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Essays on Strategic Risk Taking Under Competition

  • Author(s): Ostler, James Owen
  • Advisor(s): Lieberman, Marvin
  • et al.
Abstract

This thesis explores how competition impacts risk taking in three essays. Chapter 2 explores the role competition plays in motivating risk-taking in en entrepreneurial setting. Traditional entrepreneurship research holds that a role of entrepreneurs is to bear risk and that entrepreneurs are risk seeking, or at least less risk averse than others. Using a tournament model we show that, due to competitive effects, even risk-neutral entrepreneurs appear to be risk seeking and will take on significant levels of risk. To explain this we introduce the concept of strategic risk, which we define as rational risk taking that arises due to competition. We show that the traditional view may have it backwards: we do not observe risky behavior because entrepreneurs have a taste for risk, but rather the structure of some markets induces rational strategic risk taking, and it is the presence of risk and uncertainty that allows entrepreneurship to exist. The model predicts that industries with higher uncertainty and riskier strategies available to entrepreneurs will have higher levels of entrepreneurial entry. Thus, we offer an alternative explanation to why radical innovations disproportionately come from small entrepreneurial firms, and why certain industries are more innovative than others.

Chapter 3 tests the empirical predictions of Chapter 2 in the liver transplant market. Using a policy change to identify risky illegal behavior in the liver transplant market we find support for the model's predictions. The liver transplant market offers an ideal setting to look at how competition impacts risk taking and firm entry as it offers a setting with: substantial variation in levels of market competition, a change in policy that allows identification of risk taking in the form of illegal activity (Snyder, 2010), and a growing market with entry occurring over time. We find support for the predictions that: increased competition increases strategic risk taking, new entrants will take more strategic risk, and that the presence of risky strategies increases an entrepreneurial entrant's ability to compete leading to increased entry.

Finally, in Chapter 4 the risk taking behavior predicted in Chapter 2 is tested in a laboratory experiment. We find that actual behavior deviates from the theoretical optimal for the majority of players even though players would universally be better off playing as the model prescribes. We also explore how the framing of the competitive situation influences behavior. We find that general quantitative ability and being less risk averse predicts play closer to the optimal predicted behavior.

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