Behavioral Finance: Factors Influencing Angel Investor Decisions

155 Pages·2014·0.68 MB·English

BEHAVIORAL FINANCE:
FACTORS INFLUENCING ANGEL INVESTOR DECISIONS

by
Robert C. Forrester

A Dissertation

Presented in Partial Fulfillment of Requirements for the
Degree of
Doctorate of Business Administration
In the
Coles College of Business
Kennesaw State University

Kennesaw, GA
2014
Copyright by
Robert C. Forrester
2014
Coles College of Business
Doctor of Business Administration
Dissertation Defense: July 1, 2014
c.
D8A Candidate: Robert Forruter
The content and format of the dissertation are appropriate and acceptable for the awarding of the
degree of Doctor of Business Administration.
lucy Ackert, PhD
Committee Chair
Professor of Finance
Department of Economics, Finance & Quantitative Analysis
Coles College of Business
Kennesaw State University Signature:-~
Rongbing Huang, PhD
Committee Member
Professor of Finance
Department of Economics, Finance & Quantitative Analysis
Coles College of Business
Kennesaw State University Signature:
Xiao Huang, PhD
Reader
Associate Professor of Economics
Department of Economics, Finance & Quantitative Analysis
Coles College of Business t'"\,/' 1
Kennesaw State University Signature: N f..+.o V~
Torsten M. Pieper, PhD
Academic Director, KSU DBA Program
AssiStant Professor of Management
Department of Management and Entrepreneurship
Coles College of Business
Kennesaw State University Signature:
CharlesJ. Amlaner, Jr., DPhil
Vice President for Research and
Dean of Graduate College cW~
Kennesaw State University Signature:
ACKNOWLEDGMENTS
This has been an experience of a lifetime, and I am indebted to the many
people who supported, encouraged, and inspired this dream.
First, my deepest gratitude goes out to the highly supportive and
knowledgeable faculty at Kennesaw State University. In particular, thank you to the
seminar instructors who fed students’ developing minds from the very beginning
(including Lucy Ackert, Rongbing Huang, Xiao Huang, and Divesh Sharma). A special
thanks to Gabriel Ramirez for pushing us to be the best we can be. Many of you have
since become committee members and friends. I am indebted to you for the
opportunity to work alongside brilliant minds. Above all, thank you to my advisors,
Joe Hair for bringing me to KSU, Neal Mero, Torsten Pieper, and Juanne Greene for
their leadership at this stage of my academic life. You have been my steadfast
supporters from the beginning. I appreciate your words of wisdom and the many times
you worked on my behalf to provide personal and professional support, advice, and
guidance.
Second, I am grateful for the many friends at Kennesaw State University who
walked this road with me, including George Allen, Shalonda Bradford, Morten
Brante, Chuck Casto, Lee Macenczak, Scott Manley, Donna Pearson, Christine
Sutton, Frank Thompson, Ralph Williams and all the others in Cohort 3, as well as
several in other cohorts. This includes my closest confidants, the members of the
accounting and finance majors, Reid Cummings, Lisa Ludlum, and Tonya Smalls,
who worked, studied, and played together - as well as spending a small fortune
washing away some of a graduate students’ often tortured existence while dining at
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some of the best restaurants in Atlanta. You have been awesome companions; thanks
for all the good times and for making the less good ones better. Thank you for your
unwavering commitment to work together and tackle every “next project.”
Next, to John D. (Pete) Tackett, my friend, business partner, and the angel
investor who invested in my ideas and businesses and changed the course of my life.
Thank you for the personal, professional, and financial support along with the dedication
and encouragement this past 30 years - and for inspiring this dissertation.
Then, to my employees, my friends in business at Four Stars, who have managed
the businesses and taken care of our customers while I have focused on this journey.
Especially my business partner, Jackie Moore, who has taken the reins and guided our
companies in a positive direction to insure I could continue on this path. Thank you for
all the many hours you all have put in so that I could be here.
To my friends and colleagues at Midwestern State University, thank you for
taking the time out of your busy schedules to answer my many questions. I value the
knowledge and insight you have and your willingness to share it. Thank you for showing
me, by example, how to be an excellent colleague, valuable mentor, and friend. But,
most of all, thank you for offering me a job so that I can pay for all this!
Lastly, I could not have done this without the support of my family. To my mom
and dad, thank you for putting me on the path that helped make this possible. My success
is a testimony to all the hard work and love you have devoted to your children. To the
love of my life and my best friend, we did it! You were with me every step of the way -
my rock, my ear, my shoulder. To my children for always remaining optimistic. Thank
you for all that you sacrificed, and thank you for always believing.

