014). The authors have subsequently published “The Power of (Non) Positive Thinking:Self-Employed Pessimists Earn More than Optimists“, IZA Discussion Paper No. 9242.Featured image Credit:  Sébastien Launay CC-BY-2.0 Inside photo: Sarah Reid CC-BY-2.0 David de Meza is the Eric Sosnow Professor of Management at LSE. He has been editor ofthe Economic Journal, Economica and associate editor of the Journal of Industrial Economics.Copyright © 2015 London School of Economics

Self-employment attracts people with an optimistic personality

Abstract

Similar works

Full text

Available Versions

LSE Research Online