Newly self-employed people are overly optimistic about their future life satisfaction; this overoptimism also holds for successful entrepreneurs who remain in business

Are Newly Self-Employed Overly Optimistic About Their Future Well-Being? Reto Odermatt, Nattavudh Powdthavee, Alois Stutzer. Journal of Behavioral and Experimental Economics, October 31 2021, 101779. https://doi.org/10.1016/j.socec.2021.101779

Highlights

• We study if newly self-employed people accurately predict their future well-being

• We use individual panel data to compare expected and the realized life satisfaction

• Newly self-employed people are too optimistic about their future life satisfaction

• The overoptimism also holds for successful entrepreneurs who remain in business

• We discuss reasons for the misprediction such as underestimating heavy workload

Abstract: The formation of expectations is considered a fundamental aspect of the decision process when people reason about entering self-employment. We evaluate the accuracy of newly self-employed individuals’ predictions of their overall future well-being. Based on individual panel data for Germany, we find that they, on average, are overly optimistic when we compare their predictions right after the status change with their actual life satisfaction five years later. This finding is robust to controlling for any time invariant personality traits like individual optimism. And it also holds for those self-employed individuals who successfully remain in business for at least five years. A possible reason for the biased prediction might be that they underestimate the heavy workload reflected in higher working hours than desired, as well as the decline in leisure satisfaction after the status change.

Keywords: Self-employmentoveroptimismlife satisfactionprojection biaspredicted well-being

JEL D83 D91 J20 I31

6. Concluding remarks

The formation of expectations is a fundamental part of the process when people decide about becoming self-employed. Our evaluation of the expectations and experiences of people who become self-employed in Germany allowed us to examine empirically some of the popular beliefs about the (well-being) consequences of self-employment. We made use of the large German Socio-Economic Panel including information about people's work environment, work conditions as well as their evaluation of their satisfaction with various aspects of their work and private life. Importantly, we studied people's predictions of how satisfied they expect to be five years in the future and compare these predictions with the actual realizations five years later.

We showed that, irrespective of their stable optimistic personality traits, people who enter self-employment tend to be overly optimistic about how satisfied they will be with their lives in the future. This overoptimism is prevalent even for the successful self-employed who manage to remain self-employed for at least five years, which suggests that overoptimism is not caused entirely by people mispredicting their own probability of success in the business.9 Rather, it is more likely to be caused by people putting too much weight on the positive work engagement and too little weight on the amount of workload when making a forecast about what their life would be like as a self-employed, which is consistent with findings in the affective forecasting literature (Wilson and Gilbert, 2003, 2013). This is reflected in the evidence that self-employed people report lower leisure satisfaction and an increase in the number of hours worked that go beyond the desired level of working hours in the years after the transition. However, one promise of becoming self-employed seems to come true, namely that these people, on average, report an increase in autonomy in their occupational actions.

There are several limitations to drawing general welfare implications from our findings. First, although our results suggest that some people might only have entered self-employment due to overoptimism, the current empirical framework simply does not allow us to test such a hypothesis directly. Second, even if unrealistic expectations tend to be observed generally with the decision to become self-employed, people who take that leap but do not succeed may still gain valuable experiences from doing so. For example, first time failure might lead to a higher success rate when they run a self-employed activity for a second time. They may also become more satisfied when they return to paid employment as they might value a secure income and regular working hours more after the experience. Third, the observed overoptimism might reflect motivated beliefs (Bénabou and Tirole 2016) for which accuracy might not be the only objective as beliefs also serve an important purpose of motivating people so that they persevere with putting in effort to achieve goals. This instrumental aspect emphasizing the enhancement of self-efficacy is complemented by other motives as people might want to share beliefs in accordance with their peer group or their self-image. Fourth, the individual perspective also neglects welfare effects at the societal level. Successful as well as failed self-employment might contribute to the development of new products and services creating positive spillovers in society.

In future research, we need to better understand how the beliefs about the value of self-employed activities are formed and to what degree they influence people's decision to enter self-employment. In particular, it would be interesting to understand how the beliefs are related to the treatment of “successful” and “failed” business owners in society. This is an issue of entrepreneurial and self-employment culture but also the choice of legal institutions. A more complete understanding of how different institutional environments relate to actual as well as expected outcomes of latent and actual self-employed individuals will contribute productively to the policy discourse on self-employment and entrepreneurship.