Beyond Agency Theory: Value Creation and the Role of Cognition in the Relationship Between Entrepreneurs and Venture Capitalists

Abstract

This chapter explores entrepreneur–investor relations from a cognitive perspective. I show that entrepreneurs’ and investors’ specific mindsets matter for the perception and realization of strategic opportunity. Differences in cognitive structure and process thus influence value creation beyond economizing on agency costs. I define and add concepts of cognitive cost and cognitive value to a basic agency model, which allows me to explain why some entrepreneur–investor relations create more value than others, although they may have the same level of agency costs. This enhanced framework also helps understand why external funding may not be available to certain ventures, even if agency conflicts can be kept under control through proper incentive alignment. The concepts of cognitive cost and value are shown to be especially relevant in the context of entrepreneurial finance, where uncertainty is typically high, and knowledge about value creation opportunities is ambiguous. An investor’s appreciation of the value of entrepreneurs’ knowledge about strategic opportunity depends on the closeness of their respective mindsets. Some investor types such as venture capitalists (VCs) share certain of the entrepreneurs’ mental features and develop specific skills to identify valuable ventures at a low cognitive cost while adding cognitive value through strategic advice and mentoring, especially when entrepreneurs are still inexperienced.