THE ROLE OF SELECT PSYCHOLOGICAL AND COGNITIVE CHARACTERISTICS OF ENTREPRENEURS IN FINANCIAL DECISION MAKING AND FINANCIAL SUCCESS.

Ms Nigama K Assistant Professor, Bharathidasan Institute of Management, Post Box No 12, MHD Campus, BHEL Complex, Tiruchirappalli 620 014, Tamilnadu, India Phone: 91- 0431 2520796, Telefax: 91 0431 2520733, Mobile : 94438 15214 Email: nigama@bim.edu, k.nigama@gmail.com Dr P David Jawahar Professor, Bharathidasan Institute of Management, Post Box No 12, MHD Campus, BHEL Complex, Tiruchirappalli 620 014, Tamilnadu, India, Phone: 91- 0431 2520796, Telefax: 91 0431 2583509, Mobile : 94432 66599 Email: dj@bim.edu, davejawa@gmail.com ABSTRACT: Psychology suggests that human decision processes are subject to several cognitive illusions. Past studies show that behavioural factors undoubtedly play a role in the decision making processes of individuals. But many such studies have been conducted in large corporate but only few studies have been done in Small and Medium Sectors. Entrepreneurs are the growth engines of SMEs. The success of the enterprise is determined by entrepreneurs decisions which are influenced by his perceptions and evaluations of both micro and macro level factors. Thus decision making is a crucial characteristic of an entrepreneur and entrepreneurs decisions determine the performance of the SMEs. Despite the high risk involved, entrepreneurs decide to start new ventures. Therefore the researchers are interested in studying the various psychological and cognitive characteristics of entrepreneurs, their influence in financial decision making and financial success. This study proposes to examine the following cognitive biases, planning fallacy, illusion of control, belief in law of small numbers, overconfidence, and their influence on risk perception. It is also a well known fact that a conducive business environment influences the success or otherwise of any new venture. Relation between cognitive biases, risk perception and entrepreneurial decision to start a new venture is widely studied abroad but to the limited knowledge of the researcher, no such study has been conducted in India. The researcher proposes to follow a single cross sectional survey design. With the help of the literature review, the study proposes a model and intends to validate the same using statistical techniques and tools. The study expects that the results will reveal the relationship between the variables identified and their influence on risk perception. Also the impact of risk perception on opportunity evaluation is proposed to be validated. KEY WORDS: Behavioural Finance, SME, Entrepreneurs, Opportunity Evaluation, Risk Perception

CONTEXT OF THE STUDY: Under the paradigm of traditional financial economics, decision makers are considered to be rational and utility maximising. But the results of various studies over the past decade show that they were at variance with the rational, self-interested decision-maker posited by traditional finance and economics theory. Behavioural finance, a field that applies scientific research to our cognitive and emotional biases to better understand how we make financial decisions has emerged from shadows to limelight. Paul Slovics (1972) paper on individuals misperceptions about risk and Amos Tversky and Daniel Kahnemans papers on heuristic driven decision biases (1974) and decision frames (1979) played a seminal role in the development of behavioural finance. Psychology suggests that human decision processes are subject to several cognitive illusions. Past studies show that behavioural factors undoubtedly play a role in the decision making processes of individuals. Further, behavioural corporate finance throws light on the behavioural concepts associated with the decision making of irrational investors and irrational managers in topics such as capital budgeting, capital structure, valuation, dividend policy, corporate governance, mergers and acquisitions. (Michael Jensen, Meckling, 1986, 1994, 1998, 2001; Gompers, 2003). But many such studies have been conducted in large corporate but only few studies have been done in Small and Medium Sectors. The role of small and medium enterprises in a nations development needs no special mention. It is a well known fact that Small and Medium Enterprises (SMEs), particularly in developing countries, are the backbone of a nation's economy. India is no exception. Entrepreneurs are the growth engines of SMEs. The performance and growth of an enterprise not only depends on the respective environment but also on the entrepreneur. The success of the enterprise is determined by entrepreneurs decisions which are influenced by his perceptions and evaluations of both micro and macro level factors. There is a positive effect of entrepreneurial knowledge and all its dimensions on SME performance (Omerzel, Gomezelj, Anton i , Bo tjan, 2008). Entrepreneurial competencies affect even the long term performances of SMEs (Man, Thomas, Lau, Theresa, 2000). Thus decision making is a crucial characteristic of an entrepreneur and entrepreneurs decisions determine the performance of the SMEs. Therefore the researchers are interested in studying the various psychological and cognitive characteristics of entrepreneurs, their influence in financial decision making and financial success. REVIEW OF LITERATURE and RESEARCH FRAMEWORK There are many theories on decision making process, but most of them focus on three main components, namely, the environment, the individual characteristics of decision maker, and the nature of the decision itself (Mador, 2000; Mintzberg, 1976; Papadakis, Lioukas, Chambers, 1998). There are several studies which have tried to understand which of these three is more deterministic on the results of a decision made. Also the influence of each of these variables on the decisions has been postulated by several studies in the past (Papadakis et al, 1998; Knight F, 1921; Kotler, 1988). The researchers are therefore interested in studying the influence of personal characteristics of the entrepreneur on decision making under certain environmental conditions.

