instrumental value theory and the human capital of entrepreneurs 26.5.09
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Instrumental Value Theory and the Human Capital of Entrepreneurs
Eli Gimmon and Jonathan Levie
Eli Gimmon is a Lecturer at Tel-Hai Academic College, Israel and Jonathan Levie is a Reader in the Hunter Centre forEntrepreneurship, niversit! of "trathcl!de# The authors $ould li%e to than% the t$o anon!mous revie$ers and theeditor of the Journal of Economic Issues for their comments#
Abstract: Given the contribution of Schumpeterian entrepreneurship to technological
progress and well-being, the accuracy of investment decisions by venture capitalists is a
societal issue. Venture capitalists nd the human capital of entrepreneurs dicult to assess.
This paper employs instrumental value theory to assess the value of dierent human capital
factors to the performance of new ventures. ! meta-analysis of "# previous empirical studies
that e$amined the eect of founder%s human capital on new venture performance suggested
that instrumental value theory holds promise as a guide for research on entrepreneurs%
human capital and new venture performance. &t could also help venture capitalists to ma'e
better investment decisions, beneting society in general.
ey!ords: instrumental value theory, entrepreneurship, human capital
JEL Classi"cation Codes: ("), ()", *"+, , "
&n institutional economics, entrepreneurs are seen to play a critical role in the conversion of
technological progress into economic development and human well-being /c0aniel "112
"11)2 3lein #445. !lthough !lfred arshall and Thorstein Veblen recogni6ed this in the # th
century, 7oseph Schumpeter /#82 #85 was the rst to describe the role of innovative
entrepreneurs in the evolution of the economy in detail. Schumpeterian entrepreneurs
disrupt the status 9uo by introducing new and better ways of doing things. This typically
re9uires considerable investment of resources to succeed /see 7avary "118 for an e$ample5.
:or a new venture with little internal nancial reserves to draw on, this means e$ternal
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funding. !s Schumpeter himself pointed out, ;credit is primarily necessary to new
combinations< /Schumpeter #8, =15.
!t the e$treme end of Schumpeterian entrepreneurship are new ventures that are so
innovative and asset-poor that conventional debt nance is not appropriate. ! completely
dierent form of funding is re9uired, one that shares in the upside gain but also accepts the
downside ris'. This is venture capital. To illustrate how unusual this form of nancing is, only
around 4> of !merican start-up funding needs are met by venture capital /?eynolds "11=5.
@f the " million or so start-up attempts in the Anited States each year, only around 411 are
invested in by venture capitalists, yet venture-capital-bac'ed rms provide 4> of Bobs in A.S.
businesses /Shane "1145. !vailability of e$ternal capital, then, is a critical institutional factor
for Schumpeterian entrepreneurship.
The accuracy of venture capitalists in pic'ing which Schumpeterian entrepreneurs to
bac' is a societal issue, since poor Budgment will lead to a loss of the benets that society
can reap from technological progress. Cot only will society not gain from the innovations
these Schumpeterian entrepreneurs see' to introduce, but the venture capitalists will nd
their sources of capital drying up as their losses induce fund managers to invest their money
elsewhere. uch decision-ma'ing in venture capital is based on intuition and herd behavior
/Dider ##45. ! wide range of evidence suggests that the accuracy of venture capitalists%
predictions is not high, with a small number of spectacular successes boosting the return
rates of some funds and mas'ing a low overall ;hit< rate in the industry /Dachara'is and
eyer "1115. &ndeed, following poor returns, investment in seed and early-stage private
sector venture capital funding has been in relative decline recently, particularly in Europe
/7FFs'elFinen, aula and urray "11=5. &n summary, given the economic importance of
Schumpeterian entrepreneurship and its dependence on substantial e9uity funding,
investment choice by venture capitalists is worthy of attention, particularly given the interest
of institutional economists in value and Budgment.
Venture capitalists invest based on their Budgment of the human and social capital of the
entrepreneur/s5, the potential in the technology and the potential in the mar'et /Dachara'is
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and Shepherd "11)5. @ne of the most dicult issues for many venture capitalists is
assessing the human capital of the founder /*evie and Gimmon "1145. uman capital
/(ec'er #=)5 has more generally been recogni6ed as a 'ey success factor in new venture
performance /Stuart and !betti #4=2 art, Stevenson and 0ial ##)5. ! surprising feature of
the human capital literature is that there appears to be no e$-ante method of predicting
which of the dierent forms of human capital commonly employed in the entrepreneurship
literature, and by investors in new ventures, might be e$pected to have an eect on
performance. &n other words, no commonly accepted theory is routinely used to sort or
classify founder%s human capital factors e$-ante as relevant or irrelevant to venture
performance.
He propose the use of instrumental value theory as interpreted by 7. :agg :oster /Tool
##a2 ?anson "1145 as a tool for e&-ante prediction of the eect of dierent forms of
human capital on new venture performance. &n this article, we test its ability to predict
performance through a meta-analysis of published empirical studies of founder%s human
capital and performance. He argue that the use of instrumental value theory is valid in this
case because accurate choice of Schumpeterian entrepreneurs by venture capitalists is in
the interests of society generally, not Bust venture capitalists.
!s (aldwin ?anson /"1145 has remar'ed with specic reference to instrumental value
theory, applicability is the nal test of the correctness of theories. !lthough applying
instrumental value theory as an aid to e&-anteprediction might appear to violate 0eweyan
principles that conte$t is 'ey /0ewey ##2 Gordon ##15 and that instrumental value is
dynamic /3lein #445, we argue that by applying it in the narrow case of new venture
performance, and remaining sensitive to alternative interpretations, some degree of useful
generali6ation is possible. He nd the instrumental criterion helpful as a way of ordering, as
a rst appro$imation, the value of dierent forms of human capital to Schumpeterian
entrepreneurship, while recogni6ing that this approach has its critics.
This study aims to ma'e a contribution to instrumental value theory through illustrating
its value in classifying human capital that is useful for predicting new venture performance.
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This is important because there are many forms of human capital, and a classication
enables a theory-driven focus on the human capital that really matters in a particular
conte$t. The paper also answers a call for further meta-analysis in economics /Iressman and
ontecinos ##+, 4=#5. ! third contribution is to suggest how the instrumental value
framewor' can guide further research in areas that have not been addressed before, for
e$ample by separating out the instrumental and ceremonial value of social capital factors
such as reputation.
Instrumental Value Theory and #e! Venture $erformance
Veblen%s recognition of the importance of technological innovation to social progress, and
how such progress can be hindered, is a central concern of institutionalism. @ne way in
which progress can be hindered is what Jlarence !yres /#+, 5 refers to as ceremonial
ade9uacy,< a 'ind of imitation of technological ade9uacy. e illustrated this with the
following e$ampleK ;The tribal medicine man purports to be altering the course of events in
imitation of the tool activities by which technicians really do alter the course of events.
?ecogni6ing it ma'es possible a clear dierentiation of technological reality from ceremonial
fantasy, and so the real values from fancies, or pseudo values.