Advances in Entrepreneurial Finance Rassoul Yazdipour Advances in Entrepreneurial Finance With Applications from Behavioral Finance and Economics Rassoul Yazdipour California State University Fresno, CA, USA [email protected] ISBN 978-1-4419-7526-3 e-ISBN 978-1-4419-7527-0 DOI 10.1007/978-1-4419-7527-0 Springer New York Dordrecht Heidelberg London Library of Congress Control Number: 2010938798 © Springer Science+Business Media, LLC 2011 All rights reserved. This work may not be translated or copied in whole or in part without the written permission of the publisher (Springer Science+Business Media, LLC, 233 Spring Street, New York, NY 10013, USA), except for brief excerpts in connection with reviews or scholarly analysis. Use in connection with any form of information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed is forbidden. The use in this publication of trade names, trademarks, service marks, and similar terms, even if they are not identified as such, is not to be taken as an expression of opinion as to whether or not they are subject to proprietary rights. Printed on acid-free paper Springer is part of Springer Science+Business Media (www.springer.com) Foreword The study of entrepreneurship is vital to continued growth and innovation in our society. At its most basic level, entrepreneurship is a means for individuals to lift themselves out of poverty and to create jobs for others. The new businesses that are started each year offer the promise of wealth and independence to the entrepreneurs who take on the inherent risks. At a broader level, however, the entrepreneurs who bring truly new and innovative products and services to the market offer something even more important to all members of the community. These are the new busi- nesses that are responsible for much of the economic growth in our economy and the progress in our standard of living. The long history of new business ideas that changed our daily lives is familiar to all of us. From the radio and the television to the personal computer and new medical technologies, these innovations benefited – and continue to benefit – many more people than the entrepreneurs and their employees. Innovations promise greater prosperity for society as a whole. A greater understanding of entrepreneurship and its drivers is critical to the continued growth of our economy. It is only through the study of new businesses and their founders that we will identify the motivation to start a business and under- stand the entrepreneurial process, the financing of these businesses, the challenges entrepreneurs face, and the policies and institutions that encourage greater entrepre- neurial activity. The Ewing Marion Kauffman Foundation has devoted significant resources toward this effort at an academic level, working with economists and oth- ers who study this important phenomenon. In addition to supporting research on the topic, we have sponsored new efforts to collect data on entrepreneurial activity. These initiatives have proven fruitful. There has been increased attention to entrepreneurship among academics in recent years. The strength of the work in this book testifies to the growing interest in this work among academics from a variety of perspectives. Furthermore, the summary of statistical databases for small busi- ness financial research, the discussions of data sources within individual chapters, and the use of new data herein suggest that efforts to improve data sources for the study of entrepreneurship are progressing as well. This book, in fact, includes an analysis of Kauffman Firm Survey data, a panel study of businesses founded in 2004 that tracks them over their early years of operation. v vi Foreword Empirical research on entrepreneurship has much to offer us from a policy per- spective. Among many other topics, economists have elucidated a great deal about firm formation, growth, and death; the financing of new businesses; the institutional influences on entrepreneurship; the demographic characteristics of entrepreneurs; and the important role of entrepreneurship in economic growth. The Academy of Entrepreneurial Finance community has contributed significantly to our under- standing of how new businesses are financed, and this book presents an important summary of the current state of this knowledge. This volume is evidence of the importance of interdisciplinary works on entre- preneurship that bring together insights from different perspectives. The focus here is at the intersection of psychology and neuroscience and economics, an important junction as entrepreneurs’ and investors’ decisions do not always seem to follow traditional economic models. Among other topics, these chapters bring to light the importance of