The Nature of Information and Overconfidence on Venture Capitalists' Decision Making

Abstract

Previous research has overlooked the possibility thatoverconfidence, cognitive differences, and personal biases may significantlyimpact the decisions that venture capitalists (VCs) make. This study examinesthree questions: (1) Are VCs overconfident? (2) Does overconfidence influencedecision accuracy? and (3) Under what circumstances would we expect VCs toexhibit greater levels of overconfidence? The judgment/decision-makingliterature is reviewed and applied to the nature of the venture capitalinvestment decision. A policy capturing experiment was used to examine the investment decisionprocess of 53 venture capitalists from the Denver/Boulder area and SiliconValley. Findings indicated that VCs' investment decisions are biased byoverconfidence. Specifically, this overconfidence increases with moreinformation, unfamiliar framing of information, moderate performancepredictions relative to more extreme predictions, and with failure predictionsrelative to extreme success predictions. This can have a negative effect ondecision accuracy. VCs can use counter factual reasoning, the "humblingeffect," and actuarial decision aides to deal with overconfidence.(SFL)

Keywords: Information bias, Investment decisions, Cognitive differences, Silicon Valley, Cognition, Management decisions, Self-efficacy, Counterfactual thinking, Venture capitalists, Management decisions, Information utilization