4.1 Using institutional influences to understand government venture capitalists’ decision making
From our observations and interviews, we noted how the GVC officers relied on three interdependent institutional influences that guided their discussions and decision making. Consistent with the work of Scott (
2014), we observed how the three types of influences (regulative, normative, and cognitive) guided the GVC officers’ financing decisions. Table
3 provides examples of the three institutional influences that guided GVC officers’ decision making regarding the key assessment indicators of the market, production, finances, and human capital (Table
4).
Table 3
Government venture capitalists’ decision-making and use of key assessment indicators in the institutional system
Market, product and production | ○ Prioritized/supportable industries ○ Type of companies to support ○ Supportable/prioritized geographi-cal area ○ New markets, increased export ○ New technology solutions ○ New or refined products/services ○ Clarity of business concept ○ Competitive distortion effect ○ Market conditions | ○ Own norms among the group of financiers (e.g., on businesses, support areas, unique products, market characteristics, and competition). Ethical aspects of the funding. (e.g., entertainment machinery in tourism) ○ Although not mentioned in regulation, supportive of businesses that collaborate with large national cooperation contributing to social development | ○ Own subjective evaluation of the market, product, and production potentials ○ Own preferences. Some more favored than others ○ Taken-for-granted assumptions not shared by regulation or group |
Human capital | ○ Be legally competent ○ No payment defaults ○ Disqualified for running own business ○ Increase of employment rate ○ Educational investments (quality, environment, or organizational development) ○ New establishment of entrepreneur ○ New entrepreneur in new industries | ○ Norms on what is relevant (entrepreneurial characteristics, education, experiences, and social network). Entrepreneur’s track record | ○ Individual subjective definitions of entrepreneurs’ and key people’s characteristics that are not shared or mentioned in regulation or group norms ○ Analogies between situations that are used for decision-making argumenta-tion |
Financial | ○ Scope of support clear limits (e.g., 20%–50% of the applicant’s investment). Substantial financial effects of investment ○ Regulations on the companies’ financial situation ○ Not bankruptcy ○ Unable to self-finance the whole investment ○ Profitability of business ○ Degree of earlier public funding | ○ Group norms on scope depending on particular characterized situations ○ Group norms for interpreting the substantial financial effects of investments ○ Norms for what is acceptable counter financing | ○ Subjective perceptions of the scope of investment; how much to support ○ Subjective expectations on future financial performance, in comparison to prior own experiences (e.g., of industry performance) |
Table 4
Overshadowing forces in the GVCs decision making process
Phases in the decision-making process | Application screening | Application decision | Decision validation |
Rationales for the overshadowing force | Familiarizing | Judging the application | Outlining identity boundaries | Decreasing complexity/simplifying |
Characteristics of the overshadowing force | Expressing perceptions | Deciding potential | Defining and outlining boundary of self | Prioritizing: suppressing or emphasizing information |
Expressing emotional values | | Rationalizing |
Outlining own competence base | | | |
Illustrating quotations | This is an appealing product, both in design and price, and the market channel is promising. So is the entrepreneur, who created a good impression at our meeting. I really have a good feeling about this application | I am excited. This is an extremely talented man; he’s a solid guy, and he is smart | We, as government venture capitalists, cannot support this investment since this entrepreneur is suspect and is indulging in hocus pocus. We have an ethical responsibility to take [this] into account | Be sure to communicate this clearly to this applicant; otherwise, we will have a problem. This is a troublemaker who will use his influential connections to question our decision…We know that municipality and politicians want us to support tourism |
Yes, as you know, we are all fond of these kinds of product | My gut feeling tells me that this will be a hit; let us approve… | Our role is to approve financing where others do not; we need to be risk takers if we are to make a difference in terms of innovation and financing newly founded businesses | There are so many different factors to consider and the decision may be ok according to one direction but not ok according to another direction |
I love this product; it is so beautiful | I have a good feeling about this application; you know I like this, and I want to approve it | Let us express it like this to the media. Then we know it will be appealing | |
We do not know much about this type of product | I do not like this; I would not like to be in their shoes if they risk all in this investment...my whole system signals a BIG NO | | |
The ICT technology is really complex, and my fear is that support will not make for improved efficiency | I do not trust this person ... I am very hesitant; everything I sense leads me to a rejection | | |
Regulative influence was always present because the financiers worked in a highly regulated environment, constrained by both national and international legislation and regulations (national laws, European Commission regulations, and national regulations of government authorities). The regulative influence on GVCs’ investment decisions was based on an external orientation and the legal sanctions that they used to justify the decision outcomes. In their discussions of applications when nearing a decision, the financiers commonly asked, “What does the regulation say?” There were various restrictions on finance, the amount of finance available for allocation, and the time frame for receiving funds. As one GVC-officer reported, “There is no ambiguity when looking into the regulations. We are not allowed to support applications that have a competitive distorting effect.” Regulative influence was also the most explicit influence because it could be identified not only through discussions but also through website resources, written laws, and standardized application forms. When considering a decision, the financiers often checked and recalled explicit material. As one of the financiers stated, “Let’s make sure that this is in line with the rules and application requirements; regulations only support new investments and not the maintenance of old equipment.”
