Perceptions and Framing of Risk, Uncertainty, Loss, and Failure in Entrepreneurship

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Because this review is focused on entrepreneurs’ perspectives on loss and failure, the findings of prospect theory (Kahneman & Tversky, 1979) serve as a key foundation. In short, prospect theory suggests that a decision-maker faced with losing prospects will pursue a risky alternative in an effort to avoid the loss. This cognitive bias toward risk-taking is an example of the bounded rationality of decision-makers. The entrepreneurship research that is covered in this review indicates that there are different ways in which the outcome of “loss” or “failure” can be manifest. Of course, a business can suffer a financial loss or a series of financial losses severe enough to cause the business to close.

Some businesses, however, close without experiencing an actual financial loss, but they were not sufficiently successful to be sustainable and survive. A part of a business – such as a unit or a product line – may fail while the rest continues. The business may fail to meet an objective set by the entrepreneur, falling short of growth or profit expectations, for example. In addition to the business-specific losses, the business owner may experience some psychological or emotional loss since an owner’s identity or reputation may be closely tied to the business. Or the owner may close the business because more highly-valued alternatives exist and the business represents an opportunity cost.

Kahneman and Tversky (1979) examined the prospects for failure, referring to a future outcome. But research in prospect theory also considers that we look at future prospects based on current conditions and our past experiences. For instance, research covered in this review examines behaviors of entrepreneurs making decisions about businesses that are currently under-performing but have not failed yet. Thus, in addition to having application to entrepreneurs contemplating the gamble on starting a new business that may fail, the research covered in this review is relevant to a broad set of entrepreneurs. For instance, serial entrepreneurs may be making a decision about a new undertaking in light of a recently failed business. Individuals may not have a failed business or losses in their own past, but perhaps they are considering partnering with an entrepreneur who has overseen a failed or poorly performing business.