CHAPTER ONE

INTRODUCTION

1.1. Background of the Study

Investment represents a major determinant of output at the national level, otherwise termed Gross Domestic Product (GDP). Governments and policymakers across the world thus make considerable efforts to ameliorate the investment climate in their respective countries in a bid to attract both domestic and foreign investment, which overall creates value for different stakeholders and overall improves the quality of life in these countries.

Investment, at its core, represents the deployment of resources, typically capital, with the expectation of generating future income or appreciation in value (Kane, & Marcus, 2018). It is a fundamental driver of economic growth, fueling innovation, job creation, and increased productivity. This encompasses a wide range of activities, including purchasing physical assets like property, plant, and equipment, acquiring financial instruments such as stocks and bonds, or even investing in intangible assets like research and development (Reilly & Brown, 2012). The process of investment decision-making, therefore, involves a careful assessment of potential opportunities, evaluating the expected benefits and costs, and aligning them with the investor’s specific goals and risk tolerance (Alexander, & Bailey, 2019). For small and medium enterprises (SMEs), sound investment decisions are paramount, often dictating their ability to grow, compete effectively, and achieve long-term sustainability (Beck & Kunt, 2016). Given the limited resources and often volatile environments in which SMEs operate, understanding the factors influencing their investment choices becomes critically important, especially in emerging economies (Ayyagari & Maksimovic, 2020).

The investment choices of SME owners are not solely determined by rational economic calculations but are also significantly influenced by their inherent psychological traits, particularly their time preference and risk preference. Time preference, representing the relative weight individuals place on present versus future rewards, can be conceptualized as existing along a spectrum, ranging from present-biased individuals who prioritize immediate gratification to future-oriented individuals who are more willing to delay consumption for potentially greater future gains (Frederick & Loewenstein, 2022). Studies globally reveal that a strong present bias tends to be associated with under-investment in long-term opportunities, such as retirement savings and business expansion, favoring instead short-term, less lucrative projects (Beck, 2017).

Risk preference can be divided into three categories: risk-averse people who prefer lower-risk investments even with lower returns, risk-neutral people who are indifferent between risk levels assuming the expected returns are the same, and risk-seeking people who actively seek higher-risk investments with the potential for substantial returns. Research across various countries demonstrates that individuals’ risk preferences significantly influence their asset allocation decisions, with risk-averse investors allocating more to low-risk assets and risk-seeking investors favoring riskier but potentially more rewarding investments (Cohn et al., 2015).

The theoretical link between time preference, risk preference, and investment decisions of small and medium enterprises (SMEs) stems from behavioral economics and finance, which posits that these psychological factors systematically influence economic choices, often deviating from the predictions of purely rational models (Kahneman, 2021). Specifically, the intertemporal choice theory suggests that individuals with a strong present bias (high time preference) tend to discount future rewards more heavily, leading them to prioritize immediate consumption or short-term investments over long-term, potentially more lucrative opportunities (Frederick, 2023).

This suggests that SME owners with a high time preference may be less willing to invest in projects with long gestation periods or uncertain payoffs, even if they offer higher long-term returns.  Prospect theory suggests that risk choices are shaped by how possible gains and losses are framed, not just projected value (Kahneman & Tversky, 2019).  Prospect theory suggests that risk-averse SME owners may be more sensitive to losses than gains of the same magnitude, so they avoid riskier investments even if the expected return is high enough. The combined effect of time and risk preferences suggests that SME owners who are both present-biased and risk-averse may be particularly hesitant to invest in projects that involve delayed gratification and uncertain outcomes, potentially hindering their business growth and long-term sustainability. These two preferences affects a lot of business investment decisions (Meier, 2017).

Empirical evidence supports the theoretical links between these variables. For example, research by Meier and Sprenger (2015) found that individuals with higher levels of present bias were less likely to invest in long-term savings plans. Similarly, studies by Nguyen and Velandia (2017) demonstrated that risk aversion significantly influences farmers’ decisions to adopt new agricultural technologies, with more risk-averse farmers being less likely to adopt technologies that involve uncertain outcomes. In the context of SMEs, research by Hmieleski and Baron (2019) suggested that entrepreneurs’ risk propensity is positively associated with their willingness to pursue innovative and high-growth strategies, which often involve risky investments. Moreover, a study by Sandberg and Hoegl (2015) found that entrepreneurs with a strong future orientation were more likely to invest in long-term research and development projects. While the evidence specifically linking time and risk preferences to investment decisions of SMEs remains relatively limited, these studies from broader contexts provide strong support for the theoretical predictions and suggest that these psychological factors play a significant role in shaping investment choices across various settings and populations.

Small and medium-sized firms (SMEs) are essential to the global economy, acting as a foundation for innovation, employment, and economic development in many regions.  The International Labour Organisation (2021) reports that SMEs constitute roughly 90% of enterprises and over 50% of global employment, underscoring their importance in job creation and economic stability. In developing economies, the contribution of SMEs is even more pronounced, as they often represent the primary source of income and employment for local populations. The World Bank (2022) emphasizes that SMEs are crucial for fostering economic resilience, particularly in times of crisis, as they tend to be more adaptable and responsive to changing market conditions compared to larger corporations. Furthermore, SMEs are instrumental in driving innovation, as they often bring new ideas and technologies to market more rapidly than their larger counterparts do.

