Advertisement

Small Business Economics

, Volume 47, Issue 4, pp 819–834 | Cite as

Decision biases and entrepreneurial finance

  • Gordon K. Adomdza
  • Thomas Åstebro
  • Kevyn Yong
Article

Abstract

We study the effects of three cognitive biases by the entrepreneur on obtaining funding. We find planning fallacy to increase funding amounts, whereas optimism and overconfidence by the entrepreneur have no effects on funding amounts from others. Further, planning fallacy positively impacts the probability of strong-tie (inside) investments but negatively impacts the probability of weak-tie (outside) investments. Mediation analyses further show that planning fallacy positively impacts venture performance through both self and other investor funding amounts. Our findings are not consistent with the pecking order theory of informal finance and suggest positive effects of at least one cognitive bias on entrepreneurial business success through increased funding.

Keywords

Entrepreneurship Decision biases Cognitive biases Entrepreneurial finance Informal finance Fundraising Social ties Venture performance 

JEL Classifications

L26 D81 

References

  1. Arabsheibani, G. D., de Meza, D., Maloney, R. J., & Pearson, B. (2000). And a vision appeared unto them of a great profit: Evidence of self-deception among the self-employed. Economic Letters, 67, 35–41.CrossRefGoogle Scholar
  2. Armor, D. A., & Taylor, S. E. (1998). Situated optimism: Specific outcome expectancies and self-regulation. Advances in Experimental Social Psychology, 30, 309–379.CrossRefGoogle Scholar
  3. Åstebro, T., Jeffrey, S. A., & Adomdza, G. (2007). Inventor perseverance after being told to quit: The role of cognitive biases. Journal of Behavioral Decision Making, 20(3), 253–272.CrossRefGoogle Scholar
  4. Åstebro, T., & Koehler, D. (2007). Calibration accuracy of a judgmental process that predicts the commercial success of new product ideas. Journal of Behavioral Decision Making, 20(4), 381–403.CrossRefGoogle Scholar
  5. Åstebro, T., & Serrano, C. (2015). Business partners: Complementary assets, financing and the commercialization of inventions. Journal of Economics and Management Strategy, 24(2), 228–252.CrossRefGoogle Scholar
  6. Baron, R. A. (1998). Cognitive mechanisms in entrepreneurship: Why and when entrepreneurs think differently than other people. Journal of Business Venturing, 13, 275–294.CrossRefGoogle Scholar
  7. Baron, R. M., & Kenny, D. A. (1986). The moderator–mediator variable distinction in social psychological research: Conceptual, strategic and statistical considerations. Journal of Personality and Social Psychology, 51, 1173–1182.CrossRefGoogle Scholar
  8. Bohner, G., & Dickel, N. (2011). Attitudes and attitude change. Annual Review of Psychology, 62, 391–417.CrossRefGoogle Scholar
  9. Bohner, G., Dykema-Engblade, A., Tindale, R. S., & Meisenhelder, H. (2008a). Framing of majority and minority source information in persuasion. When and how “consensus implies correctness. Social Psychology, 39, 108–116.CrossRefGoogle Scholar
  10. Bohner, G., Erb, H. P., & Siebler, F. (2008b). Information processing approaches to persuasion integrating assumptions from the dual- and single-processing perspectives. In D. W. Crano & R. Prislin (Eds.), Attitudes and attitude change (pp. 161–188). New York: Psychology Press.Google Scholar
  11. Buehler, R., Griffin, D., & Peetz, J. (2010). Chapter one—The planning fallacy: Cognitive, motivational, and social origins. In P. Z. Mark (Ed.), Advances in experimental social psychology (Vol. 43, pp. 1–62). Cambridge: Academic Press.Google Scholar
  12. Buehler, R., Griffin, D., & Ross, M. (1994). Exploring the “planning fallacy”: Why people underestimate their completion times. Journal of Personality and Social Psychology, 67, 366–381.CrossRefGoogle Scholar
  13. Busenitz, L. W., & Barney, J. W. (1997). Differences between entrepreneurs and managers in large organizations: Biases and heuristics in strategic decision-making. Journal of Business Venturing, 12(6), 9–30.CrossRefGoogle Scholar
  14. BusinessWeek. (2006). Think twice before borrowing from family, April 19, 2006.Google Scholar
  15. Camerer, C. F., & Lovallo, D. (1999). Overconfidence and excess entry: An experimental approach. American Economic Review, 89, 306–318.CrossRefGoogle Scholar
  16. Casamatta, C. (2003). Financing and advising: Optimal financial contracts with venture capitalists. Journal of Finance, 58, 2059–2086.CrossRefGoogle Scholar
  17. Cassar, G. (2010). Are individuals entering self-employment overly optimistic? An empirical test of plans and projections on nascent entrepreneur expectations. Strategic Management Journal, 31(8), 822–840.Google Scholar
