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Intuitive Decision-Making in High Uncertainty Contexts: The Case of Venture Capital Investment in Developing Country Renewable Energy Firms

abstract Venture Capitalists (VCs), like the entrepreneurs that they invest in, tend to operate in relatively uncertain environments. As entrepreneurial firms develop new products or enter new markets, they have to deal with a variety of uncertainties, including technological and market uncertainty. VCs on their behalf face uncertainty because of information asymmetries between them and the entrepreneurs they invest in. Agency theory has gained significant popularity in the venture capital and entrepreneurship literatures to describe how these uncertainties can be mitigated, whereby principal-agent problems can be overcome through adequate contractual provisions. In contrast to this prevalent rationalist paradigm of venture capital and entrepreneurial decision-making, a number of authors have suggested alternative perspectives, whose common denominator is a bounded rationality perspective (Simon, 1955), but on closer examination these fall into two different camps. On one end of the spectrum, there has been a stream of research inspired by behavioral finance, which suggests that VCs – like other economic actors – are deviating from perfect rationality and hence exhibit a set of cognitive biases, which results in suboptimal investment decisions. Starting with pioneering work by Nobel prize laureates Kahneman and Tversky (1974), a large number of authors have created ever more comprehensive lists of biases that can be identified in financial markets and other aspects of human decision-making (Manimala, 1992). On another end of the spectrum, there is a stream of research which also concedes that investors and entrepreneurs do not behave in line with what economic textbooks would suggest, but unlike their behavioral finance counterparts, these authors (Todd & Gigerenzer, 2003; Goldstein & Gigerenzer, 2009) are suggesting that it is all but clear ex ante whether such decisions, based on intuition and heuristics, are actually superior or inferior to those that come closer to the ideal model of full rationality. In fact, Goldstein, Gigerenzer et al. (2001) demonstrate that decisions based on ‘fast and frugal’ heuristics outperform decisions based on more complex decision models in a variety of contexts, notably under high uncertainty.
This research project takes a context of particular high uncertainty, namely investments by Swiss venture capital investors in developing country renewable energy firms, to shed new light on venture capital decision-making. Our research objective is twofold:

1) On an explorative level, we want to investigate if and when venture capital investors rely on heuristics and intuition in the context of high-uncertainty investment decisions.
2) In a second stage, we would like to explore how intuitive decision-making links to performance, defined as successful investments.

With this approach, we respond to calls in the venture capital literature to develop more realistic models of VC decision-making, and especially pick up on recent proposals to adopt a longitudinal perspective on the VC investment process (Petty & Gruber, 2009), which includes a series of choices extending well beyond the actual decision to invest (or not) in a given firm. Finally, we believe that our research contributes to bridging the gap between the ‘behavioral bias’ and ’intuitive decision-making’ approaches in the literature on boundedly rational decision-making.
   
keywords Decision-making, heuristics, venture capital, renewable energies, developing country
   
partner ETH Zürich, responsAbility (tbc)
type fundamental research project
status ongoing
start of project 2010
end of project 2011
additional informations GFF project to support KTI proposal submission
topics International social Venture Capital decision-making in developing countries
methods Qualitative, exploratory case studies
contact Christoph Birkholz