cognitive theory

Using Cognitive Theory To Explain Entrepreneurial Risk-taking

Lesllie E Palich & D. Ray Bagby

Introduction

SCHUMPTER 1973KIRZNER 1973KNIGHT 1921CANTILLION 1755GOVERNMENTSMIXED OPINIONSCOGNITIVE PROCESSESDECISION DIMENSIONSSPECIFIC HYPOTHESES

Are you a self-starter?

Yes, I like to think up ideas and implement them.

If someone helps me get started, I will definitely follow through.

Frankly, I would rather follow than lead.

2. How do you feel about taking risks?

I really like the feeling of being on the edge a bit.

Calculated risks are acceptable at times.

I like the tried and true

3. Are you a leader?

Yes.

Yes, when necessary.

No, not really.

4. Can you and your family live without a regular paycheck?

Yes, if that is what it takes.

I would rather not, but understand that may be part of the process.

I do not like that idea at all.

5. Could you fire someone who really needed the job your business provided?

Yes, I may not like it, but that is the way it goes sometimes.

I hope so.

I really can't see myself doing that.

6. Are you willing to work 50 hours a week, or more?

Again, if that is what it takes, yes.

Maybe in the beginning.

I think many other things are more important than work.

7. Are you self-confident?

You bet!

Most of the time.

Unfortunately, that is not one of my strong suits.

8. Can you live with uncertainty?

Yes.

If I have to, but I don't like it.

No, I like knowing what to expect.

9. Can you stick with it once you have put your mind to something?

I usually will not let anything get in the way.

Most of the time, if I like what I am doing.

Not always.

10. Are you creative?

Yes, I do get a log of good ideas.

I can be.

No, not really

11. Are you competitive?

To a fault sometimes.

Sure, mostly.

Not really, my nature is more laid-back.

12. Do you have a lot of willpower and self-discipline?

Yes.

I am disciplined when I need to be.

Not really.

13. Are you individualistic or would you rather go along with the status quo?

I like to think things through myself and do things my way.

I am sometimes an original.

I think strongly individualistic people are a bit strange.

14. Can you live without structure?

Yes.

Actually, the idea of living without a regular job makes me nervous.

No, I like routine and structure in my life.

15. Do you have many business skills?

Yes I do, and those I don't have, I'll learn.

I have some.

No, not really.

16. Are you flexible and willing to change course when things are not going your way?

Yes.

I like to think so, but others may disagree.

No, I have a fairly rigid personality.

17. Do you have experience in the business you are thinking of starting?

Yes.

Some.

No.

18. Can you juggle multiple tasks?

Yes.

I think so.

I think not.

19. Are you willing to really hustle for clients and customers?

Sure.

If I have to.

I would rather not.

20. How well do you handle pressure?

Quite well.

Its not my strongest trait, but I can do it.

Not well at all.

Score of 80 to 100 - you have both temperament and skills to become an entrepreneur.

Score of 60 to 79 – you are not a natural entrepreneur but you can become overtime.

Score of less than 60 – it is advisable for you to take up any other profession than self employment.

Categorization Theory

Acknowledges the power of cognitive heuristics to explain human behavior & decision making.

Categorization proves useful by allowing for efficient storage of information.

Assessments are likely to be similarly skewed or distorted.

Entrepreneurs and Cognitive Process

Entrepreneurs are risk takers.They are more optimistic in their assessments

of business situations.Categorization by entrepreneurs and non

entrepreneurs.

Decision Dimensions

SWOT analysis

Provide a summary of business situationsMeasure for Optimism/Pessimism.

Strength Weakness

Opportunities Threats

Rashesh Shah – Edelweiss Capital

BSc ( Statistics)IIMA(PGP’89)Joined ICICI from

campus.Idea to start

investment bank in India.

Encouragement from his wife to take risk.

Started Edelwiss capital in February 1996.One parter – Venkat Ramaswamy, a colleague

at ICICIStarted with 1 Cr

Expected Actual

1st year Rs. 30 Lakhs Rs. 28 Lakhs

2nd year Rs. 50 Lakhs Rs. 35 Lakhs

3rd year Rs. 1 Crore Rs. 21 Lakhs

4th year Rs. 1.5 Core Rs. 1.5 Crore

5th year Rs. 11 Crores

Specific Hypotheses

•There will be no difference between in risk propensity between entrepreneurs and non entrepreneurs

H1•When

presented with identical situations, entrepreneurs will categorize them as having more Strengths versus Weakness than non entrepreneurs

H2

•When presented with identical situations, entrepreneurs will categorize them as having more opportunities versus threats than non entrepreneurs.

H3

•When presented with identical situations, entrepreneurs will categorize them as having more potential for gain versus loss than non entrepreneurs

H4

Methods

Subjects

Random sample :548 members.

Four page questionnaire with cover letter .

Non response.148 members

responded out of 548 (27%).

Scenario development

Stimuli consisted of 3

scenario

Technological

developments

Changes in

competitive

environment

Trends towards

internationalization

Measures

2 from faculty of a graduate

business school

1 from practitioner

highly familiar with

entrepreneurs and firms

Panel of 3 entrepreneurs

hip experts

Cont…..

Panel members assign subject in 2 groups according to responses to 8 survey questions that captured information e.g.

Founding new ventures .New innovationsRapid growthHigh profitability.Estimations of revenue growth.

