Eliminations Of Entrepreneurial Risk - Essay Example

Eliminations Of Entrepreneurial Risk Risk and uncertainty are very crucial factors in conducting business. Apparently, the aim of every investor and entrepreneur seems to be to minimize risk since lower the risk, lower the uncertainty of outcome of loss. This sounds like an ideal policy for any venture or entrepreneur who wants to stay safe. However, risk plays a much more dynamic role when viewed from a macroeconomics perspective. From a macroeconomics perspective, risk acts as a regulator towards success and progress. Artificial eliminations of risk such as by government intervention can sometimes even produce undesirable circumstances. A deeper analysis of risk from a multi-dimensional perspective shows that risk is a very crucial but not necessarily a detrimental factor in business. Enterprises and entrepreneurs minimize the risk of their operation by managing diverse portfolios of investments and assets. However, risk mitigation may in turn decrease the chances of a bigger reward. Risk is what separates a salaried job from a business venture. Businesses flourish in short periods of time because they undertake risk and uncertainty that turns out in their favor. Risk is not the same as gambling. It is infect much more complex. Risk calculation involves global assessment of economic and financial indicators. These indicators are run through financial models to predict the possibility of a favorable outcome. The will to take risk is dependent upon certain psychological factors. The prospect theory presented in 1979 by Kahneman explains what kind of individuals or entrepreneurs would show risk seeking behavior and on what grounds. The theory talks about a reference point which is essentially a mark that defines the cases under which an entrepreneur would feel like winning and losing (The Open University 2012). This behavior defines whether an individual will show risk averse or risk seeking behavior. How an entrepreneur defines lose and profit defines his/her behavior. In the graphical representation of the theory, the portion of the curve above the reference point shows risk averse behavior while the portion below the curve shows risk seeking behavior. This essentially means that entrepreneurs show risk seeking behavior in the domain of loss that is when they expect more. More expectation leads to a higher reference point. Entrepreneurs generally set higher reference points than other people. A higher reference point over a particular distribution of outcomes suggests more potential outcomes of loss and according to the prospect theory, people under the domain of loss tend to show risk seeking behavior. Risk seeking behavior entails greater rewards and that is why entrepreneurs tend towards undertaking risks. So for small entrepreneurs, risk is a necessary factor for taking longer leaps. Risk and reward go hand in hand as well. An entrepreneur would only undertake a venture when the rewards exceed the risks or uncertainty by a specific margin. This risk and reward analysis defines the nature of the venture. Entrepreneurs use identifiers of risk and rewards for this analysis. Risk manages the allocation of capital and resources. This allocation is defined in such a way that maximum utility is driven out of the resources. Risk assures that capital and resources are invested wherever they will be the most profitable. Profit is what entrepreneurs actually seek. Profit is what encourages entrepreneurs to undertake risk, uncertainty and innovation. If a particular venture promises substantial profits when compared with its innate risk only then an entrepreneur would embark on that venture and if not then entrepreneurs look for other alternatives where the deployment of capital and resources would produce the lesser desired circumstances but nonetheless suitable. More than that, risk enhances the efficiency of resources by allocating the wasted resources on socially undesirable ventures. If these ventures had been needed in the society then they would have entailed a higher risk and reward factor. If an entrepreneur embarks on a venture characterized by lower risk and reward, it could lead to the reallocation of resources and the entrepreneur could lose all the capital that was invested in the first place. The lost capital would end up in the hand of other entrepreneurs who would invest it in more profitable ventures. Risk assists the market by providing such services and if this were not the case than the society would have a lot of undesirable ventures and only a few that would help the society progress further. So risk favors acceptable ventures over unacceptable ventures. This principle can be applied to individual entrepreneurs as well because sometimes a less capable person possesses the perfect idea. It is important for entrepreneurs to cope with risk but what would happen if they were to artificially manipulate or even mitigate risk. Artificial manipulation of risk can be done through government intervention. Government can provide guarantees and incentive to entities. Such factors of assistance eliminate the outcome of failure but they are not actually present under natural circumstances. Under