exploring entrepreneur–investor relations from a cognitive perspec- tive, suggest that emotion and heuristics play an important role in entrepreneurs’ and investors’ risk perceptions, identify some common psychological characteris- tics of entrepreneurs (and the non-pecuniary benefits of entrepreneurship), and indicate that broader approaches to financial risk metrics are necessary. The contri- butions from neuroscience in this book allow for a more direct examination of the “internal landscape” of decision making. Ultimately, the works in this book bring out the human element of firm decision- making, and bring the teaching of psychology and neuroscience to bear on it. This understanding certainly pushes us toward a new understanding of entrepreneurship, and it reminds us that bringing together a wide range of disciplines will allow us to achieve both a broader and deeper understanding of this important topi Robert Strom, Ph.D. Director of Research and Policy, Ewing Marion Kauffman Foundation Contents 1 Introduction ............................................................................................. 1 Rassoul Yazdipour Part I Theoretical Foundation 2 A Behavioral Finance Approach to Decision Making in Entrepreneurial Finance .................................................................... 11 Rassoul Yazdipour 3 Beyond Agency Theory: Value Creation and the Role of Cognition in the Relationship between Entrepreneurs and Venture Capitalists .......................................................................... 31 Peter Wirtz 4 Financial Risk Perceptions: A Behavioral Perspective ........................ 45 Robert A. Olsen 5 Contribution of Neuroscience to Financial Decision-Making ............. 69 Richard W. Ackley and Lukasz M. Konopka 6 Uncertainty Is Psychologically Uncomfortable: A Theoretic Framework for Studying Judgments and Decision Making under Uncertainty and Risk ................................................................... 93 William P. Neace, Kate Deer, Steven Michaud, and Lauren Bolling Part II Issues in Financing Startups and Small Firms 7 The Changing Landscape of Small Firm-Finance ............................... 121 William Dunkelberg and Jonathan A. Scott 8 Applications of Behavioral Finance to Entrepreneurs and Venture Capitalists: Decision Making Under Risk and Uncertainty in Futures and Options Markets............................................................ 141 Fabio Mattos and Philip Garcia vii viii Contents 9 Insights into the Psychological Profiles of Entrepreneurs ................... 173 Hersh Shefrin Part III Issues in Growth and Beyond 10 Firm Failure Prediction Models: A Critique and a Review of Recent Developments .................................................. 185 Richard L. Constand and Rassoul Yazdipour 11 The Evolution of Entrepreneurs and Venture Capitalists ................... 205 Martin Sewell 12 Statistical Databases for Research on the Financing of Small and Start-Up Firms in the United States: An Update and Review ........................................................................... 219 Charles Ou Author Index.................................................................................................... 251 Subject Index ................................................................................................... 253 Contributors Richard W. Ackley Ph.D. Professor, The Chicago School of Professional Psychology, Chicago, IL, USA Richard L. Constand Ph.D. California State University, Fresno, CA, USA William Dunkelberg Ph.D. Temple University, Philadelphia, PA, USA and National Federation for Independent Businesses, Nashville, TN, USA Philip Garcia Ph.D. Professor, University of Illinois at Urbana – Champaign, Chicago, IL, USA Lukasz M. Konopka Ph.D., ECNS, BCIA-EEG Professor, Loyola Stritch School of Medicine and The Chicago School of Professional Psychology, Chicago, IL, USA Fabio Mattos Ph.D. Professor, University of Manitoba, Winnipeg, MB, Canada William P. Neace Ph.D. Professor, University of Hartford, West Hartford, CT, USA Robert A. Olsen Ph.D. Decision Research, Eugene, OR, USA Charles Ou Ph.D. Office of Advocacy, The US Small Business Administration, Washington, DC, USA Jonathan A. Scott Ph.D. Professor, Temple University, Philadelphia, PA, USA Martin Sewell University of Cambridge, Cambridge, UK ix x Contibutors Hersh Shefrin Ph.D. Santa Clara University, Santa Clara, CA, USA Robert Strom Ph.D. Director of Research Entrepreneurship Research and Policy, Ewing Marion Kauffman Foundation, Kansas City, MO, USA Peter Wirtz Ph.D. Professor, Université Lumière, Lyon 2, France Rassoul Yazdipour Ph.D. California State University, Fresno, CA, USA and The Academy of Entrepreneurial Finance, Los Angeles, CA, USA