We found support for the normative influence because we observed that the financiers had established strong norms and policies over the many years they had worked together. This situation was evident in statements such as “We have always followed this reasoning.” Norms and policies were typically expressed via explicit written guidelines specified by the group and via explicit and implicit or tacit verbal discussions. An example of such a norm is a decision situation described by one financier as follows: “Our written guideline on machinery in tourism is to support eco-friendly investments.” Nevertheless, re-evaluating the policies and norms was invariably an item on the regular meeting agenda. The financiers discussed specific and explicit policies and norms and subsequently changed, refined, or confirmed them. The financiers related specific venture applications to their established norms and policies. Common expressions included “What is our policy regarding this?” and “Our policy is not to support this type of business.” This evidence reflects the financiers’ normatively governed justifications of decision outcomes. The group often discussed what they could or could not do and how they were expected to act according to norms. Statements such as “All tourism ventures can’t have a full machinery park; we stipulate that we want them to cooperate” were common during the discussions.
Finally, we observed that the cognitive influence was important in investment decisions. Cognitive influence was expressed verbally in the financiers’ discussions, and cognitive guidance had both an outspoken explicit character and a less outspoken tacit character. The financiers often drew analogies with earlier situations, asking themselves questions such as “How did we respond before in a similar situation?” or “In the case of venture X, we dealt with it by...” The group often referred to feelings and emotions in the investment decisions: “I have a good feeling about this product. It is so beautiful,” “I don’t like this…,” or “I don’t trust this person.” These examples illustrate the taken-for-granted, shared understanding, and the subjectively agreed-upon criteria within the group, expressed through analogies, feelings, emotions, and beliefs (i.e., based on compliance). Cognitive influence is based on an internal orientation. The financiers discussed applications with varying degrees of passion, and their body language helped express feelings of dislike or excitement. For example, when the financiers had difficulty understanding the product or the entrepreneur and displayed a negative bias toward the application, we sometimes heard statements such as “this entrepreneur is suspect and is indulging in hocus pocus.” On such occasions, the discussions revolved around the location of the business or the reputation of the entrepreneur, particularly when linked to previous poor performance, which encouraged financiers to reject the application. The examples in our observations and interviews suggest that the justifications for decision outcomes were built on what was comprehensible, recognizable, and culturally and emotionally supported. Furthermore, cognitive logic is characterized by bounded rationality or, in some cases, irrationality in investment decisions.
Consistent with the literature on legitimacy in the institutional framework (Scott
2014; Thornton et al.
2012), we found that the investment decisions were subject to all three influences. Regulative influence serves as the basis for or the input of the work, while normative and cognitive influences are used to decide on financing support. It should be noted, however, that the regulative influence was used to justify the final decision outcome but that any signs of the involvement of norms or cognitions were absent from official communications. Interestingly, although all three institutions were present in financiers’ investment decisions, cases in which all three institutions supported a decision were rare. This finding somewhat contradicts the traditional understanding of institutional theory in terms of dynamism (DiMaggio and Powell
1983; Scott
2014) and is close to the conceptualization in research on fragmented institutions (Biniari et al.
2015; Friedland
1991; Greenwood et al.
2010; Pache and Santos
2010). By carefully analyzing the impact of the three institutions, we were able to identify meaningful implications regarding the dominance of cognitive institutions, which the institutional theory literature does not fully acknowledge. Thus, we contribute by providing new knowledge on how financial institutions deal with the multiplicity of internal and external pressures by predominantly leaning on cognitive institutions.
Notably, the institutionalized investment decision framework involves all three types of institutions, with the cognitive logic playing a dominant role in guiding investment decision outcomes. Below, we elaborate on these considerations and shed light on the official and unofficial justifications for GVCs’ investment decisions.
