This is the first in this year’s series of posts by PhD students on the job market.
Across low- and middle-income countries, most businesses are small and grow slowly. Economists have long pointed to credit constraints, poor management, or limited demand as explanations. But even when small firms have opportunities to expand, many hesitate. My research investigates a different barrier to private enterprise growth: firm risk aversion.
The prevailing view of firms in high-income settings is that they are risk neutral because investors in firms have diversified portfolios and managers typically do not own corporations. In practice, this means that enterprises will pursue investments with positive average returns even if they are risky. But the modal firm in low and middle-income countries is small and owner-operated, meaning that business losses may directly impact owners’ consumption. This may deter small firms from pursuing high average return but uncertain investments, constraining growth.
In my job market paper, I test whether fear of short-term losses discourages small firms from experimenting with new, potentially profitable products. Using two field experiments with over 1,200 Kenyan retailers, I find that reducing business risk—temporarily or through insurance—dramatically increases investment, consistent with the idea that owner-operators’ personal risk preferences can constrain firm growth. I then show that this lack of experimentation prevents firms from learning about product profitability in the longer-run: retailers temporarily shielded from the risk of stocking a new product go on to permanently stock it and report higher profits, but shops without insurance never discover it.
Why Small Retailers Avoid Risk
In 2020, a major Kenyan motorcycle importer invested over USD $3 million in a new factory to produce effective motorcycle helmets near Nairobi. The factory produces one of the first helmets that delivers meaningful safety benefits to the wearer (it complies with Kenya’s safety standards) while still being affordable to a typical household. Yet retail adoption was surprisingly slow: although more than half of nearby shops believed selling helmets would be profitable, under 6% stocked them two years after the factory was opened.
Descriptive evidence suggests that firm risk aversion may explain this mismatch: shops were particularly unlikely to stock helmets if they reported uncertain beliefs about the profitability of helmets, even if the perceived average returns were high. Motivated by this, I implemented two field experiments to test if risk aversion affects firms’ stocking decisions and prevents them from engaging in experimentation required to discover profitable new products.
Experiment 1: Testing Whether Firms Are Risk Averse
The first experiment, the Insurance Experiment, directly tested whether firms behave as if they are risk averse. I offered 350 small retailers in western Kenya the chance to buy helmet stock either with or without an insurance contract. If firms purchased helmet stock and then failed to sell out by a follow-up survey, they received a payment to offset some of their losses. The contract was designed to isolate whether firms are risk averse: under risk neutrality, it was strictly dominated—it lowered expected profits but reduced downside risk. Both treated and control firms were aware of the contract and its random assignment so that receipt of insurance did not send a signal to treated shops, and shops were not permitted to restock if they accepted the insurance payout so that the contract would not undermine incentives to sell out.
If firms were risk neutral, insurance shouldn’t matter. Yet the results were striking: insurance increased stocking by 50% (10 percentage points), with the largest effects among shops whose owners exhibited high personal risk aversion in a lottery choice game. For comparison, only 30% of firms had tried stocking any new product in the past year. The results were not driven by new or flailing firms: longer tenured and larger enterprises also exhibited large responses to the insurance contract.
Figure 1: Effects of insurance on helmet stocking rate by firm age and size
Experiment 2: Lowering Risk Temporarily to Unlock Learning
The Insurance Experiment indicates that risk aversion affects firms’ stocking decisions. But is this because helmets are new, and does this matter for longer-run productivity? The second experiment, the Learning Experiment, followed 929 Nairobi retailers who had long known about the new helmets but still hesitated to sell them. I offered two randomly assigned treatments to test if risk aversion prevents retailers from engaging in new product experimentation required to learn about profitable new goods.
In the first treatment, I temporarily offered some shops a returns policy: they could send back unsold helmets for a refund. During this first phase, adoption jumped from 6.8% to 16.4%, a 240% increase.
The real test came later. Once the return option expired and all firms faced the same risk, the previously treated shops remained 70% more likely to stock helmets. They had learned that the product was profitable—and kept selling it. Firms reported that this helped them expand their business profitability: with the average adopter reporting that selling helmets made their shop about 10% more profitable by the endline survey, with most firms reporting plans to expand how much they stock.
Could these persistent effects simply be because shops failed to account for the learning value of trying out helmet sales in their stocking decisions? I test this through a second experimental arm, the supplier commitment, that raised the value of learning without affecting short-run profits. I committed to help treated shops restock from the supplier when the study ended (many expressed concerns that they would be unable to do so without help), ensuring that shops could continue selling helmets if they found them profitable. This increase in the future value of information increased upfront stocking by 80%, showing that low helmet experimentation was not simply a result of firm myopia. Another possible story is that shops could have simply underestimated helmet profitability. But I show that the beliefs of shops induced to try stocking by the return policy were optimistic but uncertain, and experience in the market resolved their uncertainty about profitability but did not change mean profit expectations.
Taken together, these results indicate that the return policy caused shops deterred from trying to stock helmets by risk aversion to experiment, who then overcame uncertainty with experience and no longer viewed stocking as risky. The results indicate a permanent change in the production function of complying retailers that helped them grow.
Policy Lessons
The evidence shows that risk aversion itself—independent of credit or information constraints—can trap firms in low-growth equilibria. Three lessons emerge:
1. Temporary risk-reduction policies can have permanent effects.
2. Insurance for experimentation can be highly cost-effective.
3. Uncertainty about the profitability of new products can prevent their retail diffusion even when they are demanded and available.
Temporary interventions that lower the cost of experimentation can unlock lasting growth, even without changing long-run fundamentals.
Grady Killeen is a PhD candidate in Economics at the University of California, Berkeley.
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