Research articles1

Research Article # 1

Towards an interdisciplinary theory of Entrepreneurship

Entrepreneurship is a least understood topic in economics.

First part

Review role of entrepreneur in economic thought and conclude still no consensus on the theory of
Entrepreneurship.

Second part

Definition: Entrepreneurship is understood as the pursuit of opportunities without regard to resources
currently controlled.

Based on this definition, we study contributions of

- Economic decision theory
- Sociological system theory
- Psychoanalytical research and Behavioral studies.

Then the article proposes an interdisciplinary approach to development of theory.

Discussion : Importance of entrepreneurship

Shifting of jobs and whole industries
Lack of innovation in economy
Problem of unemployment and creation of jobs
Alternate to search of jobs
Distribution of economically relevant info. (von Hayek 1945)

Is a farmer (who tills land of landowner) an entrepreneur ?
Pays fix sum of money, profit uncertain and of a residual nature as cost is fixed, income
is not.

Is an author an entrepreneur?

J.B.Say (1803) “A person who shifts economic resources out of an area of lower and into an area of
higher productivity and greater yield”.

Hence stresses importance of change and innovation within an economic system but
also describes entrepreneur as an agent of change.

Neo-classical theory Began with Marginal Utility revolution (end of 19th century)

Introduction to classical and Neo-classical theories

The "Classical Theory" was developed by Adam Smith...
The classical "substance" theories of value, which took value to be a property inherent in an object gradually gave way to a
perspective in which value was associated with the relationship between the object and the person obtaining the object.

In the 1870s and 1880s, began to base value on the relationship between costs of production and "subjective elements,"
later called "supply" and "demand." This came to be known as the Marginal Revolution in economics and the overarching
theory that developed from these ideas were called Neo-classical economics.

Buyers attempt to maximize their gains from getting goods, and they do this by increasing purchases of a good until what
they gain from an extra unit is just balanced by what they have to give up to obtain it. In this way they maximize "utility"—
the satisfaction associated with the consumption of goods and services.

Producers attempt to produce units of a good so that the cost of producing the incremental or marginal unit is just
balanced by the revenue it generates. In this way they maximize profits.

Firms also hire (or fire) employees up to the point that the cost of the additional hire (or fired) is just balanced by the value
of output that the additional employee would produce (or would be lost).

At some price of cars, for example, I want to buy a new car. At that same price others may also want to buy cars. But
manufacturers may not want to produce as many cars as we all want. Our frustration may lead us to "bid up" the price of
cars, eliminating some potential buyers and encouraging some marginal producers.

The fundamental assumptions (not open to discussions):

1. People have rational preferences among outcomes. 2. Individuals maximize utility and firms maximize profits. 3. People
act independently on the basis of full and relevant information.

Hebert and Link (1988) give overview of different roles given to entrepreneur over 200 years –

1 Who assumes risk associated with uncertainity German* & Chicago schools
2 Who supplies financial capital
3 Is an innovator German
4 Is a decision maker Chicago
5 Is an industrial leader German
6 Is a manager or a superintendent
7 Is an organizer and coordinator of economic resources German
8 Is an owner of enterprise
9 Is an employer of factors of production
10 Is a contractor
11 Is an arbitrageur Austrian & Chicago school of thought
12 Is an allocator of resources among alternate uses Austrian & Chicago

* Schumpeterian tradition.
2,6,8 and 9 are Static (others dynamic) and doesn’t contribute to understanding of entrepreneur.

Theory of Economic development (Schumpeter, 1911) is most famous economic model of entrepreneurship

- ‘innovation or new combinations ‘

Knight and Chicago school - ‘uncertainity and being risk bearer’
Kirzner and Austrian school - ‘discoverer of new opportunities’ or ‘alert discoverer’

Knight and Chicago school - ‘uncertainity and being risk bearer’

‘The profit of entrepreneur is compensation for bearing uncertainity’ (Knight, 1921).
Entrepreneur bears the risk and ‘insures’ the doubtful and timid by guaranteeing the latter a specified income.

Risk is one of the main elements and Risk is consequence of controllable or uncontrollable change.
Difference between risk and uncertainity is that latter can not be measured in % - Risk is calculable, uncertainity
is not (Knight, 1921).

Schumpeter - ‘entrepreneur as innovator’ or ‘carrying out new combinations’.

Criticized Knight for not distinguishing between entrepreneur and resource owner.
Hence Risk not essential until both are same.

5 Categories of action covered by innovation:

1 Intro of new good or quality of good
2 Intro of new method of production
3 Opening of new market
4 Utilization of new source of supply of raw material or intermediate
goods
5 Carrying out new organizational form

Discussion: If ownership not essential, then are managers entrepreneurs?

Class discussion: ‘‘Pure’ entrepreneur has nothing but his alertness’ (Krizner)

Kirzner and Austrian school - ‘discoverer of new opportunities’ or ‘alert discoverer’

Austrian concept of ‘imperfect distribution of info’.

Krizner’s is market process theory which accepts imperfect knowledge and describes market as process of
discovery and learning.

- Discovering you paid more, then use knowledge for next transaction etc.
- Forced to use new knowledge because of competition.

The psychological contribution: The ‘trait ‘approach

Discussion: Are entrepreneurs different from non-entrepreneurs?
Is only founder entrepreneur or the employed managers also entrepreneur?
Will an manager always be an manager or can he / she become an entrepreneur?

The problem of trait analysis is like a high need of achievement, self-confidence/ locus of control, Risk-taking,
personal values etc is that it seems to assume it to be a particular person and a fixed state of existence (see
discussion point 2 above).

The behavioral approach

If we accept entrepreneurship is creation of new organizations, new combinations etc and
entrepreneurship is a behavioral concept, then …

…do the behaviors cease once the org. creation is over?

Then, if entrepreneur settles down to manage as others then it is not a functional approach?


Cognitive Mechanisms:
Why and when do entrepreneurs think differently than other people?

Discussions: Are entrepreneurs different from non-entrepreneurs?
Why do some people but not others, recognize and create new opportunities?
Ultimately why are some entrepreneurs more successful than others?

This article builds a bridge between ‘entrepreneurial research’ and the large literature on ‘cognitive’
mechanisms.
It then examines various biases and errors that impact the thinking of entrepreneurs and develops various
hypothesis (very interesting).

The basic research tells us that our cognitive processes are far from rational; in fact our thinking is often
influenced by a number of sources of bias and error.

And entrepreneurs actually work in situations and under conditions that would be expected to maximize the
impact of such factors ! Entrepreneurs specifically face situations that tend to overload their information
processing capacity and characterized by high levels of …. Uncertainity, novelty, emotions, time-pressure
etc.

Discussion: Are entrepreneurs more susceptible to a number of cognitive biases?

Cognition is a group of mental processes that includes attention, memory, producing and understanding
language, solving problems, and making decisions. Cognition is studied in various disciplines and usage of the
term varies in different disciplines; for example in psychology and cognitive science, it usually refers to an
information processing view of an individual's psychological functions.

The introduction:

Questions on previous page..
Initial answers focused on ‘personal characteristics’ i.e. the trait approach..psychological contribution

e.g. still assume that entrepreneurs are far above average in – willingness to take risk
desire to excel
personal optimism
tolerance for ambiguity
power preference for shaping own destiny etc

Surprisingly researchers could not pin down clear-cut differences !

Hatten, 1997 stated “the conclusions of last 30 years of research indicate that there are no personality
characteristics that predict who will be a successful entrepreneur…come in every shape, size, color and from all
backgrounds”.

But cognitive psychology rose to prominence in psychology and other behavioral sciences and has added greatly
to our understanding of – how we reason, form judgments, reach decisions etc.