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ABSTRACT

BEHAVIORAL FINANCE:
FACTORS INFLUENCING ANGEL INVESTOR DECISIONS
by
Robert C. Forrester

Angel investors are individual investors who invest in high-risk projects
without the assistance of professional portfolio advisors and are an important
source of early-stage entrepreneurial financing. When providing financing, an
angel must decide how much time to spend on due diligence, the amount of wealth
invested, and the degree of post-investment interaction with entrepreneurs. As they
are individual investors, angels may be particularly influenced by behavioral
factors. In order to provide insight into the investment decisions of angel investors
this dissertation examines angel investor and deal characteristics including
demographics, experience, perception of the management team, the source that led
the entrepreneur to the angel investor, and syndication status. The dissertation
finds that angels’ decisions are influenced by rational and behavioral factors, such
as cognitive biases and social influences. While there is strong evidence that
experienced angel investors spend more time on due diligence, older investors
spend less time on due diligence after controlling for investor experience. These
results suggest that experienced angels invest in due diligence because they
understand its importance. Gender, risk perception, venture stage, and source of
deal identification also influence due diligence. In addition, older angels are found
to invest a smaller percentage of their wealth in a deal, perhaps because they seek
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to diversify holdings. More experienced angels, however, are found to invest a
larger percentage of their wealth perhaps because experienced angels are more
susceptible to cognitive biases such as overconfidence, or because they are able to
identify ventures that will do well and choose to invest more in such ventures.
Deal syndication also influences the percent of wealth invested in a deal. Other
results suggest that after making an investment, angels continue to interact with the
companies they invest in. There is strong evidence that more experienced angels
are associated with greater post-investment interaction. Gender and risk perception
also influence the degree of post-investment interaction.

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TABLE OF CONTENTS
Title Page .......................................................................................................................... i
Copyright Page................................................................................................................. ii
Signature Page ................................................................................................................ iii
Acknowledgements ......................................................................................................... iv
Abstract ........................................................................................................................... vi
Table of Contents .......................................................................................................... viii
Chapter 1 ...........................................................................................................................1
Chapter 2 - Literature Review and Hypotheses ................................................................5
Chapter 3 - Methodology ................................................................................................53
Chapter 4 - Results ..........................................................................................................62
Chapter 5 - Discussion and Conclusion ........................................................................101
References .....................................................................................................................112
Appendices ....................................................................................................................131

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CHAPTER 1

In traditional finance theory, the predominant view is that people behave
rationally, making unbiased decisions based on relevant information (Statman, 1995; von
Neumann & Morgenstern, 1944). However, individual investors’ decisions that violate
principles of traditional finance have bedeviled researchers for years (Baker & Nofsinger,
2010; Barberis & Thaler, 2003; Fama, 1998; Miller, 1986; Shefrin, 2000; Statman, 1995;
Statman, 1999; Shiller, 2003; von Neumann & Morgenstern, 1944). Indeed, scholars
have concluded that behavioral elements in decision making are likely to be more
influential on individual investors compared with large investors or institutional investors
who rely on professional portfolio advisors and that knowledge of factors which
influence individual investors is incomplete (Barberis & Thaler, 2003; Fama, 1998;
Schleifer 2000; Shefrin, 2000; Thaler, 1999). This dissertation provides insight into
factors that influence the observed decisions of angel investors which appear to violate
the principles of traditional finance, such as investing in high risk projects that contain
high information asymmetry while performing relatively little due diligence. Moreover,
it explores variables that lead angel investors to invest time in due diligence, as well as to
invest capital in projects. An underpinning of this research is behavioral finance.
Angel investors are an important source of early-stage financing. Typically, angel
investors are individual investors who invest in high-risk, entrepreneurial projects
without the assistance of professional portfolio advisors. Angel investors invest billions
of dollars in thousands of startup companies and entrepreneurial projects annually
1
2

(DeGennaro & Dwyer, 2013; Mason & Harrison, 2000; Sohl, 1999). Despite significant
financial commitment, angel investor decisions sometimes appear to violate the
principles of traditional finance. For example, rational investors have been shown to
spend time on due diligence to reduce information asymmetry and increase return on
investments. Indeed, time spent on due diligence has been shown to be positively related
to angel investor returns on investment. Some angels, though, spend no time on due
diligence (Morrissette, 2007; Sohl, 2003a; Wiltbank & Boeker, 2007b). Wiltbank and
Boeker (2007b) report that amount of time angel investors spend on due diligence ranges
between zero and 5,000 hours per investment. Despite angel investors’ growth and
significance, very little research has examined factors that lead angel investors to expend
time on due diligence as well as to invest in projects. They are one of the most common
and least studied sources for financing new ventures (Wong, Bhatia & Freeman, 2009).
Data used to examine individual investors not using professional portfolio advisors has
been difficult to obtain. Moreover, studies examining the choices made by individual
investors have been limited. Increasing availability of data on angel investors, however,
provides an ideal opportunity to examine factors influencing individual investor decision
making (Gompers & Lerner, 2010; Kaplan & Stromberg, 2003; Kerr, Lerner & Schoar,
2011; Prowse, 1998; Van Osnabrugge & Robinson, 2000). Understanding factors that
guide angel decisions should assist in increasing their returns and help ensure their
continued contribution to national economic growth.
Behavioral finance is a relatively new field that combines behavioral and
cognitive psychology with traditional finance to provide explanations for why investors
make decisions that appear to be irrational (Ackert & Deaves, 2009; Baker & Nofsinger,