Perceiving and managing business risks: differences between entrepreneurs and bankers

I have always wondered what differentiates the two –  entrepreneur and banker.

Here is an interesting paper by D.K. Sarasvathy, , Herbert A. Simon and Lester Lave which point to probable differences:

We compared entrepreneurs with bankers in their perception and management of a variety of risks. Problems included financial risk, risk to human life and health, and risk of a natural disaster. Cluster analysis and content analysis of think-aloud protocols revealed surprising details.

Entrepreneurs accept risk as given and focus on controlling the outcomes at any given level of risk; they also frame their problem spaces with personal values and assume greater personal responsibility for the outcomes.

Bankers focus on target outcomes — attempting to control risk within structured problem spaces and avoiding situations where they risk higher levels of personal responsibility.

The key for understanding how entrepreneurs perceive and manage risk lies in the problem spaces that they construct and operate upon.

Hmm..

There is a nice graph in the paper showing how entrepreneurs fix the risk and then work returns around it. They are far more concerned about the risk given their personal stake in the game. They seem to be ok with lower returns but not higher risks.

The bankers on the other hand fix the desired returns and then move the risk factor around it. The bankers think risks can be worked around using various financial instruments available. They seem to be ok with higher risks (which can be managed) but not lower returns.

Does this behavior tell you why the 2008 crisis (and others) happened? It does in a way as bankers were just obsessed with returns thinking risks can be managed at all times. The management of risks became a case of mismanagement culminating into a bad crisis. It was shocking to most how bankers were still drawing huge bonuses not involved in any personal responsibility at all. The word banker soon became bankster.

However, I don’t think this is how it has always been. Earlier bankers were hardly a standalone profession. Most bankers were a combination of entrepreneurs plus bankers called as merchant bankers. The merchant banker did both – business and banking – under one umbrella. How did risk and return look for a merchant banker? Most likely trying to balance things as problem in one activity could see other activity also going bust.

I guess these things changed when banking became a standalone profession. Likes of Rothschilds and Morgans changed the game. Even then there was some attempt to develop things via banking/finance. Atleast histories of India’s oldest banks read in this fashion. There was a sense to provide banking facilities to develop the country/region.

It is a mixed bag actually. Even entrepreneurship is hardly as rosy.

Anyways. this thinking about the two professions from a risk and return perspective is a nice framework. Simplifies thinking quite a bit..

 

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