Kahneman & Lovallo (1994) in a though provoking article state –

Entrepreneurs in particular make ‘rosy’ forecasts about future business results is
that they tend to focus on specific, current situation (“inside view”) while largely
ignoring outcomes of previous, related situations (‘outside view) that might serve
to inform their current judgments. Daniel Kahneman, Nobel Prize 2002

Human cognition and implications for entrepreneurship –

1 Our capacity to process new info is severely limited and is readily exceeded (‘overload’)
2We seek to minimize cognitive efforts just as we seek to minimize physical effort (‘short-cuts’ in thinking – use
techniques that reduce mental effort)
3And because of above two and other factors, we are often less than totally rational in our thinking.

Schumpeter, 1934 - “the entrepreneur seeks to reform or revolutionize the pattern of production by exploiting
an invention or more generally an untried technological possibility…it consists of doing things that are not
generally done in ordinary course of business routines..”.

Holt, 1992 -“entrepreneurs are those who incubate new ideas, start enterprises based on those ideas…have
vision for growth, commitment to constructive change, persistence to gather necessary resources, and energy to
achieve unusual results…”

Any special relevance for entrepreneurs?
Think: What situations do they typically find themselves in.

1 Overload occurs – more info than they can process
2 New situations and high degree of uncertainty – situations in which can not fall back upon existing mental
frameworks (‘schemas’ in cognitive psychology)
3 Emotions run high – complex interplay between feelings and though process. Intense feelings/ emotions
distort in many aspects.
4 Time pressure and are in less than optimal physical state (resort to mental short-cuts, schemas due to
physical fatigue and stress etc)

The situation: Entrepreneurs are exposed often to unknown territory - more intensely and more frequently than
others. Higher emotions – higher stress, higher levels of commitments, longer hours etc.

The question: So they will be more susceptible to errors and biases than others?

5 cognitive errors and biases are -

1 Counterfactual thinking Imagining ‘what might’ have been if you had acted differently.
2 Affect infusion How and when feelings shape thought ..
3 Attributional styles
4 Planning fallacy
5 Escalation of commitment: self justification

1 Counterfactual Thinking :

Engaging in such mental simulations of events (that never occurred) has important effects

1 Emotional state 3 Subsequent decisions
2 Conclusions drawn concerning the ‘causes’ 4 Overt behavior

Simple exercises: When you imagine you worse off (or better off) than currently are …
3 things you regret most in (1) your entire past life and (2) over past 1-2 weeks.

Conclusion
1 First focuses on things you did not do and second on things you did but turned out wrong.
2 Experience of regret is closely related to counterfactual thinking (infact, most closely related aspect).
3 Nature of experience changes over time - initially we regret things we did that yielded disappointment
- over longer periods we tend to regret things we did not do.

What is basis of shift in patterns ?
People are better at coping psychologically with actions they did that turned out badly (can rationalize buy convincing ourselves
we had little choice – cope more effectively, experience less regret) as compared to missed opportunities (the fears and concerns
that prevented you tend to fade and becomes harder for us to understand ‘why’ we didn’t act.)

-VE consequences of actions we take are apparent (actually happened) vs. –VE consequences of actions we
did not take are uncertain – infinite bounded by imagination ! i.e. …

Asymmetries in our counterfactual thinking – action we took produce pattern of decreasing regret and actions
we did not take produce patterns of increasing regret.

Implications of Counterfactual Thinking for comparison between entrep and non-entrep.

Especially prone to regrets over failures to act or missed opportunities.

1 Entrepreneurs meet with many setbacks in early days of new ventures ..
2 Their commitment to their ideas, products and business is intense ..

… It magnifies

negative emotions

H1 More likely to engage in “if only..” thoughts especially in situations where they experience negative
outcomes. So more likely than other people to experience regret or intense regret over past failures to act
which they think are missed opportunities.

H2 Their greater tendency to experience regret or intense regret over missed opportunities constitutes one
reason why they are more likely than others to search for, identify and act upon perceived opportunities.

2 Affect Infusion : How and when feelings shape thought ..

Our current moods or feelings influence our thoughts.
Even mild shifts can influence many aspects of cognition from

Immediate reactions to stimuli Complex judgments & decisions

How do current moods influence cognitive processes?
AIM (Affect Infusion Model) by Forgas, 1995.

Ways in which affective states elicited by ‘one source or experience’ can
influence judgments about other, unrelated events.

Happens through two complex mechanisms
Affect Priming : Current moods influence thoughts by directing it into channels consistent with these moods.

Affect-as-information: Affective states influence judgments and decisions by serving as a heuristic
(a convenient rule for inferring reactions).

When do such effects occur? AIM model suggests that likelihood of Affect Infusion is higher when
individuals engage in careful thought rather than in simpler, relatively
‘automatic’ modes of thought (like recalling previous evaluations).

Why? The latter is so rapid and lacking in effort that there is little opportunity
for current moods to enter the picture.

In contrast ..

When individuals engage in careful, reason thought, there is ample opportunity for Affect Infusion to occur.
So somewhat paradoxically current moods are more likely to influence judgments and decision when …

What is relevance to entrep .?

1 What entrep. do is not routine – involves creating entirely new or modifying what exists in unique ways.
Hence engage a careful, constructive thought more than others. So more susceptible.

2 For Affect Infusion to occur, individuals must experience some emotion or mood in current situation.
Because of their deep commitments they frequently experience intense emotions in relation to work.
So more susceptible.

H3: Because of nature and requirements of their new ventures, entrep. Engage in careful constructive
thought _ more often than other people do.

H4: Entrep. Also experience stronger levels of emotions or affect (mood) than do other people in
relation to work.

H5: As a result of these tendencies, entrep. are more prone to affect infusion than others – that is their
thinking, judgments and decisions are influenced to a greater extent by affective states unrelated to
these thoughts,…..

3 Attributional Style and role of augmenting

We ask ourselves ‘why’ to understand why events occurred by careful observation of information.
Efforts to answer the ‘why’ in social psychology is described by term – Attribution.

It is a reasonable and orderly process but given to a bias -
Self serving Bias or ‘discreet attributional styles’

It consists of 2 distinct and related parts:

1 A strong tendency on part of most individuals to attribute positive outcomes to
internal causes – own skill, talent, good judgment, hard work etc
2 A corresponding tendency to attribute negative outcomes to external cause –
factors beyond their controls, incl. actions of other people, lack of resources ,
equipment etc. Most people show 1 & 2 (except when in depression).

Will she be a successful entrepreneur?

Why entrep. recognize opportunities and decide to pursue them?

1 Entrep. show an unusual strong preference for exerting personal control over their outcomes
(Shaver & Scott, 91) ..at least believe they can more strongly than others

2 Tend to perceive their own abilities, dedication and efforts as critical to success. One reason why they vastly
overestimate the odds. (Woo, Cooper and Dunkelberg, 1988, Kahneman & Lovallo, 94)

When tendencies 1 & 2 are combined, the following hypothesis is suggested -

H4: Entrep. Are more susceptible to the self-serving bias than other people. Specifically they are more
likely to attribute positive outcomes to internal and negative outcomes to external causes.

Important downside of ‘Self-Serving Bias’

Source of interpersonal friction.
An important difference between successful and non-successful entrep.

H4: The thinking of successful entrep. Is influenced to a smaller degree by the self-serving bias than is
the thinking of less successful entrep – that is successful entrep show less tendency to overestimate
their own responsibility for positive outcomes and to underestimate their own responsibility for
negative outcomes.

The Planning Fallacy

Why people often think they can do more, sooner than they really can?

That entrep. underestimate risks and overestimate likelihood of success
are well established facts. But why?

1 Kahneman & Lovallo (1994) because they don’t truly recognise or accept these risks.
It is a ‘Cognitive Blind Spot’ – reason is they tend to create current situation or decision as unique, thus
isolating it from the past (Recall the ‘Inside view’ vs. ‘Outside view’). Thus their forecasts of future are
often anchored not in lessons of the past, but on plans and glowing images of the future.

