The aim of this chapter is to develop the knowledge and understanding on the subject matter as well as providing the theoretical background for the study. Therefore, it is essential that a desk review be made on previous studies focusing on the topic of the risk taking propensity among entrepreneur. The literature reviewed will include some relevant studies that were done in the past particularly those related to the issue of study. In addition, studies related to the general issue of entrepreneurship will also be reviewed to shed additional insight on the subject matter.
The chapter starts with the discussion on the concept of entrepreneurship with special reference to the entrepreneurial process and how entrepreneurs play their role in the process. It is then followed by discussion on the micro and small business sector in Malaysia in terms of the working definition and its importance to the national economy. Next, the definition of risk and its variants are discussed in greater detail. The chapter ends with the discussion of the literature related to risk taking propensity.
Entrepreneurship is a process universally connected with the founding of business ventures, acquiring or expanding an existing business. Entrepreneurs have been considered as bearers for risks and uncertainties in making business choices (Knight, 1921), and make innovations for new goods, new methods of production, new markets, and new types of industrial organization (Schumpeter, 1934). Hull, Bosley, and Udell (1980) concurred that entrepreneurs assumed risk with the intention to expand the business. Meanwhile, Brockhaus (1980) recognized entrepreneur as a manager or owner of a business who is not employed elsewhere. However, Cooper and Dundleberg (1987) defined entrepreneur as a person who either own or manage a business. While McClelland (1961) described an entrepreneur as a business manager who has the responsibility as a decision maker and takes responsibility for the decision made. From the above definitions, it can be concluded that an entrepreneur as the owner/manager of an MSME, in which he or she may not be a founder but not only has a responsibility to make decision and but also takes the risk and responsibility for the decision made.
Entrepreneurship endeavours involve gathering of productive resources in an attempt to begin a business enterprise with the expectation of providing a reasonable income to the entrepreneur or small business operators. These resources include manpower, equipment and tools, money, time and basic raw materials which may entail some risks in procuring it. For example, the risk of not getting basic raw materials as needed to produce the product or damage to the equipment and tools means losses to the entrepreneur. These resources, along with its associated risk, should be recognized and managed to minimize losses and to increase profits. The entrepreneurial process remains the same and the roles and nature of the entrepreneur are universal, regardless of industries. Hereditary risk exists in all the processes starting from the ideation, conceptualization, enterprise creation, commercialization and ending with the growth of the enterprise.
Moreover, all businesses in the world face risk regardless of its size, thus they have to identify, assess, manage and monitor the organization’s business opportunities and risks. The current business disappointments are usually caused by entrepreneur’s misjudgements, mismanagement of risk and changes in corporate governance requirements. There are also increasing stakeholder expectations for entrepreneurs to effectively manage all risks exist within an organization.
Micro, small and medium enterprises (MSMEs) are and will continue to be the backbone of Malaysian economic growth. Undoubtedly, MSMEs contributes greatly to the economic strength in Malaysia. With the New Economic Policy introduced by government in 1971, Malaysian MSMEs were given the important task of hoisting new breed of Bumiputra entrepreneurs who would eventually grow into large business community in accordance with the social restructuring objectives of the policy. Definitely, the policy has been able to create MSMEs whereby 30% of the businesses are owned by bumiputras. As of Mac 2005, a total of 518,996 MSMEs were registered in Malaysia (Census of Establishments and Enterprises, 2005, Department of Statistics Malaysia). Most of the MSMEs are found in the service sector, accounting for 86.5%. They contribute 27.3 percent of total manufacturing output, 25.8 percent to value-added production, own 27.6 percent of fixed assets and employ 38.9 percent of the country workforce (SMIDEC, 2002). There are 192,527 establishments in the services sector and 186,728 (96.7%) of these are made up of MSMEs in Malaysia. Yusoff (2004) noted higher consumer spending and a record level of tourist arrival caused the services sector grew by 6.8% in 2004. Strong expansion in all sub-sectors with transport and communication emanated the growth in the lead at 8.4% followed by wholesale and retail trade, hotels and restaurants (7.1%) and finance, insurance, real estate and business services (6.5%). MSMEs have become one of the main drivers of economic growth as the industries contribute 32% to Malaysia’s gross domestic product (GDP), account for 56% of total employment and 19% of total exports of the nation in 2007 (SME Annual Report, 2007).
