Cognitive Evaluation Theory of Entrepreneurship
Cognitive Evaluation Theory: Why Entrepreneurs Ignore Risk
Why do entrepreneurs often pursue ventures that statistics say are doomed to fail? The answer may lie in Cognitive Evaluation Theory (CET).
A sub-theory of Self-Determination Theory, CET explains how external factors affect an individual's intrinsic motivation. The core premise is simple: Events that increase an individual's perceived competence and autonomy will increase their intrinsic motivation to act.
[Image of Self-Determination Theory diagram]Evaluating Opportunity Under Risk
Keh et al. (2002) borrowed this psychological framework to study how founders evaluate business opportunities. They found that entrepreneurs do not assess risk objectively. Instead, their cognitive processes alter their perception of reality.
The researchers identified two specific cognitive biases that lead entrepreneurs to judge risky opportunities more positively than they should:
1. Illusion of Control
Entrepreneurs often suffer from an Illusion of Control—the belief that they can influence outcomes that are actually determined by chance or external market forces.
Because they overestimate their own ability to "fix" problems, they perceive a lower level of risk. This is closely related to the Hubris Theory of Entrepreneurship. If you believe you are in the driver's seat, you don't worry about the road conditions.
2. The Law of Small Numbers
This refers to the fallacy that leads people to make hasty generalizations based on too little information. It is the same cognitive bias that motivates people to buy lottery tickets ("My neighbor won, so I can too").
Entrepreneurs with a strong belief in the Law of Small Numbers rely on anecdotal evidence and gossip rather than large-scale data. If they see one person succeed in a niche, they assume the niche is profitable, ignoring the ninety-nine who failed.
Real-World Example: The Poker Founder
These cognitive traits are often found in gamblers. There is a fascinating anecdote regarding successful entrepreneur David Daneshgar, who won his startup capital by playing in a poker tournament.
The same logic that drives a poker player—the belief that skill can overcome the "luck of the draw" (Illusion of Control) and the reliance on patterns seen in previous hands (Law of Small Numbers)—often helps entrepreneurs take the necessary leap of faith to start a business.
Video: Cognitive Evaluation Theory Explained
References
Keh, H. T., Der Foo, M., & Lim, B. C. (2002). Opportunity evaluation under risky conditions: The cognitive processes of entrepreneurs. Entrepreneurship Theory and Practice, 27(2), 125-148.