2 Familiar to all of us - General tendency of all people to overestimate how much they can accomplish
in a given period of time or underestimate the time it will take to accomplish a specific project.
Such examples abound (Kahneman & Lovallo (1994) .

But why is it so common ?

1 When formulating an estimate about how long it will take, most enter a ‘planning mode of thought’ in
which they focus primarily on the future – do not consider past experiences in similar situations because
there are important cognitive obstacles in doing so -

Predictions are by very nature induce ‘future orientation’. …then Attributional processes may interfere
with using such info. In an accurate manner.

2 Even if individuals consider past experiences that took longer than anticipated, because of Self-Serving Bias
they tend to attribute such delays to external factors beyond their control.

Relevance of these findings to entrepneurship ?

1 Entrep. tend to focus primarily on future – perhaps to a greater extent than do other people.
And, they are more susceptible to self-serving bias than other people.

2 Planning fallacy like other cognitive biases tends to operate in kind of situations hat entrep. generally face.
…so they have little relevant experience – so tendency to view present situation as isolated or separated
from past experiences may be increased.

H8 Entrep. are more susceptible to planning fallacy then are other people; this in turn contributes to the overly
confident predictions they make about future outcomes, and to beliefs that they can do more, in less time,
than is actually feasible.

The escalation of commitment : Self-justification

Individuals feel a strong pressure to continue investing time, effort or money or all in even what they recognize
is a loosing proposition.

Research on this indicates the most important factors responsible are –

1 Feelings of responsibility for initial decision
2 the efforts involved in making this decision
3 Concerns about loss of face and image from admitting I am wrong
4 Strong desires to justify one’s initial choice to oneself.

Relevance to entrepreneurs:

They are more susceptible to this because -

1 depth of commitment to ideas
2 More difficult to face ridicule and loss of face (convinced them of positive outcome initially)
3 Deep commitment to their ideas translate into powerful pressures to justify to themselves.

H9: Entrep. Are more susceptible to escalation of commitment than are other people.

The implications:

1 Entrepreneurs thinking may differ in important ways from other people in specifically that they maybe more
susceptible to various kinds of errors and biases than other people.
2 Such differences do not stem primarily from differences with respect to personal traits (while such
differences may exist) but rather the fact that they operate in situations and other conditions that would be
expected to maximize such errors or biases.

The goal would never be to making entrepreneurs entirely resistant to all cognitive sources of errors – of turning
them into totally rationally beings like Mr. Spook of Star Trek fame – looking at world through completely
rationale eyes entrepreneurs may never get started – the odds would appear realistically too daunting !

The goal of studying cognitive errors is primarily that of formulating means for limiting or holding or errors in
check, so that their decisions, their strategies have increased chances of success….

Mechanism Description Relevance to entrepreneurship Predictions/ Hypotheses
or process
Counterfactual Tendency to imagine “If only..” thoughts make you H1 They more likely to have ‘if only’
thinking what might have been dissatisfied with current life outcome. thoughts and experience regrets
in a given situation over missed opportunities.
Missed opportunities may lead to H2 One reason why they more likely
intense regrets and magnification of to search for, identify and act on
lost potential benefits perceived opportunities
Affect infusion Affective states It can lead to serious errors in H3 They engage in careful, effortful
produced by one judgments and decisions including thought more often than other
source influences concerning business situations people.
judgments' and H4 Typically experience stronger
decisions about other, emotions than others. H5 Hence
unrelated sources. more susceptible than others.
Attributional Most attribute positive First leads to over confidence in ones H6 Likely to be more prone to self-
styles outcomes to internal abilities. serving bias than other people.
causes (own talent,
efforts ..) and negative Second leads to interpersonal friction. H7 Successful entrepreneurs are less
to external causes (Self- susceptible to this bias than less
serving bias). successful others.
Planning fallacy Tendency to under These tendencies lead to unrealistic H8 They are more prone t planning
estimate the time to time-tables for completion of tasks. fallacy than others. Hence make
complete or over overly optimistic predictions about
estimate how much future.
they can accomplish in
given time.
Escalation of The tendency to Needless waste of precious resources. H9 They are more susceptible to
commitment: continue investing escalation of commitment effects
self justification time, money and Self justification is an important factor and self justification than others.
efforts in a losing in escalation of commitment.
cause. Justify.


The ‘Informational Basis’ of Entrepreneurial Discovery

Discussion: Is entrepreneurship based on special talents processed by only a few?
Do entrepreneurs have a special knack for doing things than other people?
Are they down-right ‘bold’ than others or are they smarter, more diligent or more ‘alert’?

What is Entrepreneurial Discovery ?

It is an unexpected, yet valuable economic opportunity, such as founding of a new firm, creation of a new
product line, development of innovative technology, the satisfaction of an ephemeral market need through
arbitrage, or the like. For our purpose, we will take a discovery to be valuable if it is monetarily rewarding (only).

But others also would judge the same but fail to notice it.
Lack of vision or talent… Why others fail to notice it ?
If lack of talent, then only the talented should do that ! (but is that correct?)

Lack of understanding ‘how’ ! Still don’t understand ‘how’ entrepreneurs make discoveries as most scholars
study what they ‘do’ after discovery !

Why is discovery important to entrepreneurship?

Provides competitive advantage to a business.
Without it, everything reduces to rules of thumb than can be imitated by competition.
What is risk of venture associated with …is it not the uncertain success of venture? (Yes)

Actually risk also attends choice of the type and means for acquiring information to make initial discovery of
opportunity.

Discussion: How do we acquire information?

We can purchase it like other commodity but Pro’s and cons.

Questions asked on previous slide..
The outcome of discovery process creates value and entrepreneurs create value hence “an entrepreneur is
someone who optimizes the tradeoff between investing too much or too little in specific, risk-reducing signals”.

The economics of discovery – Neo-classical view and Austrian view

Neo-Classical view

Central to it is notion that economic actors are rational and independently operate in markets that are in
equilibrium. At equilibrium, prices are co-determined by rational buyers and suppliers and everyone earns the same level of
profits that is just sufficient to maintain capital investment.

How about no incentive for entrepreneurs to bear risk?

The Austrian view

Markets are in disequilibrium an profits are a disequilibrium phenomenon (Jacobson, 1992).
Disequilibrium allows entrepreneurs to discover market imbalances that offer ways to earn above average returns.
If they can protect their discoveries, they preserve competitive advantage.

Recall Schumpeter ? Carrying out new combinations is entrepreneurship but no clue on ‘how’ they discover.

An information based model of entrepreneurial discovery

Received theory : State of ‘perfect competition’
Assumes markets are accessible by general public as well and are informationally and allocationally efficient.

Informationally efficient – when all buyers and sellers have same information.
Allocationally efficient – when prices are ‘set’ so that they equate “marginal rate of return” (adjusted for risk) for all
buyers and sellers.

Will not all discovery cease?

Proposition #1
Entrepreneurial discovery can only occur where imperfect competition exists.

Further, to answer – are they ‘bold’?
No, they are not bold. Entrepreneurs take on risk because they believe they can manage it using private info. or info with limited
distribution.

Barney, 1986: Entrepreneurs can not generate sustainable above normal returns unless its ‘circumstances’ are
private e.g. Personal contacts, market research, consulting, background investigation, commissioning or buying
research reports, due diligence etc. Private information markets are those that disseminate info that is not
available for general public but little is known about them !

Proposition #2
Entrepreneurial discovery can only occur in private markets for information.

An ‘Information based’ Model of Entrepreneurial discovery

Investments in information Roles

Specific Risk Bearer
Information Security
Signal of Arrangements
Information Innovator
Venture Risk
Channel
Previous Opportunity Evaluatio Discovery
Risk Bearer
Experience n and Innovator

Risk
Arbitrageur

Class discussion: Entrepreneurs are often pictured as welcoming risk, taking chances, bucking odds,
challenging fate, throwing caution to the wind or are they lucky . Do they?

