Here we discuss about the Criticism of Risk bearing theory of profit in detailed.
The theory establishes a direct relationship between profit and risk-taking which is not correct. A high degree of risk in an enterprise does not necessarily mean a high rate of profit. Sometimes it so happens that the entrepreneurs incur losses in more risky enterprises. Profits are influenced by several other factors besides risk-taking.
Not all the profits of the entrepreneur are entirely due to risk-taking. A part of the profit is also due to his superior organisational ability or it may be due to the existence of monopoly power or just chance.
As pointed by Professor Carver, 'Profits arise not because risks are borne but because the superior entrepreneurs are able to reduce risks by their business ability, efficiency and skill.' Hence, paradoxically it may be said that entrepreneurs get profits not because of the risks they bear but because of the risks that they do not bear. A successful entrepreneur earns profit by minimising or reducing the risks. Profits therefore are the reward for risk-avoidance or risk-minimisation rather than risk-taking.
According to Prof. Knight not all kinds of risks give rise to profit. He has classified risks as- (a) Known-risks or insurable risks and (b) unknown risks or non-insurable risks.
(a) Known Risks: These are those risks which are known or can be foreseen and therefore due to provision can be made to cover up such risks through insurance. For eg- the risk of a fire or theft in the industry is a known and foreseeable risk and therefore can be insured against by paying a regular premium. The amount of premium so paid becomes a part of the cost of production. According to Prof. Knight an insurable or foreseeable risk is in reality no risk. Profits do not arise due to such insurable risks.
(b) Unknown Risks: There are certain risks in the business which cannot be known or foreseen and therefore cannot be insured against. For eg,- the risks of a loss in the business due to a fall in the demand for the product resulting from a change in fashion or income or other factors. Such risks are unforeseeable and cannot be covered through insurance. According to Prof. Knight profit arises due to the bearing of such unforeseen or non-insurable risks. These risks he refers to as uncertainties.
The risk-bearing theory of profit, therefore, does not provide a satisfactory explanation of the true nature and origin of profit.