Extended Abstract

The scope of this chapter is to capture the extent to which immigrant entrepreneurs adjust their beliefs with respect to effort in the light of new information, rather than relying on past experience to guide their decision making and entrepreneurial success. To detect the awareness of the immigrant entrepreneurs in Germany, I develop a model in which they constantly receive valuable noisy market signals about their accurate but unobserved productivity. Correspondingly, a dynamic iterative formulation of this process is integrated into the model of optimal effort, and an econometric specification is derived that enables to investigate the behaviour change of entrepreneurs.

5.2 Introduction

In the previous chapter I have shown that enterprises established by immigrants in Upper Bavaria are less successful in comparison to native entrepreneurs by applying a parametric hazard model to predict their survival chances. The investments in human and social capital do improve the economic performance, but the explanation for the differences is complex in view of the many influences on entrepreneur’s success. One of the essential factors frequently referred to is the use of adequate information and a sound information system. Faced with dynamically changing competitive markets and shifting demands through firm’s life cycle transitions, the sustainable success of immigrant entrepreneurs also relies on their ability to utilise new information rather than relying on past experience to learn about their true (but unknown) abilities and economic environment as the interface between the firm and the market alters. In this context, learning theory presents a compelling framework through which successful immigrant entrepreneurship may be examined and understood. Learning theory explicates a dynamic process that in its simplest form serves to generate new information. This process can occur at the individual, firm, or industry level. In this chapter I will address only the individual dimension of the dynamic learning and its impact on entrepreneur’s success.

5.2.1 How important is behaviour change for entrepreneurial success?

To what extent do immigrant entrepreneurs rely on past experience when taking decisions about their business ventures? And to what extent do they utilise new information about their business performance to learn about their true (but unknown) abilities and trading environment? The answers of the above-addressed questions imply an answer to the underlying composite question: ‘How important is behaviour change for entrepreneurial success?’ that I seek to examine theoretically in this chapter. I do so by building a model in which entrepreneurs continually receive valuable noisy market signals, which they use to update their expectations as new information comes in. Additionally, I imbed a dynamic iterative formulation of this process into a model of optimal effort.

Knowing the extent to which immigrant entrepreneurs adjust their beliefs and so engage actively in behaviour change is desirable for several reasons. First, such knowledge might help us to gauge how ‘alert’ entrepreneurs are, in the sense of Kirzner's (1973, 1979) conception of an entrepreneur who observes the market and responds attentively to opportunities he perceives. Second, if immigrant entrepreneurs ignore or react sluggishly to new information then that might hinder their business performance and ultimately the vitality of the economy as a whole (Berry, 1996; Lybaert, 1998). Third, a belief that entrepreneurs are unresponsive to market signals might encourage governments to devise policy interventions such as entrepreneur education and awareness programmes (Sexton et al., 1997). Nevertheless, the suitability of such programmes presumably depends on the extent to which entrepreneurs actually do adjust their beliefs in practice - a parameter that needs to be measured. And fourth, academics, practitioners and policy-makers might be interested in finding out whether particular entrepreneurial groups are more responsive than others are. That might be valuable for targeting support programmes more effectively.

If entrepreneurs learn, and in consequence of, change their behaviour, what do they learn about? According to Minniti and Bygrave (2001), entrepreneurial decisions are a function of two types of knowledge. The first relates to market conditions, opportunities, technologies and/or new business ideas. The second relates to ‘how to be entrepreneurial’, or to the ability in entrepreneurship. In practice, entrepreneurs are rarely perfectly informed about either. For brevity, I refer to their joint impact on the entrepreneur's venture as ‘unobserved productivity’ as several authors (see, for instance, Jovanovic, 1982; Frank, 1988) argue that, in practice, entrepreneurs obtain noisy signals

about unobserved productivity, the noise deriving from stochastic variations such as macroeconomic or sector-specific shocks, or idiosyncratic luck. These entrepreneurs can update their beliefs about the unobserved productivity using both the most recent noisy signal and the past history of previous signals. Researchers following this approach tend to make strong assumption about the unobserved productivity, such as being fixed at some constant level for all time, to which expectations are expected to converge. However, such an assumption will be unrealistic if the underlying market conditions and entrepreneurial abilities change over time.

It is also important to be clear about why immigrant entrepreneurs adjust their beliefs and so engage in learning. In my view, a satisfactory model of this phenomenon should not only shed light on how entrepreneurs adjust their beliefs, but should also endogenise the incentives for doing so. It is, for instance, empirically well established that entrepreneurial learning can add considerable value to business ventures: see, for instance, Abetti (1997), Arrighetti and Vivarelli (1999) and Wesson and de Figueiredo (2001). There exists, therefore, a need for a model that specifies how adjustments to entrepreneurs’ beliefs affect their decisions and improve their subsequent performance. Entrepreneurs, for instance, might only be willing to increase their input of costly effort to their venture if they have just perceived that more favourable market conditions are emerging. In this sense, a better understanding of immigrant entrepreneurial learning and expectations formation also implies a better understanding of what determines their

success (see also Cressy, 1992).50

5.2.2 Former studies on the learning context in entrepreneurial ventures

A latest review of past studies on learning among entrepreneurs concludes, that despite the importance of the issues, research is still at a preliminary stage (Agndal, 1999). In a recent theoretical contribution, commenting on the insightful observation of Kirzner (1973) that the purposeful search of information that follows the discovery of an opportunity is essential to entrepreneurial activity, Minniti and Bygrave (2001) conclude that ‘entrepreneurship is a process of learning, and a theory of entrepreneurship requires a theory of learning’. Nevertheless, with some exceptions (Bailey, 1986; Guth et al., 1991), researchers in the field of entrepreneurship have

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Like Cressy (1992), Minniti and Bygrave (2001) and others, I treat the entrepreneurial venture as a single homogeneous unit. This is not to deny the influence of organisations on individual knowledge and learning, the implications of learning for organisational design, or social learning, which can of course all be very important in a range of different contexts.

devoted little attention to investigate how entrepreneurs learn and change accordingly their behaviour.