The definition of micro, small and medium-sized enterprises needs to be classified within the context of the country in which they operate, as typically, the concept varies according to country (Gunasekaran, Forker and Kobu, 2000). The criteria should include paid-up capital, shareholders’ funds, turnover, and number of employees or a combination of these. In Malaysia, National Small and Medium Enterprise Development Council (NSDC), (2005), defined micro, small and medium enterprises as firms employing 150 full-time employees with sales turnover less than RM 25 million. This definition covers the manufacturing including agro-based, services, primary agriculture and ICT.
In the past, there is no common definition of micro, small and medium enterprises (MSMEs) in Malaysia. Many agencies defined MSMEs differently according to their own criteria based on annual sales turnover, number of employees or shareholder. However, National Small and Medium Enterprise Development Council (NSDC) 2005, defines MSMEs across economic sectors. Bank Negara Malaysia defined MSMEs as enterprises with shareholders funds of less than RM10 million. Meanwhile, the Small and Medium Industries Development Corporation (SMECorp) defined MSMEs as enterprises based on the annual sales turnover not exceeding RM25 million and number of full-time employees not exceeding 150. The criteria used in defining MSMEs are based on annual sales turnover and number of the MSMEs as postulated in Table 2.1 below.
No. of full-time employees:
Less than 5
Annual Sales Turnover: Less than RM250,000
No. of full-time employees:
Between 5 and 50
Annual Sales Turnover: Between RM250,000 and less than RM10 million
No. of full-time employees:
Between 51 and 150
Annual Sales Turnover: Between RM10 million and RM25 million.
No. of full-time employees:
Less than 5
Annual Sales Turnover: Less than RM200,000
No. of full-time employees:
Between 5 and 19
Annual Sales Turnover: Between RM200,000 and less than RM1 million
No. of full-time employees:
Between 20 and 50
Annual Sales Turnover: Between RM1 million and RM5 million
Sources: National Small and Medium Enterprise Development Council (NSDC), (2005)
Risk become popular in the economics field in the 1920s and started to be the main focused in the academic discipline. Thus, the definition of risk has been extended within the area of decision making by various field of literature in management, environmental, insurance and psychology. Risk and its elements’ definition is complicated and multifaceted which is viewed and considered differently depending upon the taxonomy that an individual utilizing it. Generally, risk refers to uncertainty concerning the occurrence of a loss (Redja 2005). Yates and Stone (1992) defined risk as the degree of uncertainty and potential loss which may follow from a given behaviour. Risk is also defined by Greene (1962) as the “uncertainty as to the occurrence of an economic loss” and, “measurable uncertainty” (Knight, 1921) or “objectified uncertainty regarding the occurrence of an undesirable event” (Willett, 1951).
Apart from the dissimilarities in defining risk, two common themes are about uncertainty and loss. According to Crowe & Horn, (1957), the term probability may have the connotation of likelihood to specific persons as compared to probability to others. This feel of unpredictability of the actual results of a method contrary the possible expected outcomes introduces objectives suspicion about the outcome in a given circumstances (Williams & Heins, 1964). Once the event occurred, the differences can be measured in the actual versus expected outcome of an action but differs from the incidence of an unwelcome contingency (Althearn, 1962). Consequently, there is variability in the connotative definitions of risk between persons, society and ethos despite several general academic accords concerning the fundamental of risk.
In addition to the facets of uncertainty and loss, there is the constituent of the future time component in the likelihood, predictive, possibility of risk. The multitude of descriptions of risk is due to the lack of agreement by scholars and the nature of risk itself. The word of uncertainty may be unique to a particular actor if the word of uncertainty refers to the component of risk and uncertainty as a state of mind of the individual processing the risk. Besides uncertainty, risk involves loss, or something that is undesirable. Loss may be more than financial or economic. Crowe and Horn (1957) defined loss as an involuntary reduction in the capacity of an entity to satisfy its wants. Therefore, it looks that scholars have disagreements in separating an individual’s awareness, perception and attitude from the general concept of risk.
The entrepreneur is a risk taker and is prone to assume business risks. Any error in making business decision is a probable source of threat or opportunity in assuring the success of the business. The distinctiveness of entrepreneurs businesses, rivalries and the tight economic situations has obligated the entrepreneurs’ capability on predicting the business risks. Busenitz (1999) noted the basis of risk is that …“the dominant theme running throughout the entrepreneurship literature is risk and how entrepreneurs are predisposed towards risky alternatives or how the should manage risk” (p. 325). However, this statement contradicts with McCarthy (2000) statement on the risk that “…the risk construct dominates the literature on entrepreneurship and the ability to bear risk has been identified as the primary challenge facing entrepreneurs” (p.563).