Nirmal Jain

Risk.MBA,CA,CWA.HLL 5 yrs ,1989-

1994(Commodities oil).Probity Research &

service Pvt. Ltd. With Motilal Oswal & Ramdev Agrawal.95-99

Founding New Venture(IIFL)

India Info line with R.Venkatraman in 1999.Core Business: Broking and ConsultancyUtilize the opportunity e.g. Liberalization.

New innovations

Internet based Trading Model.Strong and Quality Research.Technology Includes Stock prices,

charts ,streaming quote etc.

Rapid growth & High profitability

Rs in Crore 1999 2003-2004 2007 2008

NPAT 10-20lakhs 7.5 400 1000

Analysis

Stock Market and NASDAQ crashed.(2000)

Taken risk at the time when no capital..

Strength

Strong Academic Background.

Mind set in Financial Services.

Risk Propensity

Cont….

Weakness

No capital in the Firm.

Employees left the firm.

Opportunity

FIIS Money(ADRS).Infused in Indian

Markets to make Money.

Cont….

Strength

weakness

Opportunity Threats

Nirmal Jain

Risk Propensity

Variables Mean S.D 1 2 3 4

Group 1.62 .49 - - - -

Risk Propensity

5.84 .92 -0.04

Strengths/weakness

1.09 1.29 -0.25 0.14

Opportunities/threat

1.45 1.71 -0.20 0.11 0.23

Improve/deteriorates

1.07 1.31 -0.38 0.10 0.68 .46

Results of ANOVA comparing Risk Propensity

Group NMean Risk Propensity

Entrepreneurs 35 5.89

Nonentrepreneurs 57 5.81

F 0.16 NS

Results of Multivariate and Univariate Analysis

Variables N Mean Scores

Wilkes Lambda

F R square

Multivariate Model

0.86 4.79

Strengths/weakness 5.75 0.06


Nonentrepreneurs

55 0.84

Opportunities/Threats 3.80 0.04


Nonentrepreneurs

55 1.18

Improve/Deteriorate 14.58 0.14


Nonentrepreneurs

55 0.67

Satyajith Singh

Risk takerFrom Bihar (Jamui

dist.)MA in HistoryUniversity topper and

got 2 times rejected in IAS interview

BPL dealer for 2 years

Got good knowledge in distribution, supply chain and marketing.

Founding New Venture

Started the project for makhana by late 2003His project was rejected at many panchayats,

no support from government2004 Sakthi Sudha Industries was formed

with his investment of 1.5 croreMid – 2005 got to top 3 finalist in Business

baazigar in Zee TVBy this time Nitish Kumar Govt. came into

power.The firm got good support from Govt.

New innovations

Changed the pattern of selling makhanaReduced the rely on middleman Started to tap unused cultivable land, take it

into lease and start cultivating on it

Rapid growth & High profitability

By 2006 end there were 7000 registered farmers in his company

By 2007-08 the company got a turnover of 22 crores and in the following year the fig shot up to 50 crores

Saurabh Vyas and Gaurav Rathore

Risk takerSaurabh From Jaipur,

Rajasthan Gaurav from Kanpur, UPBoth are graduate from

IITSaurabh has worked in a

stastical company called Fractal Analytics

Gaurav started his professional career at Deloitte and later shifted to schlumberger

Founding New Venture

Started the venture in May 2005 and later registered as InfoEDGE on June 2005

Both are passionate about politicsStarted with 10 – 12 people 3 guys were technicians7 to 9 people were engaged in collecting dataFirst client was Milind Deora the young

educated MP from south Mumbai

New innovations

In India, political consultancy is a new concept

They made the election candidate to know his positive and negative

They analyzed the gap between voters and politicians

Growth

Extended their service to social sectorThey currently have 18 NGO projects First year there were 8-10 clients and till

date it counts to over 225The maximum number of clients exists within

India is 5000 and there is a long way to go for them

The venture in 2008 had some internal thoughts mismatch and hence the venture got separated as PoliticalEDGE and the parent company is NDimensions

Discussion

Entrepreneur is described as the risk propensity or risk taking ability of an unique individual.

According to cognitive theory entrepreneur actually do not take risk rather they tend to categorize the business situations by their schema accessibility (rose-colored glasses).

Two condition necessary to support theory of entrepreneurial perception Doesn't report greater risk propensity than their non-

entrepreneur counterparts More optimistic cognitive structure

Implications

Lord and Maher 1990 stated that people do use simplified cognitive process when they form perception.

Categorization often lead to serious distortions in processing of information. This leads to two potential biases Excessive optimism (by entrepreneur) Pessimism (by non-entrepreneur)

When trained to identify critical dimensions and important attributes in a business decision, both entrepreneurs and non-entrepreneurs may be alike

Finally systematic differences in cognitive process helps to distinguish high growth entrepreneurs from those who are interested in lifestyle enterprises. Thus a small business owners can identify opportunities

Limitations

Heuristics such as availability, representativeness were not considered.

Response rate was less than idealSample is limited to certain geographical areaThe human perceptions are prone to distortion

due to cognitive limitation of the observers. Hence it is impossible to get the SWOT for future performance. Hence researchers cannot know certain quality of an individual

Future research

Cognition affects entrepreneurship. Experience play a vital role in decision making but still questions like, how an entrepreneur adjust his decision frames?, Do success and failure impact cognitive process? Remains un answered paving way for future research

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cognitive theory

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