What is the risk compensation theory of entrepreneurship?
Peltzman’s (1975) pioneering study of automobile accidents revealed that expected positive effects of safety regulations rarely materialized upon implementation. He argued that when drivers feel safer, they take more risks, which compensate for the safety interventions. Support for what is now dubbed the ‘Pelzman effect’ (or risk compensation theory) is far reaching and extends to varying contexts including new rules in NASCAR racing, mandated visor use in hockey, consumer vigilance in response to food safety messages, and bike helmet laws. But does this phenomenon also explain greater entrepreneurial risk-taking in the presence of social safety nets?
There is emerging evidence that social safety nets can have positive benefits for entrepreneurs by reducing the risk associated with entry. Olds (2016a) finds that states that provided more food stamps have more limited liability company registrations among members of newly covered households. The author argues that these individuals felt entrepreneurship to be a less risky option because of the availability of food stamps, should they be needed. Similarly, Olds (2016b) finds that when children received government health insurance, their parents were 12% more likely to start a business, and that business quality improved (i.e., they noted a 36% increase in incorporated ventures).
Hombert, Schoar, Sraer and Thesmar (2014) studied a unique reform in France that provided employment insurance benefits to entrepreneurs for up to three years while they developed their ventures. They found an immediate increase in monthly firm creation of 25% and conclude that the program increased productivity by spurring the creation of new firms that are more productive to replace older less productive ones.
Caliendo and Künn (2011) review the literature on start-up subsidy programs targeting the unemployed and conclude that positive results are most common, followed by null effects, whereas negative results are very rare. In their own study of German unemployed receiving startup subsidies, 80% were found to be productive after five years, earning a relatively high income, and feeling notably happier with their lives.
Fairlie, Kapur and Gates (2011) find that government provided health care boosts entrepreneurship and that employer-sponsored medical insurance strengthens the ties of employees to their jobs, increasing the risks associated with venturing. Basic income programs may also allow individuals to fund their own health care programs while they develop their startups, thus reducing employment lock.
In short, while more research is needed, we do seem to have good preliminary evidence that social safety nets encourage entrepreneurial risk-taking. This is especially relevant today as the concept of a “universal basic income” is being vigorously debated. By extending a safety net beneath all, a universal basic income may alleviate the need for entrepreneurship out of desperation from insufficient employment options. However, it also is likely to encourage risk-taking by those who already have employment. As more and more regions and nations experiment with universal basic income programs, we will likely get access to the data we need to test impacts on entrepreneurial risk-taking.