The role of signaling (ref. compendium for diagram)

An information channel is a source of signals.
A signal is a current info that changes our idea about a future state.

Entrepreneurs use information channels to position themselves so that they have access to information about
potential new venture opportunities. The signal tells them how a discovery will affect their future profit.

More valuable when they are unique or at least rare !
They combine signals with previously acquired specific information to provide a competitive advantage.

Conclusion : Entrepreneurs thrive not by qualities described above but by ‘selecting an environment’ that they
view as having an appropriate set of security arrangements, which probably includes being in close proximity to
an info channel. Security arrangements limit the risk of entrepreneurial discovery.

Proposition #3
Entrepreneurs secure their ventures from the risks associated with discovery by tapping into an information
channel from which they obtain risk-reducing signals. So acquisition of such risk reducing signals should be
viewed as an investment of sorts.

Class discussion: Very high probability of loss as long as loss was small vs.
Very low probability of loss where loss could be devastating.

Some researchers say entrepreneurs are ‘moderate’ risk takers. Is it right?

Characterizing their risk-taking propensity as moderate presupposes that they consider risk to be an exogenous
factor over which they have no control. But their confidence in their ability to manage risk comes from a belief
that they can reduce it by comparing relevant risk-reducing signals with what they believe are the discoveries
prospects.

Cost of risk evaluation and how to reduce it?

One way is to specialize in acquisition of info about particular risks e.g. focus on particular industry, limit dealings
with select suppliers and distributors etc.

Proposition #4

Entrepreneurs improve their chances of generating rewards from their discoveries by specializing in acquisition
of info. about particular types of risk.

Proposition #5

The most valuable ‘type’ of info to entrepreneurs in making a discovery is ‘specific’ info about special
circumstances (time and place etc) of a prospective deal (a decision with monetary consequences related to
prospective new venture). Specific info can be controlled and kept private and mostly it is ephemeral (short-lived
utility).

Proposition # 6
Entrepreneurs reduce their risk of discovery through assessment of specific, risk reducing signals.

Proposition # 7
Some entrepreneurs are better suited to assess the criticality of signals as a result of having previously acquired
relevant information.

Proposition #8
Previous experience can serve as a cue to inform entrepreneurs about when to invest in signals related to a
prospective discovery.

Proposition #9
Entrepreneurs evaluate signals in different ways which lead them to play different roles in discover process.

4 Entrepreneurial role in discovery Chief proponent of role Significance of specific information
process to the role
1 Risk bearer Cantillon Uses it to reduce risk while
uncertainty is irreducible.
2 Innovator Schumpeter Uses it to creatively combine
factors of production
3 Risk bearer and innovator Baudeau Uses are similar whether for
competitive circumstances or for
innovator
4 Risk arbitrageur Kirzner Uses it to identify opportunities for
risk arbitrage.


Innovation, Creativity and Success
(Student presentation Group 1)


Networking for innovation
Anecdotal evidences from a large sample study of innovative enterprises

This article is about –

1 What are networks? 5 Is there a relationship between networking and org. performance?
2 Do entrepreneurs network or not? 6 How effectively used by High innovative Group (HIG) vs. Low (LIG)?
3 Different type of networks
4 Nature of entrepreneurial networks

Class discussion: What are networks and do entrepreneurs use them?

What does ‘entrepreneurial process’ involve ?

(The context of the article) It involves receiving scarce resources from the environment, organizing them and
assimilating them into oneself and provision of goods and or services to customers. These activities can not be
undertaken without a degree of networking.

So, Personal networks are an important means for entrepreneur to organize resources.

Class discussion: The short-term and long term objectives of networking.

Short-term objectives
Based on a need to solve an immediate problem, so choice of contacts will be specific and actions more focused.

Long-term objectives
Are rather vague and may be generally defined as

1 increasing firms legitimacy
2 its future access to resources
3 creating support base for future contingencies
4 building credibility with customers, suppliers, employees, investors and others.
5 compensating for absence of track-record and public image
6 pressure for reducing cost (article says most important)
7 context of entrepreneurial discovery : aligning themselves with information channels

Researchers have identified different types/ classification of networks -

Personal/ social networks Are more important during start-up?
Professional networks Are more important latter?

Compulsory and voluntary networks Compulsory – customers, supplier and regulators etc)
Voluntary – Trade associations, accountants, lawyers …

Informal and formal networks Formal is defined as a horizontally managed alliance among
firms where co-ordination is based upon agreement. Informal
do not have a business agenda. Formal may lead to informal
over time.

Objective of study conducted –
Compare policy or behavioral orientation of HIG vs. LIG and see whether networking and org. success is closely
related and whether HIG use networking more effectively.

The findings:

All enterprises whether HIG or LIG are networking entities.

The common means Family, relatives and friends, ethnic groups and community, hobby clubs, trade
associations and business asso.
The differences are - 1 Degree and frequency of usage.
2 LIG relies on the former and HIG relies on latter.
3 HIG choice guided by competencies and resourcefulness not closeness.

HIG tactically and cost-effectively deploy networks for -

1 Manufacturing – especially in start-up phase where market and acceptance is uncertain.

2 Finance – raising finances from own network to retain control even when a good proposition of
finance is available from outside

3 Use of others expertise and knowhow for improving quality of one’s products and services
4 Keeping a high profile of one self and enterprise - reputed people on board, supporting friendly concerns,
leadership in problems affecting peers etc.

5 Aligning with information channels - reducing risk asso. with entrepreneurial discovery

…cont

The identity of a business is built through the market and if you keep a low profile, would find it difficult to grow.

So another difference is 4 HIG rarely uses n/w for marketing
LIG delegate marketing to marketing fed. etc, e.g. Small unit - dealer branding
LIG consider manufacturing to be most important.

9
Innovators use networks in different ways to be benefit their organization -
Basically, innovators use it for managing and or reducing the risk and cost of operations.

1Search for new ideas - typically explorers and seekers and keen observers
2Expertise development - special care to develop own and org. expertise
3Mobilizing funds - lack of funds don’t stop, will creatively use network
4Organizing for initial production - why huge financial commitment until market acceptance
5Marketing through networks - evolving right go-to-market strategy
6Acquiring/ developing people - knack of attracting talented people when small
7Building corporate image - asso. with significant people, agencies, causes etc
8Management of risk - (1) perfecting new product ideas (2) info channel
9Management of growth - Traditional style is acquire and Network style is alliance and
constellation model.

Constellation model - One central or principal business (partner) and rest alliances (all serve and strengthen others). HIG
take care to remain central. Enterprise defines its boundaries depending on partnerships needed at different phases. Resources
outside enterprise i.e. with partners to be used as required.

Conclusions

In pre-start up, n/w done appears to be without focus.

This vague or random multidimensional search slowly becomes more focused to a specific purpose. Then it fans
out again to cover other activities as no. of activities done increases i.e. a network created for one purpose will
serve others.

The innovators are quick in picking up leads for new ideas and follow it up quickly with others in network.
The process lead to creation of semi-personal network.

Membership in networks:

HIG keep it ‘open, global and diverse’ vs. LIG keeping it ‘locked and local’.

Based upon benefits received.
Innovators are skillful in highlighting even small benefits.
Innovators are usually careful in retaining control.

How to keep network alive?

Identify issues of common interest and build a stable network.
Network build for a common cause in more stable.
Create opportunities for regular and frequent contact.


Network Support
and success of newly founded business

“Network approach to entrepreneurship” is a prominent theoretical perspective concerning ‘founding’ process.
(Aldrich & Zimmer, 1986 is most popular on subject)

The main hypothesis is Network ‘founding’ hypothesis :
Network resources, networking activities and network support are heavily used to establish new firms.

Concerning process after ‘founding’ this study is about -

Network success hypothesis :
Entrepreneurs who can refer to a broad and diverse social network and who receive much support from
their network are more successful.

