Feature - Risk vs. return: grids reveal secrets of entrepreneurial success

Anne Villamil and Stefan Krasa are using TeraGrid resources to study entrepreneurial success. Images courtesy of University of Illinois

Economists have long debated entrepreneurial success: Are entrepreneurs uniquely optimistic and more willing to assume risks? Or are environmental factors—like bankruptcy laws and the availability of credit—more significant?

Economics researchers Anne Villamil and Stefan Krasa of the University of Illinois at Urbana-Champaign have developed a model that considers individual differences in willingness to bear risk and optimism and that can evaluate the effect of bankruptcy rules on small firms.

They applied the model to data from the Survey of Small Business Finance (SSBF).

Using Teragrid computing resources at the National Center for Supercomputing Applications, Krasa and Villamil were able to quickly determine if the behavioral predictions of a particular theory could be reconciled with economic data.

“The empirical analysis can be done on a laptop, but running the model with so many policy parameters and integrations gets very long,” Krasa says.

Villamil agrees. Without the resources provided by the TeraGrid, “it would have taken years,” she says.

Villamil and Krasa’ s model suggests that owners of small firms tend to use personal assets to support their business, often opting to “bail out” their companies rather than declare bankruptcy. Stock image from sxc.hu

Nature vs. nuture in the boardroom

The researchers’ results—which were recently presented at a Conference on the Resolution of Financial Distress at the Institute for Advanced Study, the XVI European Workshop on General Equilibrium, and the SAET International Conference on Current Trends in Economics—indicate that the environment in which businesses operate influences success more than personal characteristics, and that entrepreneurs are not excessive risk-takers.

Villamil says the model explains three puzzling trends in the SSBF data: owners of small firms: face an unattractive “risk vs. return” tradeoff; have poorly diversified personal financial investments; and tend to “bail out” their companies, rather than declare bankruptcy.

“I was especially surprised to see the degree to which people use personal assets to support their business,” Villamil says. “They do this because they truly believe the future will be better than the present, and the future is very, very important to these people. The loss protection afforded by bankruptcy and an owner’s ability to preserve the potential for high future gains by injecting personal funds alters the firm’s return trade-off.”

Krasa adds that this behavior accounts for why entrepreneurs in developed nations—dynamic settings where bankruptcy institutions may seem lenient but are efficient—often succeed, while entrepreneurs with the same level of optimism and risk-taking characteristics in developing countries may not succeed.

“Immigrants in the U.S. come here and flourish. Why is that? It is because it is not only the person, but the environment they have entered that will help them to succeed,” Villamil says.

This research was supported by grants from the National Science Foundation’s Social, Behavioral and Economic Sciences Directorate, the Ewing Marion Kauffman Foundation, and the University of Illinois’ Academy for Entrepreneurial Leadership.

- Tracy Culumber, NCSA

This story features in Teragrid’s 2007 Science Highlights booklet, to be released at Supercomputing 2007 next month.