Furthermore, Klein (1977) has summarized that the capacity to take risk as being an inherent attribute of the entrepreneurial venture as stated that if an entrepreneur is to profit from an unexploited potential, he must also inevitably deal with a greater degree of uncertainty.
Business risks occur from uncertainty about the future and the effect of current judgements, therefore business choices need to consist of an assessment of their outcomes and the possibility that the outcome may differ from expectation. Entrepreneurs confront the problem that the sum of tolerable risk is based on likelihood of unconstructive outcomes and reward is often comparative to the amount of risk taken. Bird (1989) differentiates risks to five types which four of them are clearly pertinent to any potential entrepreneurs such as economic risk, risk in social relations, risks in career development, psychological and health risk. The general concept of “risk” has been broken into several dimensions by several authors (see for example, Assael, 1981; MacCrimmon and Wehrung, 1986; Minkowick, 1964; Mowen, 1987; and Robertson, Zielinski and Ward, 1984). These include financial risk, physical risk, social risk, professional risk, performance risk, opportunity cost risk and time risk. Meanwhile, Carroll, Siridhara and Finchman (1986) used the Atkinson’s model (consumer model of risk perception) which resulted in a six dimensions to define risk among entrepreneurs as the decision to become an entrepreneur involves consumer risk. The dimensions included in the model are financial risk, social risk, psychological risk, performance risk, safety risk and convenience risk.
However, Harrington and Niehaus, (2004) noted that in business several types of risks are present and can be applied to entrepreneur business decision making such as price risks, credit risks and pure risks. Price risks include market risks associated to the victory of the business plan, demand for the product, and issues of cost and price which include output price and input price risks. Romano et al, (2001), includes price risk to business-related financial risks involving credit, cash flow, foreign currency and working capital. Every business risks are not monetary, yet, a good deal of risk is inherent in companies and operations itself. It can be concluded that many of these risks resulted from pressures related to company growth, company culture and information management.
Other type of business risks is credit risks. Credit risk is a chance and magnitude of financial loss involved in the spending of money. To quote Harrington and Niehaus, (2004), on the credit risk of the business risk:
“The risk that a firm’s customers and the parties to which it has lent money will delay or fail to make promised payments is known as credit risk. Most firms face some credit risk for account receivables. The exposure to credit risk is particularly large for financial institutions, such as commercial banks, that routinely make loans that are subject to risk of default by the borrower. When firms borrow money, they in turn expose lenders to credit risk (i.e., the risk that the firm will default on its promised payments). As a consequence, borrowing exposes the firm’s owners to the risk that the firm will be unable to pay its debt and thus be forced into bankruptcy, and the firm generally will have to pay more to borrow money as credit risk increases” (p.5).
Raghavan, (2005) noted that Probability Default (PD) and Loss Given Default (LGD) were used to measured credit risk and default percentage is quite high in SME sectors as compared to the large corporate or entity.
Finally, pure risk is another type of business risks. These risks affect business due to reduction in value of business assets such as wreck or demolition of construction, equipment, inventory, business records, or other property; recovery and replacement costs after fires, flooding, typhoon or other disaster; and loss of income during recovery. Pure risks also involve company losses due to shipping damages or losses occurring because of crimes such as misappropriation or robbery. Entrepreneurs face a range of pure risks that must be controlled and managed lest they endanger the future of the firms. This pure risk also includes legal liability for damages for harm to customers, suppliers, shareholders and also injury to employees resulting from accidents, harm product, professional malpractice, inappropriate business practices and mistakes or omission. Another type of pure risk is the risk which associated with paying benefits to injured workers under workers’ compensation laws including the risk of legal liability for injuries or other harms to employees that are not governed by workers’ compensation laws. Finally, the risk that the businesses agreed to make payments under employee benefits plans due to death, illness and disability to employees (Harrington and Niehaus, 2004). The figure below shows the major types of business risk.
Source: Harrington and Niehaus, 2004
Liles, (1974) recommended that new venture entrepreneurs, involved financial status, career opportunities and psychosocial health. The new venture also will face strain and loss of family and social relations. The private monetary risk that the entrepreneur perpetrates from a failed business can affect the major losses to the entrepreneurs, resulting in a lower standard of living. Liles (1974) also suggested that the potential entrepreneur is well counselled to analyze carefully the risks associated with his specific business proposal and then make a decision to undertake them because the financial and emotional consequences of failure could be devastating. Liles then concluded that the decision depends to a great extent upon the potential entrepreneur’s perception of the risk involved.