The personal characteristics of the decision maker influence the decisions and particularly in small enterprises there is strong personal influence of the entrepreneur (Brouthers, Andriessen, Nicolaesl, 1998). Hence the researchers feel it is important to study the entrepreneurial characteristics in order to comprehend the financial decision making process at SMEs. Though empirical studies have found it difficult to state significant differences in psychological and cognitive characteristics of entrepreneur and managers or nonentrepreneurs (McClelland, 1967; Brockhaus, 1980; Schere, 1982; Low and Macmillan, 1988), some of those characteristics identified with entrepreneurial nature are need for achievement, desire to be independent and control over situations, individualism, ability to focus and pursue a goal, optimism etc. Besides entrepreneurial nature, entrepreneurship was examined by their cognitive characteristics in the initial days of research; the way entrepreneurs recognise or perceive opportunities (Shaver and Scott, 1991; Das and Teng, 1997). The research then took a different approach to explain the ability of some people to recognise and pursue entrepreneurial activities i.e., through cognitive predispositions. The cognitive predispositions explained how entrepreneurs simply think in a different manner (Baron, 1998). Research distinguished entrepreneurs by their risk taking propensity, which is nothing but their nature to view business situations as potential profit yielding opportunities (Palich and Bagby, 1995). Also it was stated that entrepreneurs relied more on heuristics and biases in any decision making situations. (Busenitz and Barney, 1997). Though previous studies have concluded that entrepreneurs do not have great willingness to knowingly take risks, their risk perceptions may differ because of the influence of certain types of cognitive biases (Simon, Houghton & Aquino, 2000). Despite the high risk involved, entrepreneurs decide to start new ventures. In line with the previous research, (Simon, Houghton & Aquino, 2000; Keh, Foo, Boon, 2002; Sitkin & Pablo, 1992; Sitkin & Weingart, 1995; Forlani & Mullins, 2000), this study proposes to examine the following cognitive biases, planning fallacy, illusion of control, belief in law of small numbers, overconfidence, and their influence on risk perception. It is also a well known fact that the success of any new venture or any entrepreneurial activity depends on conducive business environments. Relation between cognitive biases, risk perception and entrepreneurial decision to start a new venture is widely studied abroad but to the limited knowledge of the researcher, no such study has been conducted in India. Hence, this study attempts to replicate the research conducted at Singapore by Keh et al, 2002. But the business environment differs among countries. This is supported by the fact that countries are ranked on their ease of doing business from 1 183 through business index in Doing Business 2010 report developed by World Bank, with first place being the best. A high ranking on the ease of doing business index means the regulatory environment is conducive to the operation of business. Singapore is ranked number one in ease of doing while India is ranked as 133. Hence, the researchers are interested to study the influence of cognitive biases on risk perception and therefore on opportunity evaluation in Indian context. RISK PERCEPTION Psychologically, people prefer more deterministic world in which there are known explanations for things that happen (Messick and Bazzerman, 1996). But in reality, there is always some degree of uncertainty in decision making. As entrepreneur is constantly required

