Academic journal article Entrepreneurship: Theory and Practice

The Role of Trust in the Informal Investor's Investment Decision: An Exploratory Analysis

Academic journal article Entrepreneurship: Theory and Practice

The Role of Trust in the Informal Investor's Investment Decision: An Exploratory Analysis

Article excerpt

Research into the role of informal venture capital in financing the development of entrepreneurial ventures has grown significantly in North America and, more recently, Europe (Freear, Sohl, & Wetzel, 1996; Harrison & Mason 1996a; Mason & Harrison, 1995a, 1995b, 1996a). This research can be characterized in three ways. First, it has been and remains primarily empirical in nature, reflecting the continuing need to "put boundaries on our ignorance" (Wetzel, 1986, p. 132) of what is still a largely invisible and secretive marketplace (Freear et al, 1996; Harrison & Mason, 1996a; 1996b). Second, it has had a very strong public policy and prescriptive emphasis, focused on understanding how the market operates and identifying mechanisms by which it could be made to work more efficiently and effectively (Wetzel, 1994; Harrison & Mason 1996a, 1996b; Suomi & Lumme, 1994; Mason, 1996). Third, and partly as a consequence of these two trends, research on informal venture capital has not been characterized to date by a high level of theoretical sophistication, although recent research has considered the applicability of the pecking order hypothesis (Harrison & Mason, 1991), decision theory (Landstrom, 1995; Riding, Dexbury, & Haines, 1995), the economic analysis of altruism (Sullivan, 1994), and agency theory (Landstrom, 1993; Fiet 1995a; 1995b).

In this paper, we extend this third strand of enquiry to explore the relevance of the concept of trust to the analysis of the informal venture capital market. Trust as a key constituent of economic relations is now receiving increased attention in both the general literature (Gambetta, 1990; Fukuyama 1995; Kramer & Tyler, 1996) and within entrepreneurship itself (Low & Srivatsan, 1993; Dibben, Marsh, & Scott, 1996). In the entrepreneurial context, under conditions of uncertainty in dyadic relations (Larson, 1992), trust has been identified as a major lubricant, which is essential for cooperation to arise (Low & Srivatsan, 1993). Within the research canon on informal venture capital, the issue of trust has been explored as part of a wider study of information sources, networks, and reliance structures (Fiet, 1991): for the informal venture capital market, Fiet's results suggest that the degree of reliance on others in the personal contact network (which was lower in any case for informal investors compared to venture capitalists) was a function of the amount of network experience; in other words, "experience generated trust which controlled opportunism" (Freear et al., 1996, p. 16).

Trust in this context can be construed as a means of speeding decision making and negotiations by reducing transaction costs between individuals in organizations under conditions of risk (Creed & Miles, 1996, pp. 16-35; Mishra, 1996, pp. 276-278). As such, the detailed exploration of the trust construct and its application to the informal venture capital market as a community characterized by informality and personal contact and referral (Mason & Harrison, 1994) represents a potentially fruitful opportunity to provide a theoretically robust basis for continued research in this field. However, much of the interest in trust to date has focused on monitoring relationships post-investment, and there has been relatively little interest in the role of trust at earlier stages in the process: this represents the key focus of this paper. In the following section we develop a model of the informal investment decision-making process based on the identification of five situational domains, or discrete stages in the process, within which we would expect to find evidence of trust relationships; following a theoretical discussion of the concepts of swift trust and swift cooperation and their relevance to the investment opportunity identification and appraisal process, we outline the methodology and data analysis procedures used to explore the applicability of this model of trust. …

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