Raghvan, (2005), specify the risks to SME sectors include the following:
The study of decision making behaviour categorized the risk into three elements: risk perception, risk propensity and preparedness to take risk (Brindley, 2005). Brockhaus (1980) defined risk propensity:
“The perceived probability of receiving the rewards associated with success of a proposed situation, which is required by an individual before he will subject himself to consequence associated with failure, the alternative situation providing less reward as well as less severe consequences than the proposed situation.” (p. 513)
Risk taking also can be defined as one of the three dimensions of entrepreneurial orientation of a company and refers to the readiness of the organization to consign significant resources to opportunities that might be uncertain (Junehed and Davidsson 1998). Sitkin and Weingart (1995) defined risk perception as a subjective interpretation of expected loss which affected by individual’s view of the uncertainty of the decision and the consequence of the decision. Meanwhile, risk propensity is usually defined as an individual’s general tendency toward either taking or avoiding risk within a particular kind of decision context (Sitkin and Pablo, 1992). Risk propensity is a common tendency to accept or avert risks (Sitkin and Weigart, 1995). Summary of past trend of the selected research in risk propensity have produced mixed conclusions is tabulated in Table 2.1 (p. 23). Some studies have indicated no significant differences in risk taking propensities among entrepreneurs.
Risk propensity and risk perception influence risk taking. Risky decisions will be made when the situations of high risk propensity and low risk perception. Therefore, risk-taking initiatives should be more necessary in order to achieve good results in hostile markets. Or, in other words, business owners or managers who dare to take more risks take actions that are more suitable and perform better.
Abby and Slater (1989) noted that organization which has an international vision, favorable perception and attitudes toward international business, is willing to take risk and has the capacity to engage positively in international business activities is likely to lead a company to business success. In line to minimize risks, entrepreneurs are required to identify which variables influence their business performance. If they have a higher risk-taking propensity, they positively affect the business performance.
Begley, (1995) defined risk-taking propensity as the willingness to take moderate risks. This means that when entrepreneurs faced with different situations, they will probably show different risk propensities. At the same time, different entrepreneurs faced with the same situation may present different risk propensities. Entrepreneurs are willing to accept the unknown. They are distinctively able to start and orchestrate events that have risk consequences (Mitton. 1989). Entrepreneurial study, yet, propose that successful entrepreneurs are moderate risk-takers (Bridge, O’Neil, Cromie, 1998). Douglas and Shepherd (2002) found that those with a greater risk acceptance had stronger levels of entrepreneurial intention.
McClelland (1961) found that individuals would have moderate propensities to take risk if they have high achievement needs. However, Liles (1974) argued that entrepreneurs frequently have to adopt uncertainty with respect to financial well-being, psychic well-being, career security and family relations. Group’s risk propensity could be influenced by various variables. Among them was characteristic of the group as suggested by Sitkin and Pablo (1992) that outcomes associated with prior risky decisions can influence risk propensity, with more positive outcomes leading to greater risk propensity. Prediction by people that groups with higher levels of collective efficacy (Gibson, McKeon and Ostrom, 2000) could have greater risk propensity because they feel more capable of handling problems that arise. Also, groups with more ambitious goals or groups that compete closely with other groups may have greater risk propensity because risk taking is necessary for their success. The environment was another variable that may also play a role in the risk propensity of groups. For example, the group may have greater risk propensity if risk is valued in a group’s social environment (Stine-Cheyne, 2002). According to Moreland & Levine, (1992), the group may have a greater risk propensity because it has less fear of failure if a group expects outsiders to provide help when it is needed. And when the consequences of failure are smaller, a group may be more willing to take more risks. This relationship may be moderated, however, by the availability and value of outside help.
Brockhaus and Nord(1979)
New founders (N=31), newly promoted managers (N=31), and newly hired managers (N=31)
United States
Choice Dilemmas Questionnaire (CDQ)
No significant differences in risk taking propensity of the three groups.
Brockhaus (1980a)
New founders (N=31), newly promoted managers (N=31), and newly hired managers (N=31)
United States
CDQ
No significant differences in risk taking propensity of the three groups.