Compensation hypothesis:
Can social capital (network support) compensate for shortfall of say human capital, financial capital, transaction
cost economics, organization ecology etc ?

Class discussion: Can these be true and which one(s)?

Theory: Compensation and success via social support?

There are 2 very different approaches to network approach to entrepreneurship –

1Personal network of entrepreneurs (focal person is individual founder)
2Organizational network i.e. collective relations of firms

This article about personal networks (only) .

Background -

The premise that entrepreneurship is a social role, embedded in a social, political, cultural context.
Entrepreneurs are not isolated and autonomous decision makers, but actors involved in a micro-context.

Aldrich and Zimmer, 1986 - Entrepreneurship is either channeled and facilitated or constraints and
inhibited by people’s position in social networks.

Hebert and Link, 1989 – If we conceive them as organizers and coordinators of resources, social
networking is directly connected to idea of entrepreneur.

… to the extent it is a relational task, a combinatorial problem
..inherently an networking activity (Dublin and Aldrich, 1991).

Functions served by social/ personal networks –

1 Access to information Formal sources
Informal sources info is considered more useful, reliable,
exclusive etc.
Weak ties info is particularly valuable as come from distant
social circle.
Larger social circle with many weak ties.

2 Access to customers n suppliers Friends and acquaintances be first customers then their networks

3 Opens possibility to broaden Informal credits especially helpful in start-up phase.
financial basis of a new firm Ethnic networks – rotating credit associations etc.

A special network type: Family network
Especially start-up : unpaid work, emotional support,
controlling etc

What should be studied for networking effects and performance and success:

First General characteristics of entrepreneurs personal network
- Network size, density, diversity, strong or weak ties and n/w redundancy.
Second Looks at activities carried out in formation stage and amount of support received.

An interesting hypothesis – Network compensation hypotheses

Entrepreneurs with less favorable human capital profile and with restricted financial resources struggle harder to
mobilize their social contacts and receive more support from their social networks.

I don’t agree – only true for first-time salaried class probably, the business class (and maybe the disadvantaged)
deploy it to the hilt !

“…highly developed social networks…can compensate shortfalls of human capital “.

Is this true ?

Conclusions:

Network success hypotheses: Valid, it does improve survival and growth of newly established business.

Network compensation Not valid, can not compensate shortfalls in human and financial capital
hypothesis:


A proposed research model of
Entrepreneurial Motivation

Class discussion: Can we predict who is likely to start a business?
Or what they do in process of deciding to start a business?

The context of the study:

Early literature focused on what personality characteristics distinguished –

Entrepreneurs from non-entrepreneurs
Entrepreneurs from managers in large firms
Successful entrepreneur from unsuccessful..

Then over the years tendency was to concentrate on everything else but the entrepreneur.

Marketing is critical
Finance is critical
Public agency assistance is critical …

But can these alone create a new venture?

We need a person in whose mind all possibilities come together (idea), who believes in innovation, who
has a strategy and motivation to persist until job is done.

So it is about a person, process and choice !

Entrepreneurship is a multi-dimensional process

So, following needs to be a part of psychological study :

Gartner, 1985 The individual, the organization, the environment and entrepreneurial behavior.

Greenberger and Individual characteristics and environmental influences.
Sexton, 1988 Their model presented new venture creation as a interactive process in which
personal characteristics incl. personality interacted with an interpretation of
salient events in environment to influence decisions on creation.

Concept of ‘vision’ – entrepreneurs abstract image of kind of biz. to create which
serves as a guide to own actions.

Bird, 1988 ‘Intentionality’
Domicone, 1990 ‘Propensity’
Learned, 1992 Model of interaction of traits, intention, propensity and the situation.

Herron, 1992 ‘Motivation’

Johnson, 1990 “it remains worthwhile to study the role of individual, including his or her
psychological profile. Individuals are after all the energizers of entre. process.”

This article believes - predicting who is likely to start a business
and what they do in process of deciding to start a business is a partial view

What is needed is… an expanded view of the process of entrepreneurship !
an entirety of entrepreneurial experience i.e.

1 behaviors necessary in operation of firm and its performance, and
2 psychological and non-psychological out comes resulting from firm ownership.
3 role of firm performance in the process
4 also role in deciding to continue and sustaining entrepreneurship as a career choice.

A model of entrepreneurial motivation:

PC = Personal Characteristics PE = Personal Environment PG = Personal Goals BE = Business Environment

Perceived Expectation - Intrinsic /
Outcome relationship Extrinsic rewards

PC PE PG

Decision to Entrepreneurial Entrepreneurial
behave Firm outcomes
entrepreneurially Strategy Management

BE Idea

Perceived Implementation
-Outcome relationship

Decision to 3 Factors: Characteristics of economic context
behave Characteristics of individuals life or career context
entrepreneurially Underlying personal disposition (propensity)

Based on these3 factors, we have 5 variables:

1 Individuals personal characteristics

- need of achievement, locus of control, risk taking, energy level, conformity, need for autonomy, attitude about
self..

2 Individuals personal environment

- family factors, whether entrepreneurial family, his or her peers, mentors, role models, teachers, public figures etc
- Social and entrepreneurial networks, access to finance and advice etc

3 Individuals personal Goals

- rapidly grow and cash out, retire and move on, financial security for self and family, providing for future
generations..This is ‘intentionality’ and ‘propensity’. It leads to vision and becomes the guiding force.

4 Business environment

- Societal attitudes, economic climate, accessible funds, memberships in bodies, business incubators, institutions ..

5 Specific business idea itself

Cooper and Dunkelberg, 1987 found 58% of sample left previous employers because of ‘pull’ of their idea.

Perceived Implementation – Outcome Relationship

Entrepreneur’s perception of strength of relationship between implementation and outcome.
He will try to understand what managerial actions and strategies lead to what outcomes.

His motivation will grow if he perceives a strong relationship.
Will sustain entrepreneurship.

Perceived Expectation – Outcome Relationship

Entrepreneur’s perception of strength of relationship between outcome and expectations.
He will try to compare what outcomes meet or exceed the same.

His motivation will grow if he perceives a strong relationship.
Will sustain entrepreneurship.


Using cognitive theory to explain
Entrepreneurial Risk taking

Palich & Bagby

(Add PPT by students)

What is Cognitive (mental) Categorization and or Categorization Theory?

One of several theories of ‘social cognition’.
Pioneered by Rosch and colleagues.

It says ‘Cognitive Heuristics’ can explain
human behavior and decision making.

Why?

We simply do not have cognitive capacity to process and remember all info ‘Stimuli’
that arise from complex situations therefore for sake of ‘mental economy’ they use
cognitive mechanisms (like heuristics) to manage such complicated ‘cues’.

How?

One common heuristic involves Matching ‘observed Stimuli’ with a ‘mental prototype’
or with the schema represented by prototype.

This cognitive or mental organization allows the perceiver to make ‘inferences’ about the ‘attributes’ of a
situation and also the relationship between the attributes…

i.e. based on observations of salient attributes of a complex situation, the decision maker will formulate
‘mental categories’ to optimize management of that info. (Dutton and Jackson, 1987).

So Categorization is useful by allowing efficient storage of information.

.. Categorizations is one of the most basic of cognitive functions.

It improves the accuracy of predictions regarding (previously) ‘categorized’ situations as well as gives us an
efficient communication about features of category members.

Summary of Benefits 1 Optimize the management of info
2 Efficient storage of info
3 Improves accuracy of predictions

e.g. Managers are quick to apply this heuristic as they form
opinions about complex business situations that reveal less than
complete information (relevant to new ventures).

But different people or groups of people perceive situations differently ..

…Yes, that is why it leaves room for ‘alternate interpretations’ (assessments) of the same situation or
scenario, depending upon the mental ‘short-cut’ each perceiver is predisposed to take.

