Assessing venture capital investments with noncompensatory behavioral decision models

Abstract

This article examines the prospect of a decision support system for the assessment of venture capital investments. It approaches the task of developing decision models from the perspective of the venture capitalist. Thus venture capitalists have played an active role in defining the predictor variables and in providing data on their own investments. Venture capitalists (and recent research) underscore the importance of the entrepreneur in new ventures and the predictor variables selected reflect this bias. The literature is now replete with studies demonstrating the superiority of multiattribute actuarial models over human judgment for diverse decision environments, ranging from medical science to finance. This class of behavioral decision models consists of the simultaneous consideration of several attributes relevant to a decision. Actuarial models of this kind can be applied to attribute and decision data based on the decision maker's judgments (i.e., expected outcomes) before the events transpire—termed judgment-based models. They can also be applied to data on past events or actual outcomes where known—termed environment-based models. Again, it needs to be emphasized that actuarial models, whether based on the decision maker's judgments or on the environment, usually outperform the decision maker. These general principles are applied here. Among actuarial models a particular subclass of models is called noncompensatory. In these models, a low value for one attribute cannot be compensated by a high value for another attribute. As an example. in selecting a place-kicker in football, athletic skills other than kicking ability are irrelevant. In this study, two types of noncompensatory actuarial models, conjunctive and disjunctive, are used to model both venture capitalists' judgments and the environment. Interviews with venture capitalists reveal that some place strong emphasis on one or two attributes in judging a potential investment. This type of decision-making behavior indicates a disjunctive decision process. At the same time, there can be a tendency to ensure that a prospective investment is satisfactory at a minimum the entrepreneur's tenacity/courage is a redundant variable that is sublimated in desire for success and enthusiasm/capacity for work.