  18. Chen, X.-P., Xin, Y., & Kotha, S. (2009). Entrepreneur passion and preparedness in business plan presentation: A persuasion analysis of venture capitalists’ funding decisions. Academy of Management Journal, 52(1), 199–214.CrossRefGoogle Scholar
  19. Clogg, C. C., Petkova, E., & Haritou, A. (1995). Statistical methods for comparing regression coefficients between models. American Journal of Sociology, 100, 1269–1293.Google Scholar
  20. Dew, N., Read, S., Sarasvathy, S., & Wiltbank, R. (2009). Effectual versus predictive logics in entrepreneurial decision-making: Differences between experts and novices. Journal of Business Venturing, 24(4), 287–309.CrossRefGoogle Scholar
  21. Dushnitsky, G. (2009). A cross-country study of entrepreneurial optimism and valuations. Working paper http://dushnitsky.com/research.html
  22. Dushnitsky, G. (2010). Entrepreneurial optimism in the market for technology inventions. Organization Science, 21(1), 150–167.CrossRefGoogle Scholar
  23. Erb, H.-P., Pierro, A., Mannetti, L., Spiegel, S., & Kruglanski, A. W. (2007). Biased processing of persuasive information: On the functional equivalence of cues and message arguments. European Journal of Social Psychology, 37, 1057–1075.CrossRefGoogle Scholar
  24. Evans, D. S., & Jovanovic, B. (1989). An estimated model of entrepreneurial choice under liquidity constraints. Journal of Political Economy, 97(4), 808–827.CrossRefGoogle Scholar
  25. Fischhoff, B., Slovic, P., & Lichtenstein, S. (1977). Knowing with Certainty: The Appropriateness of extreme confidence. Journal of Experimental Psychology: Human Perception and Performance, 3(4), 552–564.Google Scholar
  26. Gibson, R., Tanner, C., & Wagner, A. F. (2014). Preferences for truthfulness: Heterogeneity among and within individuals. American Economic Review, 103, 532–548.CrossRefGoogle Scholar
  27. Graham, J. W., & Hofer, S. M. (2000). Multiple imputation in multivariate research. In T. D. Little, K. U. Schnabel, & J. Baumert (Eds.), Modeling longitudinal and multiple-group data: Practical issues, applied approaches, and specific examples (pp. 201–218). Hillsdale, NJ: Erlbaum.Google Scholar
  28. Granovetter, M. (1974). Getting a job: A study of contacts and careers. Cambridge, MA: Harvard University Press.Google Scholar
  29. Greene, W. H. (2003). Econometric analysis (5th ed.). New Jersey: Prentice Hall.Google Scholar
  30. Griffin, D., & Tversky, A. (1992). The weighing of evidence and the determinants of confidence. Cognitive Psychology, 24, 411–435.CrossRefGoogle Scholar
  31. Hellmann, T., & Puri, M. (2002). Venture capital and the professionalization of start-up firms: Empirical evidence. Journal of Finance, 57(1), 169–197.CrossRefGoogle Scholar
  32. Hmieleski, K. M., & Baron, R. A. (2009). Entrepreneurs’ optimism and new venture performance: A social cognitive perspective. Academy of Management Journal, 52(3), 473–488.CrossRefGoogle Scholar
  33. Holt, D., Smith, M. F., & Winter, P. D. (1980). Regression analysis of data from complex surveys. Journal of the Royal Statistical Society. Series A (General), 143(4), 474–487.CrossRefGoogle Scholar
  34. Kahneman, D. (2011). Thinking, fast and slow. London: Penguin.Google Scholar
  35. Kahneman, D., & Lovallo, D. (1993). Timid choices and bold forecasts: A cognitive perspective on risk-taking. Management Science, 39, 17–31.CrossRefGoogle Scholar
  36. Kahneman, D., & Tversky, A. (1972). Subjective probability: A judgment of representativeness. In D. Kahneman, P. Slovic, & P. Tversky (Eds.), Judgment under uncertainty: Heuristics and biases. Cambridge: Cambridge University Press.Google Scholar
  37. Kahneman, D., & Tversky, A. (1996). On the reality of cognitive illusions: A reply to Gigerenzer’s critique. Psychological Review, 103, 582–591.CrossRefGoogle Scholar
  38. Keh, H. T., Foo, M. D., & Lim, B. C. (2002). Opportunity evaluation under risky conditions: The cognitive processes of entrepreneurs. Entrepreneurship Theory & Practice, 27(2), 125–149.CrossRefGoogle Scholar
  39. Koellinger, P., Minniti, M., & Schade, C. (2007). I think I can, I think I can—Overconfidence and entrepreneurial behavior. Journal of Economic Psychology, 28(4), 502–507.CrossRefGoogle Scholar
  40. Lee, S., & Persson, P. (2015). Financing from family and friends. (September 10, 2015). IFN Working Paper No. 933; NYU Stern Working Paper FIN-12-007; ECGI—Finance Working Paper No. 358. http://ssrn.com/abstract=2086625.
  41. Moore, D. A., & Healy, P. J. (2008). The trouble with overconfidence. Psychological Review, 115(2), 502–517.CrossRefGoogle Scholar
