**2. Theoretical Background**

### *2.1. Research on Cognitive Biases in Entrepreneurship*

Research on cognitive biases in entrepreneurship has increased rapidly since its inception in the early nineties and in two decades it has become an important research area for entrepreneurship (Zhang and Cueto 2017). From their structured literature review of research on entrepreneurial biases, Zhang and Cueto (2017) also portray the research domain (in our words) as fragmented: a lack of consistent use of definitions, showing overlap and redundancy in biases (like *overconfidence* and *overoptimism*). The figures in their review, as well as their analysis, also indicate a very high representation of in-depth studies that put the spotlight on individual 'popular' cognitive biases (like *overconfidence*) 1. Furthermore, after they defined a typology of cognitive biases to structure their assessment, Zhang and Cueto (2017) identified a need for research on relatively underexposed biases related to emotions (for example on *a*ff*ect heuristic*) or biases related to the social context of the

<sup>1</sup> The literature review by Zhang and Cueto (2017) shows that 33 out of 41 papers focused on one single cognitive bias, 5 papers examined two biases and no papers investigated more than four biases in one study. More than half of all papers examined *overconfidence* or *overoptimism*.

entrepreneur (environmental pressure). Since the literature review by Zhang and Cueto (2017), we are aware of only one paper (Abatecola et al. 2018), who examined a combination of multiple cognitive biases, (including one associated with *a*ff*ect heuristic*), and how they are related.

The tables in the review by Zhang and Cueto (2017), show that a large portion of the research on entrepreneurial biases examined specific biases in the context of strategic investment decisions (start-up, market entry) or exit decisions (disinvestments). While there is no doubt that those financial decisions have been proven to be very good candidates to examine cognitive biases in entrepreneurial decision making, this spotlight approach could raise the issue whether other entrepreneurial decisions involving business risks and uncertainties might be underexposed. Furthermore, it could raise the issue whether the importance of specific biases in strategic investment decisions carries to other domains of entrepreneurial decisions as well.

In our attempt to supplement the many valuable spotlight studies in this domain, we aim to shed broader light on these issues. Therefore, we explore the importance of a series of (12) cognitive biases across a broader range of entrepreneurial decisions that involve business risks and uncertainties and for which decisions entrepreneurs seek external advice from their accountants. From their third-party role, accountants are in the position to have an overview of various types of decisions that entrepreneurs struggle with and seek advice for, as well as the cognitive biases that entrepreneurs may fall victim to in those decisions. Interestingly, a very recent conceptual study by Liebregts et al. (2020) confirms that people in the social context of entrepreneurs (like the accountants in our study) and who can observe entrepreneurs in their decision making processes, are in a unique position to examine cognitive biases and Liebregts et al. (2020) find this a promising avenue to advance our understanding of entrepreneurial decision making.

Before we further elaborate the literature background of the decisions and the cognitive biases that we included in our study, we first define the two concepts—biases and heuristics—that we put central. *Bias* refers to the systematic deviation from rational choice theory when people choose actions and estimate probabilities (Tversky and Kahneman 1974). *Heuristics* refer to simplifying shortcuts or principles that people use for problem solving and information processing (Baron 2007). Heuristics are fast and frugal, freeing people from making complete and systematic and e ffortful processing of information. As heuristics simplify information processing, they are associated with biases. Both biases and heuristics are part of what Stanovich and West (2000) referred to as experiential and intuitive decision-making processes (labeled as system 1). Although biases are portrayed as deviations from rationality, we do not take the position that biases are always bad. Moreover, while it has been documented that biases influence risk perceptions as well as decisions that involve risk, the desirability of biases should be considered in the context of the risk appetite (or desired risk-taking behavior) of the organization (Croce et al. 2020). We think this warrants the value of our study to explore whether cognitive biases are equally important across di fferent domains of entrepreneurial decisions that involve business risk and uncertainties.

In the remainder of this section, we use the third-party stance of the SME accountant to develop our theoretical background. First, we describe for what kind of decisions entrepreneurs seek the advice from their accountants and we clustered those decisions to domains. Next, we determine a list of cognitive biases from literature that we can use for the purpose of our study and that allows us to exploit the unique position that accountants have to observe cognitive biases in entrepreneurial decision making in real-life situations.

### *2.2. Domains of Decisions for Which SME Entrepreneurs Seek Advice from Accountants*

Table 1 provides an overview of literature and shows the various decisions for which SME entrepreneurs seek advice from accountants. Based on this overview of the existing literature, we have identified five decision domains that accountants are involved in as advisors. Table 1 shows how each of the various types of decisions from prior literature have been mapped to the following five decision domains:


**Table 1.** Types of decisions in which entrepreneurs seek advice of accountants


 Roman numerals indicate to which of the five decision domains, describedtype has been assigned.

### *2.3. Cognitive Biases That Can A*ff*ect SME Entrepreneurs*

To serve the purpose of our study, we selected a set of appropriate cognitive biases following an approach that is similar to the one that was followed by Cristofaro (2017). Since our research design required in-depth interviews with SME accountants, we decided that 60 topics would be our maximum (12 biases across 5 decision domains). Therefore, we limited ourselves to 12 biases so that it would remain possible to interview respondents in one interview.