4.2 The importance of the cognitive logic and the presence of overshadowing forces
We observed that cognitive institutions substantially influenced the way in which the decision making was institutionalized. The cognitive influence underpins the habitual ways of thinking and behaving within a particular organization. This was found to be the case with the funding decisions by the GVCs (see Mouritsen
1994; Sharma
2015). Furthermore, we noted that the cognitive logic affected how complexity in investment decisions was framed and how the financiers, in their discussions prior to investment decisions, found solutions and justified decision outcomes in the absence of clear regulative guidance (Greenwood et al.
2011; Thornton et al.
2012; Lawrence et al.
2011).
In the context of this study, cognitive institutions enabled financiers to orient their investment decisions with a degree of assurance when facing multiple macro logics. The GVCs often turned to bounded rationality when relying on these multiple macro logics to assess information and make decisions (Gabrielsson and Huse
2002). Certain decisions were somewhat irrational given the major influence of the cognitive logic. We noted that bounded rational-irrational cognitive frameworks were involved at critical decision points. These frameworks helped financiers make more balanced decisions, ultimately reaching decisions where the regulative and normative logics were not satisfied or where the logics conflicted. The financiers could thus act flexibly and renegotiate their behavior from situation to situation (e.g., depending on the pressure and direction for legitimation needed for instance internal or external pressure or legitimation).
We assessed how much time the financiers spent discussing important information and how the three institutional influences interacted. During these investment decisions, GVCs discussed the key assessment indicators: markets, production, and products (83% of the content), human capital (10% of the content), and financial and investment information (7% of the content). Previous studies of traditional venture capitalists have shown that the financial and investment information and human capital are the most critical assessment indicators and that venture capitalists focus on what can be measured (Hall and Hofer
1993). GVCs use the same type of assessment indicators as traditional venture capitalists, although they rely less on measurable criteria. The venture capital literature has moved away from the mere identification of assessment indicators. We follow this trend by further examining the behavioral aspects of decision making. The structure of the assessment indicators clearly relates to the imperative to legitimize decisions; indeed, financiers’ decisions are legitimized to the extent that they conform to the existing basis of compliance (Scott and Davis
2007; Trevino et al.
2008). Such legitimatization is consistent with institutionalized investment decisions (Gorman et al.
2005; MacMillan et al.
1985). The discussions that focused on whether to approve an application showed that the cognitive logic played a crucial role in investment decisions. We observed that 47% of discussions were associated with the cognitive logic, 16% with the normative logic, and 14% with the regulative logic. We also observed that the cognitive logic appeared to be built on the four overshadowing forces presented below, allowing it to dominate in the investment decisions. In our view, the four overshadowing forces ensured the dominance of the cognitive logic when the institutional logics, including the normative and regulative logics, were non-aligned.
First, formulating what we labeled the initial perspective to assess the venture application allowed the financiers to familiarize themselves with each venture and each application. This is the deal originating phase in Silva’s (
2004) study of venture capital decision making. The financiers in this phase used the cognitive logic to assess venture information so that they could comprehend the venture, the investment, and the effects of the investment (cf. Baum and Silverman
2004). The cognitive logic is important early in the investment decision. This phase emphasizes the GVCs’ perceptions, emotional values, and lack of competence in relation to, for example, products, markets, and regulations. Statements such as the following illustrate this point:
This is an appealing product, both in design and price, and the market channel is promising. So is the entrepreneur, who created a good impression at our meeting. I really have a good feeling about this application.
Yes, as you know, we are all fond of these kinds of products.
The converse is also true, as reflected by statements such as the following:
We don’t know much about this type of product. The ICT technology is really complex, and my fear is that support will not make for improved efficiency.
Doesn’t this product function like wiretapping and societal control? We do not want to be part of such activities. How can we get out of this one? What regulation can we turn to?
These statements suggest that the financiers’ initial perspective also influenced the use of regulative and normative logics. Overall, initial learning about a venture and forming an initial perspective laid the foundations for the financiers to use the other institutional logics to make a decision. This initial use of the cognitive logic outlines dominance of cognitive logic.
By making sense of key assessment indicators and attributes when processing venture applications, the financiers fashioned a social perception that produced a collective image of the venture. This social perception also helped them evaluate the venture’s potential fit with the multiple macro logics that the financiers used, thus widening the scope for funding approval. In many cases, the financiers spent considerable time (up to 98%) developing a collective image and evaluating the venture’s potential. Overall, forming the initial perspective proved important for the ultimate financing decision because it oriented the financiers’ thinking toward the use of the regulative and normative logics. This was an overshadowing force because in cases where the initial perspective conflicted with other logics, it was the initial perspective that determined whether financial support was granted.