Traditionally, research on the psychology of entrepreneurs focused on the cognitive traits, such as risk propensity, need for achievement, and self-confidence, that differentiate entrepreneurs from non-entrepreneurs (Begley and Boyd, 1987; Forlani and Mullins, 2000). Empirical studies aimed at demonstrating the peculiarity of entrepreneurs’ traits, however, seem to have failed to produce conclusive results (Low and MacMillan, 1988). More recently, some studies shifted attention to the cognitive processes and mechanisms, according to which entrepreneurs select and process information, to make sense of the external environment (Nicholls-Nixon et al., 2000; Shane and Venkataraman, 2000). Drawing on cognitive schema theory, Palich and Bagby (1995) observed that entrepreneurs tend to frame opportunities in more favourable way than non-entrepreneurs do. When facing an uncertain business situation, entrepreneurs seem to lay emphasis on strengths and potentials for gain, whereas non- entrepreneurs tend to stress weaknesses and potentials for loss. Busenitz and Barney (1997) compared the way entrepreneurs and managers make decisions, and found that entrepreneurs are inclined to use heuristics – simple decision rules that reduce the complexity of decision processes – more extensively than mangers do. The two authors speculate that these cognitive biases may be beneficial, insofar as they let entrepreneurs catch windows of opportunities even when time constraints do not allow a thorough and rational analysis. Finally, Shane’s study (2000) on different market applications of the same invention supports the argument that opportunity recognition is driven more by the distinctive knowledge possessed by individuals, rather than by their personality characteristics. This idiosyncratic information allows individuals to discover opportunities that others cannot see, even if they are not actively searching for them (Kirzner, 1997).

A distinctive feature of numerous studies on entrepreneurial cognition – be it related to opportunity recognition, risk taking or other – appears to be the assumption that what makes entrepreneurs different is either a set of psychological characteristics or the way they collect, select and process information. Recent theoretical modelling of entrepreneurial learning seems to follow the same approach. Agndal’s research agenda for studying learning among entrepreneurs, for instance, concentrates on individual learning styles (Bailey, 1986), implicitly assuming the existence of a fundamental difference between entrepreneurs and non-entrepreneurs. The dynamic model of Minniti

and Bygrave (2001) of entrepreneurial learning proposes a representation of the way entrepreneurs modify their courses of action over time, on the basis of their experience. In other words, studying entrepreneurial learning has generally been conceived as investigating the unique and distinctive way in which entrepreneurs acquire, store and use knowledge (Agndal, 1999; Minniti and Bygrave, 2001). In this sense, what makes my theoretical formulation unique?

5.2.3 What makes my theoretical formulation unique?

Several previous researchers have suggested that the establishment and development of enterprises involves ongoing adjustment of original plans and beliefs, possibly through an iterative process of trial and error (e.g., Nicholls-Nixon et al., 2000). I conceptualise how immigrant entrepreneurs adjust their beliefs by imagining them comparing the latest noisy signals about their unobserved productivity with their prior expectation. Any divergence between the two conveys potentially valuable information that the entrepreneur can exploit. Like Minniti and Bygrave (2001), I contend that a learning approach based on ongoing adjustment is likely to describe entrepreneurs’ actual behaviour change better than an assumption of ‘rational expectations’. Rational expectations imply that agents learn all there is to know immediately, making only unsystematic and unpredictable forecasting errors. I argue that this presumes a level of knowledge and awareness that few immigrant entrepreneurs are likely to possess in practice.

For these reasons, adaptive expectation adjustment forms the basis of my approach. Additionally, I propose a framework that is theoretically and empirically tractable, and that avoids having to make strong assumptions about unobserved productivity, such as it being fixed at some constant level for all time, to which

expectations converge.51 An assumption of this type will be unrealistic if underlying

market conditions and entrepreneurial abilities change over time. An entrepreneur's ability might improve as he gains experience from managing his venture; and new innovations might impact on an entrepreneur’s venture in a profound and ongoing manner that he, nevertheless, does not fully comprehend at the time.

The analytical framework analysis described here makes three contributions, which to the best of my knowledge are new additions to the literature. First, I propose a

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joint model of entrepreneurial adjustment of beliefs, effort, and performance, which links all of these phenomena together in a unified way. Second, I provide an econometric formulation of the model that enables me to estimate the extent to which immigrant entrepreneurs exploit new information when adjusting their expectations. A key aspect of the formulation is its simplicity and ease of application, placing relatively few demands on the researcher in terms of data requirements, and being amenable to

estimation by regression analysis.52

5.2.4 Structure of this chapter

The reminder of this chapter is organised as follows. First, I introduce the theoretical specification of my model of dynamic behaviour change in an entrepreneurial context. Second, I discuss thoroughly the robustness of the so derived model. More precisely, while investigating the theoretical robustness of the model, I provide an answer to the questions whether there are alternative interpretations of the autoregressive effort, and on the other side, how observable individual- and venture-specific characteristics might change the so specified model. And finally, I go on to discuss what can be learnt about the entrepreneurial success from the beliefs’ adjustment process.