The Endowment Effect and the Entrpreneurial Impulse

In a recent New Yorker, James Surowiecki (author of The Wisdom of Crowds) wrote an article about health-care reform in which he brought up what’s known as the Endowment Effect. The Endowment Effect (EE) essentially says that people overvalue what they already have. There’s debate among behavioral economists about the existence or importance of this impulse, but it’s supported by a small body of empirical evidence.

My thoughts, when I first read the article and then did a little research into this hypothesis, turned to entrepreneurism, and whether or not the EE can help explain why or why not certain people can make the leap from the comfort of a full-time job working for someone else to the risks and potential rewards of starting a new business. Do people overvalue the safety of working for someone else? Perhaps classic risk-aversion theory be supplemented with the EE to explain why potential entrepreneurs struggle with the decision to strike out on their own.

What factors come into play here? In terms of the Endowment Effect, what might you be overvaluing or undervaluing as you ponder an entrepreneurial life?

A lot of these things are non-economic and have to do with behavioral psychology. What’s interesting, and valuable, about the EE hypothesis is that it can be used to explain both hard-economic as well as soft-psychological value. Although explained experimentally in terms of financial value, the EE is not strictly an economic hypothesis – the concept of value can take on forms. We don’t need to be able to experimentally assign a hard-dollar value to the notion of “predictability”, for example, to know that predictability is valuable to many people. And when you debate whether to launch your startup, how can you know for sure – and thus, fairly evaluate – the financial rewards? Even more problematic is trying to assign a value to things like job safety. For example, at some level, we all know that the value of job safety is not the same as in our parent's’ day. The social contract has changed; economic cycles are swifter and more volatile; the certainty of lifetime employment is an ephemera. But the EE suggests that, for those of us who are employed, we still overvalue our jobs, merely because we have them. The flip side of the argument, then, is that we systematically undervalue entrepreneurism, merely because we haven’t yet done it.

I’m curious to hear from the entrepreneurs who have made the leap – what, in hindsight, did you overvalue before you started your business, and what about the entrepreneurial life did you come to understand to be much more valuable than you originally thought? Let us know in the comments!