When prosocial investments signal trustworthiness: Theory and Experiment

Abstract

This paper studies in theory and in a laboratory experiment the conditions under which prosocial investments signal trustworthiness. Results show that the choice alone of a prosocial investment, if the level of prosocial activity is not visible, does not increase investors’ transfers to prosocial investments but a visible high level of prosociality does as long as the prosocial activity is not too costly. The announcement of the level of prosocial activity is a valid signal of trustworthiness as the entrepreneurs who announce a higher level are more trustworthy. However, the prosocial entrepreneurs pay this signal “out-of-pocket” as they carry the cost of the prosocial activity by returning to the investors as much as the entrepreneurs who chose purely financial project. The mechanisms behind investors believing that prosocial entrepreneurs will be more trustworthy is that the mere project type is insufficient and information about the effective spillover is necessary; making that quantitative information visible allows investors to differentiate between investment opportunities. Furthermore, while entrepreneurs are found to respond to fiscal incentives by choosing more often the impact project under tax exemption, they prevent signal dilution by maintaining the level of spillover under tax exemption.

Keywords: Signaling, Prosocial Investment, Visibility, Trust, Entrepreneurial financing, Pro-social motivations.

JEL Classification: C92, G41, L31