Inflating the bubble: examining dot-com investor behaviour

Findings are presented from a study of the cognitive behaviours of 57 venture capital investors in the early-stage technology sector during the 1998 -- 2001 Internet bubble period. The inductive research methodology was based on open-ended qualitative interviews with investment practitioners, conducted by the lead author who was an investment practitioner during the bubble. The data obtained were used to develop a grounded model of how generally accepted venture capital industry decision-making practices were bypassed and modified by investors competing intensively in an unfamiliar sector with unknown success criteria, which contributed to the creation of the bubble. Insights from prospect theory, attribution theory and cognitive dissonance theory were used to identify the cognitive processes that led through groupthink to the development of a conceptual framework in the industry, similar to what organizational theorist Gareth Morgan has called a Psychic Prison. The study identified four positive feedback loops in the environment surrounding the activities of Internet investors that contributed to the bypassing of generally accepted practices by investors who believed they were behaving rationally.