such cases the risk still exists but it burden lies on the guarantor. Hence the entity or entrepreneur can proceed without any fear of loss. This can lead to reckless behavior of an investor. Moreover, such manipulations would provide incentive to enter into the particular industry where the government has artificially eliminated risk. Anyone and everyone would be interested in an opportunity where there is guaranteed success regardless of actual performance and potential. When an industrial sector is crowded with entrepreneurs such as in the case above then overall social success is not guaranteed. This idea can be communicated better through the following example (Bush 2009). A country going through fuel crises would need to consider other alternatives of energy. Now there may be many other alternatives such as hydrogen, electricity and fossil fuel etc. and each one of these alternatives will carry their own risk. If the situation were to proceed naturally without any artificial manipulation of risk then all these idea would be put to test and development. This way the undesirable outcomes will start surfacing which will identify the undesirable ventures. Eventually the less desirable ventures will keep dropping out until the most desirable alternative is left. The market will identify this alternative as the best choice. Other alternatives will require a reallocation of resources which would be fruitful for the society as well. This is the natural and ideal environment for the human society to progress. Now with the interference of the government, things could turn out differently. If the government artificially eliminates the risk from a particular alternative, it would provide a great deal of incentive to entrepreneurs to invest in that particular option. This would lead to the accumulation of a pool of investors in a particular sector of the industry. To ease the demonstration let us say there are two alternatives. Venture A has been incentivized by artificial elimination of risk while venture B still bears the risk. However, venture B is the one that would turn out to be the most lucrative and productive for the society. Venture will start receiving more capital allocation compared to venture B as venture A has been indemnified by the government. The optimal choice that is venture B would progress but at a very slow pace also it will face artificially induced supplementary risk as well because of competition caused by venture A. Eventually venture A would prevail even though it would bring unexpected and undesirable outcomes in the future. These undesirable outcomes may include another fuel crisis, rising costs etc. With the passage of time, venture B would be recognized as the ideal choice but only after the occurrence of detrimental consequences. This illustration shows how risk in businesses affects the whole society. Its importance cannot be ignored and this importance lays emphasis on it being a key factor in businesses. Uncertainty is what provides all the options with an equal chance of progress and this progress when compared, rules out the undesirable options. Every sane entrepreneur aims to mitigate the risk as it is a good trait for a profitable business but by viewing the overall picture, it would not be unwise to say that coping with risk is not detrimental in all its sense. It can be highly productive as it can eliminate the competition providing more profitable ventures to the society. A small business entity can be among the first to reject unwanted options. Risk keeps the environment of a small enterprise efficient by encouraging thorough examination of every aspect of the entity’s operations and hence the use of bootstrapping. Bootstrapping can induce additional risk but it can be eliminated by the injection of more capital. Bootstrapping is very productive as it offers various advantages such as methodical analysis of cost which leads to the efficient use of each unit of the currency. This way the enterprise can pursue the most profitable and socially desirable ventures. Funding of such operations is the main risk involved in the pursuit but it is acceptable as long as the reward is worth the risk. Moreover, with the deployment to techniques such as bootstrapping, the entity can improve its business skill that would have been improbable in other conditions. So in essence, an entrepreneur must learn to cope with the risk and for that the entrepreneur should learn to embrace what the risk might bring. Works Cited Billy Bush. 2009. The Importance of Risk in Entrepreneurship. [ONLINE] Available at: http://ezinearticles.com/?The-Importance-of-Risk-in-Entrepreneurship&id=3209119. [Accessed 09 August 12]. Heaton, John, 1999. Portfolio Choice and Asset Prices; The Importance of Entrepreneurial Risk. Ph.D.. Chicago: University of Chicago. The Open University. 2012. Prospect Theory. [ONLINE] Available at: http://openlearn.open.ac.uk/mod/oucontent/view.php?id=397325§ion=6.4. [Accessed 09 August 12]. Vereshchagina, Galina , 2009. Risk Taking by Entrepreneurs . American Economic Review, [Online]. 99/5, 1808-1830. Available at: http://www.aeaweb.org/articles.php?doi=10.1257/aer.99.5.1808 [Accessed 09 August 2012]. Read More