A report by the Organisation for Economic Co-operation and Development (OECD, 2023) reveals that SMEs play a crucial role in research and development, representing a considerable portion of patents and technological innovations.  Nonetheless, despite their significance, SMEs encounter other hurdles, such as restricted access to financing, regulatory obstacles, and a deficiency of skilled labour, which may impede their growth and viability.  The COVID-19 pandemic intensified these concerns, as numerous SMEs faced difficulties in enduring economic declines and changing customer behaviours (European Commission, 2021). To support the growth and resilience of SMEs, governments and international organizations are increasingly recognizing the need for targeted policies and initiatives that promote access to finance, enhance digital capabilities, and foster entrepreneurship. As the global economy continues to evolve, the role of SMEs will remain critical in driving sustainable development, creating jobs, and fostering innovation, making it essential for stakeholders to prioritize their support and development.

1.2. Statement of problem

SMEs in Bamenda, a region characterized by unique economic and social dynamics, face a complex reality with regards to investment decision-making. While SMEs form the backbone of the local economy, driving employment and contributing to regional growth, their investment choices are often constrained by a multitude of factors, including limited access to capital, inadequate market information, and a challenging business environment (Tambe, 2015). Empirical observations suggest that many SME owners in Bamenda tend to prioritize short-term profitability and survival over long-term strategic investments, often opting for smaller, less risky projects with quicker returns (Che, 2010). This tendency can be attributed to several factors, including a lack of financial literacy, a strong aversion to risk, and a high degree of uncertainty about the future economic outlook (Fai, 2012). Furthermore, cultural norms and social pressures may also influence investment decisions, with many SME owners prioritizing family needs and social obligations over reinvesting profits back into their businesses, thereby limiting their growth potential and hindering the overall economic development of the region.

Ideally, the investment decisions of SMEs in Bamenda should be characterized by a more strategic and long-term orientation, driven by informed assessments of market opportunities, a balanced consideration of risk and return, and a willingness to invest in innovation and expansion (Peter, 2012). This ideal scenario would involve SME owners actively seeking out information and advice, engaging in rigorous planning and analysis, and adopting a more proactive approach to managing risk (Abor & Biekpe, 2017). Such a shift would necessitate improved access to financial resources, enhanced business support services, and a more conducive regulatory environment that encourages investment and innovation. Moreover, fostering a culture of entrepreneurship that values long-term vision, strategic thinking, and risk-taking would be crucial in promoting more informed and effective investment decisions among SMEs in Bamenda.

However, the consequences of the current reality, where investment decisions of SMEs in Bamenda are often characterized by short-termism and risk aversion, are far-reaching and detrimental to the region’s long-term economic prospects. This suboptimal investment behavior limits the growth potential of individual SMEs, hindering their ability to create new jobs, increase productivity, and compete effectively in the global market (Beck, 2016). Moreover, it inhibits innovation and obstructs the integration of new technology, thereby impeding the general economic advancement of the region (Audretsch, 2020).  The absence of significant investments in infrastructure, education, and human capital perpetuates a cycle of poverty and underdevelopment, hindering Bamenda’s ability to realise its full economic potential.  Resolving this issue necessitates a holistic strategy that addresses the fundamental determinants affecting investment decisions, fostering a more informed, strategic, and long-term perspective among SMEs in Bamenda.  This study aims to address this gap by evaluating the influence of temporal and risk preferences on the investment decisions of SME owners and investors in Bamenda.

1.3. Research question

1.3.1. Main research question

This study aims to address the following primary research question: What is the impact of time and risk preference on the investment decisions of SME owners/investors in Bamenda?

1.3.2. Specific research questions

• What impact do time preferences have on the investment decisions of SME owners and investors in Bamenda?
• What impact do risk preferences have on the investment decisions of SME owners/investors in Bamenda?
• What is the combined impact of time and risk preferences on the investment decisions of SME owners/investors in Bamenda?

1.4. Objective of Research

1.4.1. Main objective of research

To assess the effect of time and risk preference on investment decisions of SME owners/investors in Bamenda

1.4.2. Specific objectives of research

To meet the main research objective above, the following specific objectives will be pursued:

• To assess the effect of time preferences on investment decisions of SMEs owners/investors in Bamenda.
• To assess the effect of risk preference on investment decisions of SMEs owners/investors in Bamenda.
• To assess the joint effect of time and risk preference on investment decisions of SMEs owners/investors in Bamenda.

1.5. Research hypothesis

• H1: Time preferences has no significant effect on investment decisions of investors of SMEs owners/investors in Bamenda
• H2: Risk preferences has no significant effect on investment decisions of investors of SMEs owners/investors in Bamenda
• H3: Joint effect of time and risk preference has no significant effect on investment decisions of SMEs investors/investors in Bamenda