Sexton and Bowman (1983)
Entrepreneurship majors (N=61) and non business majors (N= 113)
United States
Jackson Personality Inventory
(JPI)
Personality Research Form E
(PRF-E)
CDQ
Entrepreneurship majors higher in risk taking
Sexton and Bowman (1984)
Entrepreneurship majors (N=45) , business majors (N=75) and non business majors (N= 98)
United States
JPI
PRF-E
Entrepreneurship majors higher in risk taking
Schwer and Yucelt (1984)
Owners and small business managers (N=71)
CDQ
No differences in personal risk; other risks mitigated by age and education
Masters & Meier (1988)
Male and Female owners/owner-managers and managers (N=50)
United States
CDQ
No significant differences in risk taking propensity neither between owners and managers nor between males and females owners.
MacCrimmon and Wehrung (1990)
Business owners and Executives
Canada
CDQ
-The greater success was related to greater risk taking.
-Education was also found to be related to risk taking.
-Age, seniority, number of dependents was inversely related to risk taking.
Carland, J.W., III, Carland, J.W., Carland, J.A & Pearce, J.W. (1995)
Entrepreneurs (N=114), Small Business Owners (N=347) and Managers (N=387)
South Eastern United States
JPI
– Older respondents explained a lower of risk taking propensity than the younger.
– Respondents with higher level of education had higher propensities for risk taking,
– Female exhibited a lower level of risk taking propensity compared to male.
Begley (1995),
Business executive (N=239)
New England
JPI
failed to identify whether the level of entrepreneurial risk taking was
low, moderate, or high.
Koiranen, Hyrsky and Tuunanen (1997)
Entrepreneurs, Small business owners and managers (N=1000)
India, Turkey and United States
JPI
-Americans were more inclined to assume risks.
-Finnish entrepreneurs, small business owners and managers were more risk averse than Americans.
-Americans males have a higher scores than Finnish males
-No significant difference between female US entrepreneurs, small business owners and managers and their Finnish female counterparts
Stewart, Watson, Carland and Carland (1998),
Students (N=206)
United States and Rusia
JPI and CDQ
– CDQ failed to measure the construct of risk taking in the investigation.
– JPI was more successful; however, it has components which may not be well matched for measuring entrepreneurial risk taking.
Hyrsky and Tuunanen (1999)
Entrepreneurs, Small business owners and managers (N=1000)
Finland and United States
Carland Entrepreneurship index (CEI)
American had greater risk taking propensity.
Forlani and Mullins (2000)
CEO of the firms (N=540)
United States
Risk Style Scale
Differences in risk propensities among entrepreneurs on their new venture choices.
Petrakis (2005),
Small Businessmen of SMEs (N=120)
Greek
13 risk measures by author.
Risk propensity affects the way entrepreneurs decide to finance their venture and also affects the first performance principal component which includes the risk undertaken and the profit rate.
Leko-Simic and Horvat (2006),
Croatian exporters (N=300)
Croatia
5 point Likert scale
There is significant difference between ‘risk taking’ and ‘non-risk taking’ but do not have a very high risk-taking propensity when doing business internationally.
Shivani, Mukherjee and Sharan (2006)
Small Entrepreneurs (N=200)
India
Risk Attitudes Inventory designed by Gene Calvert (1993)
-A substantial proportion of respondents have low level of risk taking propensity.
-No differences between male and female respondents.
Ozturk and Hancer (2006)
Middle level hotel managers (N=106)
Turkey
Zalaskiewicz (2001) risk scale
There was no significant relationship between the risk items and corporate entrepreneurship.
Walker, Geddes and Webster (2006)
Small business owners (N=1600)
Western Australia
Measures by author
-Some gender differences with women being more emotionally risk averse than their male counterparts.
-Younger people, irrespective of gender were more emotionally and financially risk averse compared to older people.
– There were differences between gender and age cohorts in regard to initial business start-up motivation.
Nieuwenhuizen and Groenewald (2006),
Owners of SMEs (N=50)
South Africa
Neethling Brain Instrument (NBI)
-The majority of the identified successful, established entrepreneurs did have a strong tendency towards creativity and propensity for calculated risk taking.
Naldi, Nordqvist, Sjoberg, Wiklund, (2007)
CEOs of the SMEs firms (N=2455)
Sweden
Entrepreneurial Orientation.
-Risk taking is a distinct dimension of entrepreneurial orientation in family firms and that is positively associated with proactive ness a
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