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Fear Factor: In Business and Life, It May Separate Smart Luck from Dumb Luck

December 12, 2014
by Michael Kershner
An empty office

Taking big risks might actually keep you from succeeding. 

John Morgan is haunted by the prospect of failure. However, he tells his classroom of aspiring entrepreneurs, this fear might not be as unhealthy as your “clinical psychologist will tell you.”

We may like to peg successful entrepreneurs as overconfident thrill seekers, but such thrill seekers “never appear in Forbes,” according to Morgan, a professor at UC Berkeley’s Haas School of Business. That’s because, by and large, these individuals fail and never bounce back.

As a bankruptcy consultant in the 1990s, Morgan became intrigued by the “entrepreneurial gene”—the pivotal characteristic that determines an entrepreneur’s success. After Morgan became a professor in 2002, he began his research evaluating risk and its effect on decision making.

According to traditional economic theory, an individual is either skilled at handling risk, or not. But what if not all risk is created equal? In a recent study with Dana Sisak, assistant professor at Erasmus University Rotterdam, Morgan set up a lab experiment that simulated the real market. Participants were asked to choose between investing money in a risky venture or in a safer option. Morgan discovered that individuals were highly skilled at evaluating strategic risk (knowing when to enter or exit a market based on the projected value of the stock), but were inept at handling natural risk (understanding the role luck plays in their success or failure). Trial after trial, participants would exit the market after being unlucky and overbet when fortune favored them. They treated luck as a constant, expecting either good luck or bad luck to repeat.

Not satisfied with this conclusion, Morgan became determined to understand what separates “smart luck from dumb luck.” He found that individuals who fear failing, who are “loss averse,” fare better in a competitive market than those who focus on lofty goals. That’s because someone who fears failure is more willing to invest the resources necessary to justify their decision and avoid a complete flop. Meanwhile, reports Morgan, goal-oriented entrepreneurs have a tendency to “set the yardstick so far out of reach” that it becomes unattainable, leading them to “fail and torture themselves.”

Just as loss aversion can motivate individuals, it also provides a model for helping entrepreneurs know when to throw in the towel. Morgan argues that individuals who are loss averse are more cognizant of how to measure failure and know when to quit.

Some experts estimate only one in ten Silicon Valley startups succeed. That means 90 percent of businesses must decide when to move on to other projects or cut their losses entirely. Knowing when to make this decision can be the difference between staying above water and hitting rock bottom.

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