Cognitive biases in entrepreneurship: a research report

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Scenario 1 – Joe and Jane decided to play a game in which they toss a coin a few times. Every time a head came up, Joe had to give Jane $10 and every time a tail came up, Jane had to give Joe $10. They could toss the coin any number of times they want until one of them objects. The coin was tossed once, and a tail came up. Joe gave Jane $10. The coin was tossed again and again 8 more times, and every time, a tail came up, ergo, Joe had to give Jane money. Jane started feeling kinda bad after about 4 tosses and asked Joe if they should stop. But Joe wanted to keep going. He was sure that he would win sooner or later. After 5 more coin tosses, Joe finally gave up when all the tosses gave tails and he had no more money. So, why didn’t Joe give up sooner? What made him keep going?

Scenario 2 – Jane went to a classy restaurant to have a 3-course meal. She absolutely loved the entrée and the main course but disliked the dessert because of a slight off-taste. But she had already paid for the food so she finished the dessert despite not liking it. She told Joe about her experience with the restaurant and couldn’t stress it enough that the dessert had an off-taste which made her dislike it and kinda ruined the whole. Why did she mention a tiny flaw of an overall great experience with such vigour? Moreover, why did she finish eating the dessert despite not liking it? Since the money was already paid, whether or not she finished the dessert wouldn’t have made a difference. She could have just left it unfinished (assume that there are no moral considerations involved here – it’s about the money) and avoided further discomfort.

The answers to all the questions can be summed up in two words—cognitive biases. Cognitive biases are systematic errors in thinking that make us deviate from rational thoughts and judgement. In the first scenario, Joe kept pushing for more tosses because he expected a head to come up soon. He believed that since tails came up so far, a head coming up was inevitable despite the fact that the chances of heads to tails coming up remains the same (50-50) in every single toss.

Just because the previous 5 tosses gave tails, doesn’t mean that the probability of occurrence of a head in the next throw increases. He was gambling with the same chances in every single throw yet he continued doing it until he was out of money. Here, one can say that Joe kept going because of optimism, an illusion of control, and something called gambler’s fallacy—all of which are different types of cognitive biases which made him keep going despite knowing his odds are the same.

In the second scenario, Jane couldn’t get the bad dessert out of her mind despite the other delicious courses. She was annoyed about the money wasted on something so bad but felt like she got its worth by finishing the dessert. Here, we can see that she emphasized her negative experience more than the positive one despite the fact that her positive experience probably outweighs the negative one.

I mean, she had two delicious courses. Rationally speaking, one can argue that they more than made up for a dessert with a slight off-taste. This is because of a phenomenon called negativity bias which makes negative events more potent and significant to a person than a positive experience.

The other thing notable here is that she kept eating the dessert despite disliking it thinking that she should get her money’s worth. But did she though? Whether or not she finished it, she wouldn’t have gotten the money back. Besides, if she had stopped eating it, she could have stopped enduring further discomfort. But she decided to do what she did because of a cognitive bias called sunk cost fallacy which is the tendency to make investments in vain to prevent wasting sunk investments made earlier.

I hope that these examples are enough to show the power of these biases and their significance in our actions. Cognitive biases play a major role in our lives and I have acquired a bit of knowledge about them in the past few months. In an effort to share whatever information I could gather through my research, I have put together a report which discusses a few of the most common biases and their impact on entrepreneurs. I was pointed to this amazing topic by Anne-Laure and I have had so much fun working on this project. So, I would love to express my gratitude to her before proceeding.

Cognitive biases in entrepreneurship report

The reason why we decided to study the impact of cognitive biases on entrepreneurs was that it is a subject which is relevant to the current times. Start-ups are popping up and going down all the time these days. Despite statistics showing that new ventures are more likely to fail, there is no scarcity of new start-ups.

Would you get on a plane that you know has a 70% chance of crashing? No! I wouldn’t even get in if the chance of that happening was greater than 20%. So, what makes individuals pursue the route of entrepreneurship despite the risks involved, despite the facts saying that they shouldn’t do it? What makes them successful when they are? What are the reasons for their failure?

While it would be totally inaccurate to say that cognitive biases are the answers to these questions, it wouldn’t be inaccurate at all to say that they do play an important part in it. Cognitive biases affect the rationalising and judgmental power of an individual and skew it based on their perceptions instead of cold cut facts. They influence crucial aspects of entrepreneurship like idea formation and decision making. Decisions take us forward in life. When we make decisions based on a skew judgement, we get in trouble. Do we always get in trouble though? 

Sometimes, being optimistic and taking a few risks may actually pay off. So, optimism is good in particular situations. Most of the time, a sense of control helps drive us. When we lose the sense of control, we feel helpless which can lead to unhappiness. But optimism and illusion of control are both biases and they actually help us function well and stay happy. So, are the biases not as bad as we thought they are? Not all of them. While some of them do take us down, a few of them help to keep us sane, happy and normal—when they are present in moderate amounts. The key is a balance as too much or too less can cause trouble. For example, a lack of optimism was found in people diagnosed with depression.

Cognitive biases are too many and too vast to comprehend them all without a lifetime of dedication. So I have penned only the most relevant ones in the report. It contains details on 10 most common biases well-researched in the context of entrepreneurship. I have tried to include information from at least 2 of the most cited papers on each bias. Though the report is intended for entrepreneurs, I truly believe that it will benefit everyone thanks to the information on how these biases work in general for everyone. The short description at the beginning of each bias will give you a summary of the longer version underneath.

Finally, cognitive biases are wired into our system. They manifest themselves without us being aware of them and hence, it is difficult for us to identify that the mistake we made or the bad decision we took was due to an unintentional bias towards a personal perception. Hence, awareness is the best way to tackle these biases. Knowing what they are and how they affect us will help us recognize and take action to keep them in check when they make themselves known. And my quest was to help people gain that awareness. I hope that my intention will be evident from the report and I truly believe that the readers will benefit from it.

The report is only available to Ness Labs member. Become a member to support our research work at Ness Labs, then come back to this page to see the download link. If you’re already a member and can’t download the report, make sure you’re signed in or let us know in the community.

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