Palich & Bagby developed basis of the article from above -

If these categorizations vary systematically between perceivers or groups of perceivers..
then their assessments are likely to be similarly skewed or distorted. (Kahneman 92)

What is this article about ?

Given that ‘Risk taking’ seems to be common denominator in most definitions of entrepreneurship…

…Categorization theory in this context would mean all entrep and non-entrep assessments will be
similar within their group & the two groups will be different from each other (for e.g. one group more
optimistic, perceives less risk given same situation).

So Palich & Bagby hypothesize -

“Although risk taking is the common denominator in most definitions of entrepreneurship, we postulate that
entrepreneurs may have no greater propensity to bear risk than the non-entrepreneurs but actually the result
of systematic differences in cognitive processes. So it means that entrep. may simply categorize and then
frame the same stimuli differently from non-entrep.

i.e. what is widely recognized as a ‘propensity for risk’ may instead be an ‘artifact’ of this alternative framing ..

Hence … their behavior may be the result of framing a given situation more positively than negatively focusing
on high probability for favorable outcomes and responding accordingly according to those perceptions.

In contrast, non-entrep. may not share this ‘rose garden’ view leading them to react more cautiously.

It means entrep will generally categorize more situations as holding strengths and opportunities because the
positive attributes* (and potential outcomes) of a situation are more salient (relevant) to them.

* Strengths vs. weakness, opportunity vs. threats, potential for
future performance improvements vs. deterioration.

And it means non-entrep are less likely to categorize the situation in optimistic terms i.e. holding more
weakness and threats and thus make decisions reflecting the negative perspective.

Weick 1979 said it best - believing is seeing !!
i.e. when we receive Equivocal (vague or ambiguous) information, individuals are likely to perceive which they
are predisposed to see.

Also called “Schema Accessibility” or the “Available Heuristic”.

Higgins and King 1981 - The readiness with which a particular Schema is used
in info processing.

Bruner 1957 - The availability of a specific Schema or Cognitive
Structure in a persons memory which increases
likelihood of its use.

Specific hypothesis:

H1 There will be no difference in risk propensity between entrep and non-entrep.

H2 When presented with identical situations, entrep will categorize them as having
more strengths (vs. weakness) than non-entrep.

more opportunities (vs. threats) than non-entrep.

more potential for gain (vs. loss) than non-entrep.

Their research found these two groups did not vary significantly in the responses
to Gomez-Mejia ‘Risk Propensity Scale’. Hence proving H1.

Both MANOVA and Univariate tests confirmed the H2, H3 and H4.

The Implications

Unfortunately when people use simplified cognitive processes (like Cognitive Heuristics, Schema
Accessibility” or the “Available Heuristic etc) categorizations often lead to serious distortions in the
processing of information.

But it can lead to two biases which yield less than optimal business decisions.

- Excessive optimism (for entrep)
- Excessive pessimism (for non-entrep)

When observations are consistent with expectations or the mental prototype of perceiver, the categorization
process operates ‘automatically’ and often increases the inaccuracy of subsequent recall.

Fortunately unlike personality traits, cognitive processes can be changed or learned.
Trainings like ‘Frame of Reference’ can increase frequency of correct ‘categorizations’, hence assessments.

Conclusion: Entrepreneurs exhibit evidence of unique cognitive categorization process when they are
presented with equivocal data. In contrast, distinctive (not vague, not ambiguous) data tended to evoke
the same decision frame in all (subjects).

_______
Time and Entrepreneurial Risk behavior
______

Class discussion: Can we predict who will be an entrepreneurship and who will not be?
Are all entrepreneurs similar in their risk taking behavior?
Are non-entrepreneurs not take any risk whatsoever?

Who assumes risk of a new venture?
The Entrepreneur.

So study of Risk and Risk behavior form an important part of all entre. literature.
Risk behavior has been extensively studied with both ‘trait’ and ‘cognitive’ approaches.
The short-coming of such approaches –

1 It does not tell us how entrepreneurs differ from non-entrepreneurs.
2 It does not tell us how different types of entrepreneurs differ in terms of risk behavior.
3 It neglects the temporal context (risk is intrinsically embedded in time)
i.e. risk behavior, perception over time.

This article provides –

1 A coherent and comprehensive framework of risk behavior of 1 & 2 (above).
2 A frame-work to predict who will take it as career choice and who will not.
3 Which entrepreneurs are likely to use formal and others who will be using informal networks?
4 Why entrepreneurs avoid getting into strategic alliances with established firms?

…and many more significant facts.

THE BACKDROP

Definition of Risk: “variance in outcomes (to expectations and goals) that are of consequence”.

So what is high-risk and low-risk?
High-risk is substantial variance to …. And Low-risk is marginal variance to ..

The Trait approach

It is research based on premise that entrepreneurs have distinctive personality characteristics.

- Need for achievement
- Locus of control
- Tolerance for ambiguity
- Risk-propensity

Conflicting arguments for Risk-propensity

Leibenstein, 1968 - Entrepreneur is the ultimate uncertainty and or risk taker.
Gasse, 1982 - Distinction between creating risk and bearing risk distinguishes
manager and entrepreneurs.

Versus

McClelland, 1961 - Entrepreneurs actually have a moderate level of risk-propensity.

Empirical evidence is weak and contradictory…what can be a reason?

…Results may be inconclusive as there may be as much difference between entrepreneurs themselves as
between entrepreneurs and non-entrepreneurs … Gartner, 1985. And if so…then a ‘typical’ entrepreneur
may not exist and ‘who is an entrepreneur’ may be a wrong question (Gartner, 1989).

It means different entrepreneurial types exist !

Webster 1977 - 5 types : Cantillon, industry-maker, administrative, small business owner/
operator and independent.
Smith, 1967 - 2 types : Craftsman and Opportunistic entrepreneur

Conclusion - No adequate demonstration of how basic personality traits link to entre. types !
(Woo, Cooper and Dunkelberg, 1991)

The Cognitive approach

Approach of how following affect their behavior including entrepreneurial behavior –
(incl. to be or not to be an entrep.)
1 Perceptions
2 Cognitive and decision making styles
3 Errors and biases
4 Intentions
5 Heuristics

Krizner (1973) pioneered a theory of entrepreneurial alertness - unique ability to see that others fail to see.
Palich and Bagby (1995) - entre. not more disposed to taking risk but simply perceive ‘risky’ situations
more optimistically, so more willing to undertake than others.

First ‘Temporal’ attribute : ‘Risk horizon or Temporal’ Horizons of Entrepreneurial Risk
(i.e. differentiating Short range risk & long range risk)

Risk and uncertainty is about unpredictable future ..therefore ‘embedded in time’.
Researchers established several risk behaviors are related to time …

One is “discounting in time” (Vlek & Stallen, 1980)
- Individuals tendency to take risks when possible gains are immediate but possible losses in distant future !

Low Risk vs. High Risk A mild versus significant variation in outcome.

Short Range and Long Range Risk Variance in outcome in near future vs. distant future.
Taking or avoiding actions that may cause a (mild or
significant) variation in outcome in near or over distant
future.

Time Short Range Long Range No auto or medical insurance
Smoking, no further studies
Risk propensity
Drinking n driving, Casino
Low Risk ? ? Cheating ..

Long range low risk but also
High Risk ? ? Short range high risk. E.g. ?

Types of ‘Temporally’ based Entrepreneurial Risk
Dickson and Giglierano, 1986 on 2 types of downside risks –

Sinking-the-boat ‘Risk’

Risk that venture will fail to reach a satisfactory level of performance.
Or risk associated with cost of pursuing a false opportunity.

…is more associated with short range (esp. new ventures)

- Unfolds rather quickly e.g. venture goes under
- Typically risk highest in beginning and then less and less
- Established companies less concerned about sinking the boat

Missing-the-boat ‘Risk’

Risk of failing to undertake a venture that would have succeeded or
Risk associated with costs of not pursuing a potentially profitable venture.

