Opportunity Evaluation under Risky Conditions: The Cognitive Processes of Entrepreneurs

Article excerpt

Even though the entrepreneurship literature places much emphasis on opportunity recognition, little is known about how entrepreneurs actually evaluate opportunities. This study uses a cognitive approach to examine opportunity evaluation, as the perception of opportunity is essentially a cognitive phenomenon. We present s model that consists of four independent variables (overconfidence, belief in the law of small numbers, planning fallacy, and illusion of control), a mediating variable (risk perception), two control variables (demographics and risk prosperity), and the dependent variable (opportunity evaluation). We find that illusion of control and belief in the law of small numbers are related to how entrepreneurs evaluate opportunities. Our results also indicate that risk perception mediates opportunity evaluation.

INTRODUCTION

The entrepreneurial process involves all the functions, activities, and actions associated with the perception of opportunities and the creation of the organizations to pursue these opportunities (Bygrave & Hofer, 1991). In order to understand what promotes or inhibits entrepreneurial activity, it is important to understand how entrepreneurs construct credible opportunities and the role of perceptions in that process (Krueger, 2000). Some researchers (Kirzner, 1973; Kaish & Gilad, 1991; Douglas & Shepherd, 1999) argue that opportunity recognition is the cornerstone of entrepreneurship. Entrepreneurs often see opportunities where others do not, and envision future possibilities that others fail to recognize (Allinson, Chell, & Hayes, 2000).

An opportunity is defined as a future situation that the decisionmakers deem personally desirable and feasible (i.e., within their control and competence). The state of being "desirable" and "feasible" is subjective to the individual (Krueger, 1993). An opportunity is said to exist when a bundle of resources can be sold at a higher price than the cost to package and deliver this bundle (Shane & Venkataraman, 2000). Most entrepreneurs do not have problems generating ideas, as there are numerous sources of ideas of what they can sell, and evaluation is the key to differentiate an idea from an opportunity (Hills & Shrader, 1998). As such, it is important to understand how entrepreneurs evaluate the alternatives presented to them. We term this process Opportunity Evaluation (OE).

Deciding whether an idea is an opportunity involves judgments made under conditions of uncertainty and complexity (Das & Teng, 1997; Allinson, Chell, & Hayes, 2000). Closely associated with uncertainty is risk, which is the probability that an entrepreneur is able to successfully turn an idea into an opportunity. An entrepreneur who fails in the business could incur financial losses instead. As such, perceived risk is a significant aspect of how entrepreneurs evaluate available ideas. Entrepreneurs are more likely to evaluate an idea more favorably when they perceive less risk in that idea.

What is less known, however, are the antecedents of risk perception of entrepreneurs. While others have shown that people's cognitive biases affect their decision to start a business venture (e.g., Simon, Houghton, & Aquino, 2000), it is not certain whether entrepreneurs exhibit the same cognitive biases. Kirzner (1973) argues that entrepreneurs are entrepreneurially alert and able to discern opportunities while others are not. Although this assertion has been challenged (e.g., Gaglio, 1997), researchers have found that the cognitive processes of entrepreneurs and nonentrepreneurs are different. For instance, entrepreneurs focus on the future and engage in less counterfactual thinking than nonentrepreneurs (Baron, 1999).

In this article, we study how various cognitive processes affect opportunity evaluation, mediated by risk perception, as opportunity evaluation is essentially a cognitive phenomenon (Palich & Bagby, 1995; Krueger, 2000). …