  42. Nagy, B. G., Pollack, J. M., Rutherford, M. W., & Lohrke, F. T. (2012). The influence of entrepreneurs’ credentials and impression management behaviors on perceptions of new venture legitimacy. Entrepreneurship Theory and Practice, 36(5), 941–965.CrossRefGoogle Scholar
  43. Oregon Research Institute. (2001). A scientific collaboratory for the development of advanced measures of personality traits and other individual differences. http://ipip.ori.org/.
  44. Oskamp, S. (1965). Overconfidence in case-study judgements. Journal of Consulting Psychology, 2, 261–265.CrossRefGoogle Scholar
  45. Petty, R. E., & Cacioppo, J. T. (1986). The elaboration likelihood model of persuasion. Advances in Experimental Social Psychology, 19, 123–205.CrossRefGoogle Scholar
  46. Pollack, J. M., Rutherford, M. W., & Nagy, B. G. (2012). Preparedness and cognitive legitimacy as antecedents of new venture funding in televised business pitches. Entrepreneurship Theory and Practice, 36(5), 915–939.CrossRefGoogle Scholar
  47. Puri, M., & Robinson, D. T. (2007). Optimism and economic choice. Journal of Financial Economics, 86(1), 71–99.CrossRefGoogle Scholar
  48. Robinson, D., & Robb, A. (2014). The capital structure decisions of new firms. Review of Financial Studies, 27(1), 153–179.CrossRefGoogle Scholar
  49. Scheier, M. F., Carver, C. S., & Bridges, M. W. (1994). Distinguishing optimism from neuroticism (and trait anxiety, self-mastery, and self-esteem): a reevaluation of the Life Orientation Test. Journal of Personality and Social Psychology, 67(6), 1063.CrossRefGoogle Scholar
  50. Scheier, M. F., Carver, C. S., & Bridges, M. W. (2001). Optimism, pessimism, and psychological well-being. In E. C. Chang (Ed.), Optimism and pessimism: Implications for theory, research, and practice (pp. 189–216). Washington, DC: American Psychological Association.CrossRefGoogle Scholar
  51. Schwardmann, P., & Van der Weele, J. J. (2016). Deception and self-deception. Tinbergen Institute Discussion Paper, TI 2016-012/I. Available at SSRN: http://ssrn.com/abstract=2734736.
  52. Shane, S., & Cable, D. (2002). Network ties, reputation, and the financing of new ventures. Management Science, 48(3), 364–381.CrossRefGoogle Scholar
  53. Shanteau, J. (1988). Psychological characteristics and strategies of expert decision makers. Acta Psychologica, 68(1–3), 203–215.CrossRefGoogle Scholar
  54. Shanteau, J. (1992). How much information does an expert use? Is it relevant? Acta Psychologica, 81(1), 75–86.CrossRefGoogle Scholar
  55. Simon, M., & Houghton, S. M. (2002). The relationship among biases, misperceptions and introducing pioneering products: Examining differences in venture decision contexts. Entrepreneurship Theory and Practice, 27, 105–124.CrossRefGoogle Scholar
  56. Simon, M., & Shrader, R. C. (2012). Entrepreneurial actions and optimistic overconfidence: The role of motivated reasoning in new product introductions. Journal of Business Venturing, 27(3), 291–309.CrossRefGoogle Scholar
  57. Taylor, S. E., Pham, L. B., Rivkin, I. D., & Armor, D. A. (1998). Harnessing the imagination: Mental simulation, self-regulation, and coping. American Psychologist, 53(4), 429–439.CrossRefGoogle Scholar
  58. Trivers, R. (1985). Social evolution. Menlo Park, CA: The Benjamin-Cummings Publishing Company.Google Scholar
  59. Van Buuren, S., Boshuizen, H. C., & Knook, D. L. (1999). Multiple imputation of missing blood pressure covariates in survival analysis. Statistics in Medicine, 18, 681–694.CrossRefGoogle Scholar
  60. Van den Steen, E. (2004). Rational overoptimism (and other biases). The American Economic Review, 94(4), 1141–1151.CrossRefGoogle Scholar
  61. Von Hippel, W., & Trivers, R. (2011). The evolution and psychology of self-deception. Behavioral and Brain Sciences, 34(1), 1–16.CrossRefGoogle Scholar
  62. Wanous, J. P., & Hudy, M. J. (2001). Single-item reliability: A replication and extension. Organizational Research Methods, 4, 361–375.CrossRefGoogle Scholar
  63. Weesie, J. (1999). Seemingly unrelated estimation and the cluster-adjusted sandwich estimator. STATA Technical Bulletin, STB, 52, 34–47.Google Scholar
  64. Wong, A., Bhatia, M., & Freeman, Z. Freeman. (2009). Angel finance: The other venture capital. Strategic Change, 18, 221–230.CrossRefGoogle Scholar

Copyright information

© Springer Science+Business Media New York 2016

Authors and Affiliations

  • Gordon K. Adomdza
    • 1
  • Thomas Åstebro
    • 2
  • Kevyn Yong
    • 3
  1. 1.Ashesi University CollegeAccraGhana
  2. 2.HEC ParisJouy-en-JosasFrance
  3. 3.ESSEC Business SchoolSingaporeSingapore

Personalised recommendations