to make decision in an indefinite environment, risk is one principal features characterizing entrepreneurship. Scientists differentiate risk from uncertainty as the former is measurable and the latter is immeasurable (Knight, 1921). Risk taking is not a feature, approach or a response, but it is the way of entrepreneur perceive world and entrepreneurs have more optimistic perceptions for risky conditions than others (McCarthy and Leavy, 1999). H1: Perceiving a lower level of risk is associated with more positive opportunity evaluation. ILLUSION OF CONTROL The concept of locus of control refers to a generalised belief of a persons control over his destiny. People are classified along a continuum from very internal to very external (Rotter, 1966). Illusion of control is a bias often suggested as a characteristic of entrepreneurs because research shows that they show strong preference for exerting control over their outcomes as they believe they can exert control over people and events (Shaver and Scott, 1991). Boyd and Vozikis (1994) argued that an individuals belief in his ability to control a ventures outcome affects his intentions to form a venture. Simon et al. (2000) found that an illusion of control decreases ones perception of the level of risk associated with forming a venture. Almost three decades of research consistently shows that internals are alert, discover opportunities and scrutinise their environment to find information needed to formulate the optimal approach to developing those opportunities Gilad (1982). Thus, illusion of control also plays a great part in entrepreneurial decision of opportunity evaluation, hence the hypotheses, H2 : Entrepreneurs with a stronger illusion of control bias will perceive less risk. BELIEF IN LAW OF SMALL NUMBERS People regard a sample randomly drawn from a population as highly representative, that is, similar to the population in all essential characteristics, this characteristic termed as belief in law of small numbers (Tversky and Kahneman, 1971). Entrepreneurs neither use large random samples nor do they engage in systematic data collection (Busenitz and Barney, 1997). Furthermore, literature suggests that entrepreneurs frequently make judgement on what is called as gut feeling or the subjective factors that induce high optimism in the entrepreneur to decide about any venture as opportunity (Palich and Bagby, 1995; Cooper et al, 1988; McCarthy et al, 1993; Kahneman and Lovallo, 1993). Thus it is hypothesised that H3: Entrepreneurs who have stronger belief in law of small numbers will perceive less risk. PLANNING FALLACY The planning fallacy refers to the systematic tendency to hold a confident belief that one's own task will proceed as planned. Entrepreneurs overestimate how much they can accomplish in a given period of time or turning the question around, how long will it take for them to complete a specific project, this effect is called planning fallacy (Baron, 1998). This planning fallacy invariably arises because people ignore distributional information available in related past outcomes and instead focus only a single plausible scenario for completion of the current specific task (Kahneman and Tversky, 1979). Decision makers may isolate their past experiences with similar circumstances to treat the current situation unique or they may anchor the plans of successes rather than past results, on the future plans or scenarios, and may even be possibly be overly optimistic (Kahneman and Lovallo, 1993). This indicates planning fallacy will have its influence on opportunity evaluation. Hence the hypothesis, H4: Entrepreneurs who are influenced by planning fallacy to a greater extent will perceive less risk. OVERCONFIDENCE

Overconfidence is the failure to know the limits of ones knowledge (Russo and Schoemaker, 1992). Overconfidence occurs because individuals do not sufficiently revise their estimates according to the new information. Therefore, they do not realise the extent to which they are incorrect. (Tversky and Kahneman, 1974). Entrepreneurs who exhibit overconfidence fail to differentiate their assumptions from facts and hence do not see the uncertainty associated with those assumptions (Simon et al, 2000). Hence the hypothesis, H5: Entrepreneurs exhibiting higher overconfidence will perceive less risk. PROPOSED RESEARCH MODEL This study has conceptualised a research model based on the literature review and the identified research gap. The research model is proposed in Figure 1
Overconfidence

Belief in law of small numbers

Risk perception

Opportunity evaluation

Planning Fallacy

Illusion of control

METHODOLOGY: The researcher proposes to follow a single cross sectional survey design. The population of the study will be first generation opportunistic entrepreneurs in Tamil Nadu. With the help of the literature review, the study will develop a model and validate the same using statistical techniques and tools. EXPECTED FINDINGS: The study explores the cognitive approach to opportunity evaluation. The relationship between the variables identified and their influence on risk perception is expected to be revealed. Also the impact of risk perception on opportunity evaluation is proposed to be validated. RESEARCH LIMITATIONS/IMPLICATIONS: The study focuses on first generation entrepreneurs, hence the conclusions cannot be generalised to other entrepreneurs. For the purpose of collecting the data, the geographic location is limited initially to Tamil Nadu, hence natural extensions of the findings to other places may not be logical, because every state has different set of policies and practices. Also the researchers attempt to include only few cognitive biases and other such biases may also be studied. ORIGINALITY/VALUE: The study will add value to the existing literature. As this study is conducted in Indian context, the impact of business environments across countries can be compared and suitable modifications can be carried out either to make the environments more conducive for successful decision making or modify the cognitive predispositions accordingly. The researcher expects that the findings will be of help to the entrepreneurs and others who deal with entrepreneurs to understand the decision making behaviour. The study also expects to help the entrepreneurs be conscious of the various factors that impact their decisions. REFERENCES Baron R. A. (1998). Cognitive mechanisms in entrepreneurship: Why and when entrepreneurs think differently than other people. Journal of Business Venturing. 13: 275294. Boyd Nancy G, Vozikis George S. (1994). The Influence of Self-Efficacy on the Development of Entrepreneurial Intentions and Actions. Entrepreneurship: Theory & Practice. 18(4). 63-77 Brockhaus R. (1980). Risk taking propensity of entrepreneurs, Academy of Management Journal. 23(3). 509-520 Brouthers, K., F Andriessen, and I Nicolaes. (1998). Driving blind: Strategic decision making in small companies. Long Range Planning. 31 (1). 130-138

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