- Some risks only measure in long run –personal relations n psychological well being
- What one may miss in future by not acting?
- Level of missing-the-boat risk gets larger n large in future e.g. no college.

Class discussion: What type of risk entrepreneurs more vulnerable to?

But is it always about risk taking?

People consider entrepreneurs as risk taking because it is about greater gains or losses as compared to
others. It may seem to differentiate it from other activities but it does not follow it is always about risk-
taking.

Certain entrepreneurial functions actually involve risk-avoiding !
Certain non-entrepreneurial functions actually involve risk-taking ! ???

Summary: Different types of entrepreneurs so different risk behavior.

e.g. One who thinks he is investor
MBA

Types of entrepreneurship (Smith, 1967) :

Craftsman
Opportunistic

The authors believe certain personality traits do account for risk behavior specifically –

Future Orientation and Risk Propensity

Future Orientation refers to individuals psychological attribute regarding their perception of future and flow
of time.

Some people more future-oriented, more attention to what may happen in distant future – Distant
Orientation.
Others more present oriented, more attention to current or near-future events – Near future Orientation.

Future Orientation
Near Future Distant Future

SHORT-RANGE LONG RANGE
LOW-RISK LOW-RISK
AVERTING
Non-entrepreneur Opportunistic
entrepreneur

RISK
PROPENSITY SHORT-RANGE LONG-RANGE
HIGH RISK HIGH-RISK

Craftsman Non-entrepreneur
SEEKING
entrepreneur

Characteristics evolved from ‘Sinking the ship risk’ or ‘missing the ship’ risk
- entrepreneurs - type of ventures - networks they use
- sophistication n social awareness - whether use networks or strategic alliances

Evolve 4 propositions outcomes vs. goal...

(Take-Avoid Sinking-Missing)

Proposition 1

Since craftsman entrepreneurs _ take short-range ‘sinking the boat’ risk _ their initial performance
outcomes will vary from their goal _ as compared to all other types of entrepreneurs and of non-
entrepreneurs.

Proposition 2

Since opportunistic entrepreneurs _ avoid long-range ‘missing the boat’ risk _ their long term performance
outcomes will vary less from their goal _ as compared to all other types of entrepreneurs and of non-
entrepreneurs.

Proposition 3

Since non-entrepreneurs _ avoid short-range ‘sinking the boat’ risk _ their short term performance
outcomes
will vary less from their goal _ as compared to those of entrepreneurs.

Proposition 4

Since non-entrepreneurs _ take long-range ‘missing the boat’ risk _ their long term performance outcomes
will vary more from their goal _ as compared to that of entrepreneurs

Entrepreneurial Networking and Alliances (co-operative linkages)

No previous study linking entrep. Risk behavior with this topic.
Co-operative linkages especially important for entrep. process due to lack of established internal Resources (Aldrich &
Zimmer, 1986). Networks are associations of individuals or groups that facilitate access to info. or resources (Holt, 87).

Informal vs. Formal networks
Formal are based upon business contracts and agreements with sufficient controls, clear rights and obligations.
- VC, Banks, Creditors, Accountants, Lawyers & trade associations etc.
Informal are essentially trust-based organizing vehicles.
The risk is ‘internalized’ by this inner circle and not shared by external people as VC.

Craftsman - Tend to commit own money and all others who ‘trust’ them (on what?) instead of raising
money from VC or Banks etc. They remain ‘free’ to do what they want (is that the reason?)

No …They rely informal ‘cause of incompetence in dealing with a broad social environment.
Smith & Miner, 1983) and Smith described them as having low social awareness and
involvement.

Think of quality of resources like expertise, information etc they can potentially secure.

Opportunistic - Great fit between them & formal networks – Oppor. constantly look for new and formal
players also look to invest in promising ventures (Goals and expectations are same !).

They are ‘Long-range Low-Risk’ so are motivated to minimize their personal risk by such
asso. with strong reliance on contractual agreements and monitoring mechanisms.

Q. Which of the two is actually exposing his or her venture to more risk ??

Discuss how all propositions arrived at
Proposition 5
Individuals with near future orientation and a risk averting propensity are less likely to be entrepreneurs.

Proposition 6
Individuals with near future orientation and a risk seeking propensity are more likely to be Craftsman
entrepreneurs.

Proposition 7
Individuals with distant future orientation and a risk averting propensity are more likely to be Opportunistic
entrepreneurs.

Proposition 8
Individuals with distant future orientation and a risk seeking propensity are less likely to be entrepreneurs.

Proposition 9
Craftsman entrepreneurs will rely more on informal networks than on formal networks.

Proposition 10
Opportunistic entrepreneurs will rely more on formal networks than on informal networks.

Proposition 11
Entrepreneurial firma are less likely to be involved in strategic alliances than more established firms.

Entrepreneurs and Strategic Alliances

S.A. are more ‘integrative forms’ of inter-firm cooperation such as JV, joint R&D, Designing,
Distribution (Das & Teng, 1996)

Often by firms in same industry: More integrative – more intensive inter-firm co-op. work together for explicit
strategic objectives (value chain).

1 Alliance with larger co. can help avoid short-term ‘sinking the ship’ risk.
i.e. gives legitimacy- credibility… eliminates risk of bankruptcy.
- Dealership and supplier relationships.

2 Expeditiously capitalize on opportunities tat otherwise cant (in short-run)

Dangerous because 1 If alliance becomes an interim and covert cover for M&A, manipulations.
2 New venture becomes so embedded that difficult to survive on own.
- Strategic flexibility compromised.

Craftsman ‘Short-range High Risk’ so do not care much for ‘sinking the ship’ risk.

Opportunistic ‘Long-range Low Risk’ so they do not go this route.

Conclusion > S.A. are ‘high risk’ and not compatible for either group of entrep.
Hence not preferred by entrepreneurs.

My comments

An entrepreneurs current engagement is not end of the world for him.
But obsessed with scope of current idea…the scope evolves over time…

Critical is to actively seek learning, connections, legitimacy, credibility, reputation, confidence and
to sustain (till reach success).


Pre-Start up preparations:
Why Business plan is not always written


Form or substance:
Plans in Venture Capital decision making

Simpson, you promised you wouldn’t tell
anybody that I turned down Bill Gates
and funded Kingfisher instead !

Form or substance ?

Business Plans in Venture Capital decision making
Resumes for Interviewer decision making
Book proposals for publishing

Do you see a parallel ?

? ?

Say, that’s an mighty impressive resume.
Mind if I borrow it for a few minutes?

In the context of initial screening by

Venture Capitalists for funding

(answer the same for initial screening by a Hiring Manager)

Does an entrep. try to control the info and hence the outcome?

Yes. He drafts proposal as per his understanding of ‘what is critical’ info
(what he thinks is a high validity cue) and what can influence the outcome
of VC decision making.

What is a Cue ?

What are High Validity Cues ?

Cues that have strong association with quality of investment.

What are Low Validity Cues ?

Cues that have little association with quality of investment.

What is the most important class of signals ?

‘The presentation and the content of business planning documents’.

The introduction

1 Are you trying to outwit the VC through your Business Plan Documentation ?
2 Is presence of documents strongly or weekly associated with VC decision making?
3 Whether VC’s learn information independent of its inclusion in proposals?

Venture Capitalists review hundreds or thousands of proposals for each one that receives funding.
Decision makers are often forced to make fast yet high-stake decisions with ‘limited’ information
i.e. high uncertainty and strong info asymmetries (next page).

1 Entrepreneurs control the initial flow of info to potential investors.

2 Further, time constraints prevent VC’s from studying proposals in detail.
Hence their initial screening decisions are based upon sparse info and necessarily rely upon ‘shortcuts’
or Heuristics , to increase speed of decision making…

… Cognitive decision theory suggests that in such settings individuals rely on ‘cues’ to facilitate
decisions.
(Rosch, 1975).