Given the design of our study, biases should show in practice and must be recognized and easily distinguished by accountants from a third-party stance. We derived our set of biases from an initial literature review on SME entrepreneurial biases and we tested and refined the set of biases in our pilot with SME accountants. We also asked them whether important biases were missing.

At the time we set up our study, we were not familiar with the list of important biases that Zhang and Cueto (2017) derived from SME literature. Nevertheless, we have 8 out of 12 biases in common with their list. Four biases from their list are not in ours, and we think for good reason, since they appeared to be conceptually confusing for our respondents (too proximate with other biases we did include). From their list we did not have in ours: *law of small numbers* (could be confused with *representativeness bias*), *self-serving attribution* (is more hindsight to the decision, and could be confused with *confirmation bias* and *illusion of control*), *similarity* (could be confused with *confirmation bias* and *a*ff*ect heuristic*), and *over-optimism* (could be confused with *overconfidence*).

Furthermore, we included four biases that were not in Zhang and Cueto's list. First, we included the more generic *confirmation bias*, that covered the more situated bias *similarity* in Zang and Cueto's list. Next, we included *groupthink* which blends well with Zhang and Cueto's call to examine biases related to the entrepreneurs' social context. The accountants in our pilot mentioned that many entrepreneurs participate in entrepreneurial network events from Rotary, Lions and alike. There they discuss and exchange business decisions to larger extent and ge<sup>t</sup> influenced by other entrepreneurs as well as some entrepreneurs ge<sup>t</sup> influenced by family members who are or have been involved in the SME. We also included two biases that were not in Zhang and Cueto's list but which blend well with their call to do further research on biases that are associated with SME entrepreneurs' emotions. We added *a*ff*ect heuristic* that taps into the happiness emotion (proposed by accountants who told of entrepreneurs who felt in love with their products and company). And finally, our fourth added bias is *regret* that taps into the fear emotion of 'missing the boat', which was also mentioned by the accountants in our pilot. Following this approach, we arrived at the set of 12 cognitive biases and heuristics that we will briefly introduce.

### 2.3.1. Bias #1: Anchoring

Anchoring is a heuristic that influences one's intuitive judgment. Individuals subconsciously base their decisions on a reference point, the so-called anchor, and subsequently make adjustments to this initial anchor to come to their estimation or judgment. However, these adjustments are often insu fficient causing the ultimate outcome to be biased towards the initial anchor, thereby limiting rational decision making (Tversky and Kahneman 1974). For example, in negotiations, the first o ffer made forms the anchor, causing the outcome of the negotiations to be strongly influenced by the first offer (Galinsky and Mussweiler 2001). Similarly, the entrepreneurial decision of whether to start a new venture has also been found to be subject to the anchoring bias (Barbosa and Fayolle 2007).

### 2.3.2. Bias #2: Availability Heuristic

The availability heuristic is a mental shortcut where prior examples that easily come to mind can receive disproportionate weight in decision making (Tversky and Kahneman 1973; Palich and Bagby 1995). As such, strongly positive or negative experiences, which come to mind easily, can strongly bias the decision-making process. Recent experiences have also been shown to come to mind more easily than experiences from a long time ago. In this context, entrepreneurs have been found susceptible to the availability heuristic in a study which showed that the decision of whether to found a new venture was strongly biased based on recent experiences (Barbosa and Fayolle 2007).

### 2.3.3. Bias #3: Confirmation Bias

The confirmation bias causes individuals to look for information that supports their opinion or decision, while disregarding information that is contradicting (Baron 2004). Entrepreneurs have been found to be prone to the confirmation bias, particularly when they have not experienced failure before. These entrepreneurs tend to overestimate their own previous successes, focusing on positive information and thereby rejecting disconfirming evidence (Carr and Blettner 2010).

### 2.3.4. Bias #4: Regret and Counterfactual Thinking

Counterfactual thoughts are thoughts that form an alternative to past events or situations, whereby one thinks about "what could have happened if ... ". This can lead to forming alternative strategies for the future, which in turn can influence decision making processes (Baron 2013). Related to counterfactual thinking is the concept of regret, a counterfactual emotion, which is also strongly associated with decision making. Mullins and Forlani (2005) and Zeelenberg (1999) documented the regre<sup>t</sup> effect in the field of new venture decisions and SME as the 'fear of missing the boat'. Family firms are more prone to regre<sup>t</sup> in terms of family-based circumstances as well as business-related regret. The experienced regre<sup>t</sup> in a family firm has been found to bias decision making (Hirigoyen and Labaki 2012).

### 2.3.5. Bias #5: Escalation of Commitment

Escalation of commitment occurs when decision makers overcommit to a previously chosen course of action, despite negative feedback indicating that this will not lead to success (Staw 1976). The longer people continue along the same path, the more di fficult it generally becomes for them to change direction (Drummond 2004). Escalation of commitment in the context of SME's is primarily caused by a shortsighted vision as well as by the mixing of economic and personal interests (Drummond 2004). Furthermore, entrepreneurs are often highly dedicated to making their firm a success, which can hamper their ability or willingness to recognize that they, or their firm, are currently on a failing course of action. As long as this is not recognized, entrepreneurs are prone to escalation of commitment (Baron 1998).

