Andrew L. Zacharakis
Waltham, MA 02154
The current project is part of a larger research effort that examines VC decision making. The current paper looks at VC confidence in their decision. Research within cognitive psychology finds that experts are more confident in their decisions when they have access to more information, yet their decision accuracy often remains the same or even decreases. Thus, the experts confidence is unfounded. There are two types of overconfidence. First, optimistic overconfidence is the tendency to overestimate the likelihood that one's favored outcome will occur. This bias may be adaptive in that the increased confidence may spur the decision maker to work harder at ensuring the desired outcome. Over estimation of one's own knowledge is the second form of overconfidence. These individuals overestimate the validity of their own judgment when they do not have a personally favored outcome. It is likely that VCs are more prone to the second type of overconfidence, but may also suffer from optimistic overconfidence if they have an emotional attachment to a certain proposal.
Fifty-three VCs from Denver/Boulder and the Silicon Valley participated
in a decision making experiment. On the basis of fifty presented
cases, the VCs judged how likely each venture was to succeed, as well as
how confident they were in their judgment. VCs participated in one
of three treatments that varied by the type and amount of information provided
to make the decision. The VC's judgment is compared with the venture's
actual outcome. Thus, the level of confidence can be compared across
treatments, by judgment of success potential (is confidence higher for
those ventures that the VC expects to succeed or fail), and by how quickly
the VC reaches a decision.
Confidence varies based upon the type and amount of information that VCs use in making a decision. As more information becomes available, VC confidence increases significantly. However, VC decision accuracy (as measured by whether the VC correctly predicts the venture's outcome) decreases with more information. Moreover, VC confidence seems to be greater than the VC's performance on the decision task-VCs appear overconfident. VCs are more confident the greater they believe the venture's potential to be. However, a U-shaped relationship exists. VCs are least confident when they are unsure of a venture's potential and somewhat more confident if they believe the venture will fail (but not as confident as when they believe the venture will succeed).
Although overconfidence in of itself does not necessarily lead to a
wrong decision, the bias likely inhibits learning and impedes improving
the decision process. Overconfident VCs may not fully consider all
relevant information, nor search for additional information to bolster
their decision. Controlling this bias should improve overall VC decision
making and lead to even higher success rates. Moreover, overconfidence
can be managed. Thus, there appears to be great promise in improving
VC decision making if overconfidence is reduced.
||This research was funded in part by the Center for Entrepreneurial Leadership Inc., and the Ewing Marion Kauffman Foundation. The contents of this publication are solely the responsibility of the author|