Why do entrepreneurs do what they do?

March 30, 2017
Why do entrepreneurs do what they do?

There are roughly 27 million entrepreneurs in the U.S., ranging from high tech software developers to restaurateurs.. These individuals are often lauded by the public and policymakers alike for their contributions to job growth and the disruption of staid industries. Entrepreneurs create a great deal of value for our country, yet surprisingly most entrepreneurs make less money over their lifetimes on average than people in a regular “wage job.” And, even though they earn less, entrepreneurs work longer hours, have worse family lives, and carry “undiversifiable” risks. This is well-supported by research across many countries, industries, and recent decades.

So, why become an entrepreneur? The answer is complicated.

A chance at winning the lottery. Mathematically, the distribution of lifetime returns an entrepreneur can expect to make are “skewed.” Even though a randomly sampled entrepreneur will make less than they would in a wage job, they have a higher probability than a wage worker of becoming fabulously wealthy, like Steve Jobs or Richard Branson. This is particularly true of entrepreneurs who start the 1% of “high growth” companies that are backed by venture capitalist investors.  In some sense, entrepreneurs trade in the predictability of a wage for a lottery ticket: one that rarely pays off, but when it does can pay off big.

Being overly optimistic. Research shows that entrepreneurs are more optimistic than their wage-earning counterparts. Even if entrepreneurs are fully aware of the odds stacked against them, they are confident in their own ability to win: they know they’ll be the next Jobs or Branson. These people may have, as Adam Smith said, “the contempt of risk and the presumptuous hope of success.” Of course, because statistics do not fib, we know that optimistic entrepreneurs are often overly-optimistic, particularly with respect to their own abilities and control of their destiny.

It is not about the money. Many academic studies show that entrepreneurs derive a great deal of so-called “non-pecuniary benefits” from their entrepreneurial endeavors. These are the improvements to their life other than money, like being your own boss, choosing your own hours, pursuing your passion. Half of entrepreneurs report such non-pecuniary benefits as one of the primary reasons they started their business. Austrian economist Joseph Schumpeter was one of the first to study entrepreneurs. He wrote of the motives of entrepreneurs “...there is the will to conquer: the impulse to fight, to prove oneself superior to others, to succeed for the sake, not of the fruits of success, but of success itself. From this aspect, economic action becomes akin to sport - there are financial races, or rather boxing-matches. The financial result is a secondary consideration.”

These non-pecuniary motives that Schumpeter enumerates are not in great supply in our modern world. Few of us will be explorers, astronauts, or mountaineers. Entrepreneurship is one of the last great adventures available to us, and this may be a partial explanation for why so many talented people pursue it despite its financial irrationality.