### 2.3.6. Bias #6: Illusion of Control

The illusion of control bias occurs when people overestimate the amount of control that they have over a situation. It specifically constitutes an 'illusion' of control in the case where someone believes to have control even over those outcomes which are objectively outside of their control (Langer 1975). Entrepreneurs have been shown to be more inclined to overestimate the amount of control that they have. Due to this illusion of control they tend to underestimate risks, since they believe their own skills can prevent potential negative outcomes (Keh et al. 2002; Le Roux et al. 2006).

### 2.3.7. Bias #7: Overconfidence

In the context of our study, overconfidence comes in the form of the tendency to overestimate the correctness of an initial assessment in relation to complex situations (Busenitz and Barney 1997). Whereas the illusion of control relates to the false belief of having control over situations outside one's control, overconfidence relates to overestimating one's personal chances of success in any situation. Entrepreneurs have been found to show more overconfidence than managers in large organizations (Busenitz and Barney 1997; Forbes 2005). This has been related to di fferences in individual characteristics and the complexity and uncertainty that many entrepreneurs face, amongs<sup>t</sup> others (Forbes 2005).

### 2.3.8. Bias #8: Planning Fallacy

The planning fallacy is associated with overoptimism in estimations about the amount of work that can be completed within a certain time period (Baron 1998; Kahneman and Lovallo 1993). This is often the result of assuming ideal circumstances or of underestimating or not accounting for events or risks that can add to the workload. The planning fallacy is more likely to occur in environments which are characterized by new and unique situations including a lot of uncertainty. These are also the types of environments that entrepreneurs operate in. Similarly, entrepreneurs have a more di fficult time basing their estimations on prior experiences, an approach which has shown to reduce the planning fallacy (Kahneman and Lovallo 1993), due to the typically smaller size and younger age of the firm (Baron 1998).

### 2.3.9. Bias #9: Representativeness Bias

The representativeness bias can make decision makers falsely assume that limited experiences can be generalized and apply in all instances. Recognizing elements of past experiences in new situations can lead decision makers to incorrectly draw analogies and assume the same result will be achieved once more (Schwenk 1984). Busenitz and Barney (1997) conclude that entrepreneurs are more subject to the representativeness bias than managers in large organizations. Simon et al. (2000) argue that entrepreneurs are prone to the representativeness bias because they lack past examples on which to base estimations, forcing them to rely on the limited amount of data that they do have, which can lead to oversimplified analogies of complex situations. In line with this, Mehrabi and Kolabi (2012) show that representativeness negatively influences the quality of strategic decisions by entrepreneurs.

### 2.3.10. Bias #10: Status Quo Bias

The status quo bias is a tendency to stick to previously made choices and decisions, thereby sticking with and being unwilling to deviate from past decisions either made by yourself or by someone else, even if this is no longer rational (Burmeister and Schade 2007). Burmeister and Schade (2007) argue that entrepreneurs are not necessarily more prone to the status quo bias than other decision makers. However, they do argue that the status quo bias is more likely to occur in decisions or situation that the decision maker has a lot of experience with. Previous experience leads to a reduction in flexibility and a less varied range of potential choices (Burmeister and Schade 2007). In line with this, Gibbons and O'Connor (2005) found that the experience of SME CEO's was positively related to their commitment to the status quo.

### 2.3.11. Bias #11: The A ffect Heuristic

Often, decisions are not made mostly based on the objective weighting of pros and cons but rather on how "good" or "bad" something feels, i.e., we buy the products, or hire that people, that we "like". This is referred to as the a ffect heuristic. Such a ffective reactions have been found to be important in decision making by entrepreneurs (Baron 2008) and entrepreneurs are often passionate people who follow their emotions (Cardon et al. 2009). In line with this, Nouri et al. (2017) describe that entrepreneurs may be particularly susceptible to the a ffect heuristic. For example, a ffect has been shown to have an influence on entrepreneurial opportunity evaluation (Foo 2011) and the pursuit of entrepreneurial ideas and even the decision to become an entrepreneur and start a business (Hayton and Cholakova 2012).

### 2.3.12. Bias #12: Groupthink

Whereas the previous biases are all focused on decision making by the individual, groupthink is a bias which can occur when people make decisions in a group. Groupthink originates from the human tendency to not want to go against the group. Groupthink occurs when "*the members' strivings for unanimity override their motivation to realistically appraise alternative courses of action*" (Janis 1972, p. 9). Groupthink tendencies in entrepreneurial teams can threaten entrepreneurial adaptation and renewal of the firm (Kor et al. 2007). In high-velocity environments (Bourgeois and Eisenhardt 1988), a free exchange of views among entrepreneurs is preferred to conformist thinking (Hambrick 1995).
