Cognitive Biases, Risk Perception, and Individual's Decision to Start a New Venture

Cognitive Biases, Risk Perception, and Individual's Decision to Start a New Venture

Salma Zaiane (Faculty of Economics and Management Sciences of Tunis, Tunis, Tunisia) and Fatma Ben Moussa (Faculty of Economics and Management Sciences of Tunis, Tunis, Tunisia)
DOI: 10.4018/IJSSMET.2018070102

Abstract

The purpose of this article is to investigate the relationship of overconfidence and illusion of control towards the start of new venture, taking in consideration the mediating role of risk perception in the context of Tunisia. This article examines students' responses to surveys based on a teaching case titled “Optical Distortion, Inc.” The authors tested hypotheses by correlation and regression analysis. The results show that the perception towards risk associated with new venture plays an important role in decision-making. Moreover, they find that overconfidence and illusion of control reduce risk perception associated to the decision to start a venture. While overconfidence directly affects the decision to start a venture and indirectly through its effect on reducing the risk perception, illusion of control has neither a direct nor an indirect impact on that. These results partially confirm those of Simon show that the mediation exists but partially.
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1. Introduction

Nowadays, all businesses face an unstable business environment with high levels of uncertainty. This uncertainty makes decision-making more complex than ever before. In a rapidly changing environment, it is a challenging task to use available opportunities and make decisions by utilizing all available information for being a rational decision maker. By the time decisions are made, there is a possibility that the opportunity would not exist. In such complex circumstances, cognitive biases play an important role in decision-making. In fact, they are considered as common types of mental shortcuts used to make judgments.

In order to explain venture creation decisions, a cognitive approach can offer great insights into entrepreneurship research (Robinson and Marino, 2013). In fact, many researchers have studied how the entrepreneur think and the role-played by cognition in the process (Nigel Wadeson, 2008; Baron, 1998).

The decision to start a new venture involves risk (Kannadashan et al., 2014). In fact, decisions makers base their decisions upon interpretations of risks representing the possibility for loss and uncertainty (Forlani& Mullins, 2000).

Based upon anticipated chances of success, individual’s perceptions of risk may influence venture creation decision. In fact, lowered risk perception help us to explain why ventures are formed at such high rates relative to high failure rates (Hayward et al., 2006).

This study extends the cognitive theory in the context of new venture formation by capturing the students’ perceptions regarding their overconfidence, illusion of control, risk perception and decision to start a new venture.

Our study examines the relationship among two cognitive biases. The first bias is overconfidence. It refers to the failure to know the limits of one’s knowledge. The second bias is illusion of control. It occurs when individuals overemphasize the extent to which their skill can lead to an increase in the performance in situations where chance plays a major role.

Our study is among the fewest studies that provide empirical evidence for the interconnections between overconfidence, illusion of control, risk perception and the decision to start a venture. In fact, under developed country, the relationship among cognitive biases to start a new venture and risk perception, as a mediator is less investigated (Bhatnagar, 2007). As limited literature is available in the Tunisian context, our study explores the relationship that would exist between cognitive biases and perceived risk. Secondly, the relationship between perceived risk and starting a new venture.

To understand the relationship between these psychological factors, risk perception and individual’s decision to start a venture, we apply the same method used in past research by Simon et al (2000). This method ensured that all the participants analyzed the same venture. We collect responses from 74 postgraduate students after teaching discussion of a Harvard Business School case titled ‘Optical Distortion, Inc. (Clarke, 1988). The survey contains questions about the students’ willingness to start a new venture, their perception of the risk related to this venture, and the extent to which they are subject to cognitive biases in their decision processes.

This study finds that overconfidence and illusion of control reduce risk perception associated to the decision to start a venture. While overconfidence affects directly the decision to start a venture and indirectly through its effect on reducing the risk perception, illusion of control has neither a direct nor an indirect impact on that.

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