Second, what we categorized as expressions of positive or negative feelings regarding venture attributes were part of the cognitive logic guiding the investment decision. This phase corresponded to the deal evaluation phase where judgment of the application took place and where the GVCs determined the investment potential (cf. Silva
2004). Like Cardon et al. (
2009), we found that the financiers often based their evaluations on their passion for a venture application. Positive feelings about the products and the entrepreneurs were advantageous for ventures in securing funding. This phase highlighted stereotypical expressions of what was considered “right” and “wrong.” GVCs showed overconfidence in investments due to emotions. This was expressed in statements such as the following:
I am excited. This is an extremely talented man; he’s a solid guy, and he is smart.
The entire team expressed approval. Other statements reiterated the role of positive feelings:
I have a good feeling about this application; you know I like this, and I want to approve it.
My gut feeling tells me that this will be a hit; let’s approve…
The group often referred to negative feelings and emotions in investment decisions:
I don’t like this; I would not like to be in their shoes if they risk all in this investment...my whole system signals a BIG NO.
I don’t trust this person ... I am very hesitant; everything I sense leads me to a rejection.
Although limited time (between 20 and 30% of the discussions) was devoted to expressing emotions, such expressions based on the cognitive logic had a substantial influence on decision outcomes when they were verbalized. The use of both normative and regulative logics was influenced by such expressions. In fact, when feelings were expressed, discussions often took new directions. Several cases were observed in which expressing positive feelings ran counter to the regulative logic but nevertheless received support upon revising the normative logic. Such behavior caused inconsistency in the GVCs’ decision making (cf. Dimov et al.
2007)
Third, financiers’ confirmation of themselves, including their cognitive and social identity (e.g., being government representatives with their attendant responsibilities) and what we refer to as financiers’ cognitive identity restriction guided investment decisions based on financiers’ pre-existing value judgments of what can be financed (Ashforth and Mael
1989; March and Olsen
1989; Thornton et al.
2012). This behavior refers to the deal closing phase (cf. Silva
2004) involving rationalization of the decision. The financiers in this phase often voiced reputational concerns in relation to their roles as GVC officers, their professional functions, and their codes of conduct. Concerns of own reputation were evident when the GVCs initiated their discussions with statements such as the following:
We, as government venture capitalists can’t support this investment since this entrepreneur is suspect and is indulging in hocus pocus. We have an ethical responsibility to take [this] into account.
Our role is to approve financing where others do not; we need to be risk takers if we are to make a difference in terms of innovation and financing newly founded businesses.
Given this cognitive identity restriction, the GVCs discussed what they could or could not do and how they were expected to act according to their roles (e.g., their authority). Although only 9% of the discussions related to this overshadowing force, it influenced their behavior substantially when making their investment decisions and discussing the granting of financial approval.
Fourth, the cognitive logic was used to formulate decisions through what we call multiple-perspective validation. This phase was also part of deal closing. It refers to finding links between the financiers’ own knowledge and how the financiers perceived the external expectations of multiple stakeholders such as venture applicants, the media, municipalities, and politicians. This phase involved simplifying complex situations, suppressing information that did not support the decision, and emphasizing information that did support the decision. The GVC officers dealt with high complexity and high uncertainty due to conflicting expectations and conflicting goals. The financiers developed techniques to respond cognitively to macro logics while legitimizing and rationalizing their investment decisions. Statements such as the following support this point:
Let’s express it like this to the media. Then we know it will be appealing.
Be sure to communicate this clearly to this applicant; otherwise, we will have a problem. This is a troublemaker who will use his influential connections to question our decision…We know that the municipality and politicians want us to support tourism.
Our data show that this multiple-perspective validation influenced the prospect of approving finance for entrepreneurial endeavors. The financiers appeared to use their bank contacts, the media, and politicians to test their perspectives on how best to legitimize their investment decisions. Although this overshadowing force was subtle, the multiple-perspective validation not only removed some of the uncertainty but also made the work appear rational (Scott
2014). We observed that 15% of the discussions touched on the multiple-perspective validation, and our observations support the importance of this kind of discussion in influencing decisions concerning venture capital approval. Again, these observations support the prominent role of the cognitive logic.