This study advances our understanding of use of cues in strategic settings by ‘empirically identifying and
characterizing’ cues associated with successful resource acquisition in context of VC Funding.

Information Asymmetries between VC’s and entrepreneurs

Obviously there is a difference between what the entrep knows and what he includes and omits
that creates info asymmetries. Entrep try to choose signals that are costly to acquire to
‘suggest’ (and hopefully effectively) that their ventures are of high quality.

Communicative View - These signals are important decision cues if they effectively communicate
info. about the venture. Rosch, 1975 stated that such cues are said to
have a ‘high validity’.

But do VC’s and entrep share common view of what constitute high
validity cues ?

While entrep’s sure think so.. the fact is in uncertain environments, high
validity cues may be difficult to identify.

Ceremonial view - Instead participants rely on cues that have a mimetic conformance to
prevailing norms, even when such cues have ‘low validity’.

Info. disclosed by the entrep that signified an understanding of the norms
of exchange would legitimize the venture in eyes of the investor.

In effect ‘content’ would matter less than the ways in which its delivery
conformed to expectations.

Conceptual development

The venture investment decision is made under conditions of high uncertainty and strong information
asymmetries . . . a lemon’s problem.

Definition of 'Lemons Problem'
The issue of information asymmetry between the buyer and seller of an
investment or product. Lemons problem was popularized by a 1970 research paper by economist
George Akerlof through the example of defective used cars, which are known as lemons in marketplace.

To mitigate the ‘lemons’ problem entrep. seek to provide signals of underlying quality to VCs.

e.g. 1 Employers use educational attainment as a proxy for critical but
unobservable differences amongst potential employees
2 Price is a surrogate indicator of quality for many consumers.

3 Markets may use surrogate indicators of quality as effective sources of info. cues
that help to filter and screen new firms in emerging industries. If investors in
newly public co. are relying on such signals (And IPO candidates are already
much more advanced than co.s seeking initial funding), investors in early stage
co.s are even more likely to rely upon such cues in their initial screening
decisions.

Thus the venture capitalist will reply upon observable signals to discern underlying quality of the investment
target.

Screening, heuristics and prototype theory

Signaling theory offers little guidance about exact content of relevant signal, noting that for a signal to be
meaningful, it must be costly to obtain and co-related with underlying characteristics that are relevant to
the decision maker.

fast decisions under limited info.
In this environment, VCs have to categorize funding requests into – more or less attractive.

Applicable theories in Cognitive science – Prototype Theory and Cue Validity.

Prototype Theory

Explains the likelihood that a particular object will be classified into pre-existing mental categories.
This classification allows for ‘induction of invisible features’ when such objects are not exact replicas
of previous instances.

Prototype theory is a mode of graded categorization in cognitive science, where some members
of a category are more central than others. For example, when asked to give an example of the
concept furniture, chair is more frequently cited than, say, stool.

Subtle differences between planning documents may trigger distinct reactions among potential investors.
The theory implies that VCs will infer differences in underlying quality base upon easily observed
characteristics of funding requests.

Shepherd (1999) argues that cognitive cues facilitate decision making amongst VCs.

Different attributes possess varying levels of ‘cue validity’.

Cue validity is the likelihood that a piece of info is associated with a particular outcome and is measured on
a scale of 0 to 1. for e.g. Lightening associated with electrical discharge is 1, Lightening with rain is lower.

An effective signal will, by definition, possess some cue validity and allow for quick info processing by
appealing to existing cognitive associations in mind of decision maker (Rosch, 1975).
Hence a VC should react to info with high validity.

At the same time some characteristics of funding request may have low validity but still influence VC
decision making – operationally we classify such characteristics as Ceremonial.
In general the outer characteristics of the request, which presumably
are meant to conform to the norms of exchange, are likely to
have lower cue validity
than info indicating presence of a known success factor.

for e.g. the degree to which an entrep. prepares a document in a ‘standard’ way is not necessarily
correlated to the quality of proposed venture.

Given that entrep is source of info, he or she is motivated to present the opportunity in a positive light and
must decide whether or not to include specific info in request for funding.

This logic leads to two different types of hypothesis –

First, we hypothesize about the inclusion of particular types of info.

Second, conditional on its inclusion, we hypothesize about the quality of the venture as proxied by this info.

Inclusion of info clearly indicates … that entrep believes that this info is an important signal to VC.
so mere inclusion is an important cognitive clue.

If that type of info. fulfils a communicative function, then that info
content will also be a valid cue.

In contrast the content will be ignored when inclusion of that info
performs ceremonial role.

Entrep include info that fulfils ceremonial and communicative functions. .
and hide ‘unfaltering’ qualities of venture.

Bull & Watson (2004) examined disclosures in a court of law and
concluded that positive evidence is forthcoming, negative is withheld,
unless there is a punishment for withholding evidence that is sure
to be discovered.

If a cue is high validity, then it should be predictive of VC decision making.
Conditional on its inclusion, we also observe the content.
If there is variation within content, this info should also be predictive of funding outcome.

Thus if inclusion of a cue and the cue’s content, conditional on its inclusion are predictive of venture outcomes,
we conclude that cue is Communicative.

If only inclusion of the cue is associative with venture decision making, then the cue is Ceremonial.

e.g. from compendium

Note –

A finding that info. content matters is a sufficient test to conclude that this cue is communicative …. (!!)
..though it is insufficient to conclude that this info was learned from the planning documents.

"When you reach an obstacle, turn it into an opportunity. You have the choice. You can overcome and be a winner, or you
can allow it to overcome you and be a loser. The choice is yours and yours alone. Refuse to throw in the towel. Go that extra
mile that failures refuse to travel. It is far better to be exhausted from success than to be rested from failure."
- Mary Kay Ash, founder of Mary Kay Cosmetics

"An entrepreneur tends to bite off a little more than he can chew hoping he'll quickly learn how to chew it.”
- Roy Ash, co-founder of Litton Industries

"Business opportunities are like buses, there's always another one coming."
- Richard Branson, founder of Virgin Enterprises

"The critical ingredient is getting off your butt and doing something. It's as simple as that. A lot of people have ideas, but
there are few who decide to do something about them now. Not tomorrow. Not next week. But today. The true
entrepreneur is a doer, not a dreamer."
- Nolan Bushnell, founder of Atari and Chuck E. Cheese's

"Innovation is the specific tool of entrepreneurs, the means by which they exploit change as an opportunity for a different
business or a different service. It is capable of being presented as a discipline, capable of being learned, capable of being
practiced. Entrepreneurs need to search purposefully for the sources of innovation, the changes and their symptoms that
indicate opportunities for successful innovation. And they need to know and to apply the principles of successful
innovation."
- Peter F. Drucker, "The Father of Modern Management"

"I never perfected an invention that I did not think about in terms of the service it might give others... I find out what the
world needs, then I proceed to invent."
- Thomas Edison

"We were young, but we had good advice and good ideas and lots of enthusiasm."
- Bill Gates, founder of Microsoft Corporation

"Our success has really been based on partnerships from the very beginning."
- Bill Gates

"The important thing is not being afraid to take a chance. Remember, the greatest failure is to not try. Once you find
something you love to do, be the best at doing it."
- Debbi Fields, founder of Mrs. Fields Cookies

"I have always found that my view of success has been iconoclastic: success to me is not about money or status or fame, its
about finding a livelihood that brings me joy and self-sufficiency and a sense of contributing to the world."
- Anita Roddick

"Experience taught me a few things. One is to listen to your gut, no matter how good something sounds on paper. The
second is that you're generally better off sticking with what you know. And the third is that sometimes your best
investments are the ones you don't make.“
- Donald Trump, real estate and entertainment mogul

My son is now an 'entrepreneur'. That's what you're called when you don't have a job.“
- Ted Turner, broadcasting entrepreneur

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