Profit Risk Theory
F. B. Hawley emphasized risk taking as the function of the entrepreneur for which he needs the inducement of profit. Every business involves some risk or the other. Since the entrepreneur undertakes risk he becomes entitled to profit. If risk is not properly rewarded nobody would be willing to undertake risk. Higher the risk the greater must be the possibility of profit. We should not forget that the profit of ordinary return on line. Hawley mentioned four types of obsolescence. Hawley held that profit is the reward for risk and responsibilities that the undertaker subject himself to replacement or depreciation is calculated and provided for an item of cost. Obsolescence is not calculable because to anticipate technical progress is difficult. But even then it is counted as a cost. Risk proper is the risk of market provided for as an item of cost. Business risk and certainty are not provided for in costs in the conventional sense. The entrepreneur bears these in anticipation of profit. But for profit, nobody will bear these risks. They are called staying in business. The greater the amount of risk involved in a business higher is the expected profit necessary to induce entrepreneur to bear risk.
Criticisms:
The theory is criticized on the following grounds:
1. Prof. Carver said that profit accurse to the entrepreneur not because he undertake risk, but because he avoids risk with the use of his business ability. Profit is the reward for risk reduction instead of risk-taking.
2. According to critics there is no direct relationship between profit and risk-taking. In reality, many other factors besides risk influence profit.
3. According to Knight, there are two types of risks: (i) foreseeable risk and (ii) unforeseen risk. The former can be anticipated and provided against through insurance. For example the risk of fire in a factory can be covered through fire insurance. The premium so paid may be makes provision against it; it creases to be risk.
Unforeseen risk on the other hand cannot be foreseen by entrepreneur and as such they cannot be covered through insurance. For example, the risk of commercial loss in business is an unforeseeable risk or uncertainty risk.
The above criticisms make that it considers profit is not satisfactory. Its main handicap is that it clear risk as the sole determination of profit. Since risk is an entrepreneur determinant of profit, the theory has some truth in it.
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