Signaling Trustworthiness with Impact Investments: An Experimental Study
37 Pages Posted: 20 Jun 2018 Last revised: 12 May 2019
Date Written: May 10, 2019
Entrepreneurs may differentiate their ventures and attract investments by advertising that their firm produces positive externalities for society. Such signaling of entrepreneurs’ trustworthiness may be a prevalent practice in these “impact investment’’ opportunities. This paper investigates theoretically this possible signaling and it studies its interplay with altruistic and fiscal motives in a laboratory experiment. Entrepreneurs choose between a conventional investment opportunity and an impact investment opportunity involving a spillover – a donation to society – whose size they need to decide on. Investors may transfer funds to the entrepreneur, who may then invest some, all or none of this money onto the opportunity, and then decide whether or not to transfer some of the funds back. The results confirm theoretically grounded hypotheses that the choice alone of an impact project does not increase investors’ transfers to impact investments but a higher spillover does as long as the spillover is not too high. Entrepreneurs who announce higher rates of spillovers return more funds to investors, making a high spillover a valid signal of trustworthiness, and they also pay “out-of-pocket” the spillover by sending the same amount back as the entrepreneurs who chose purely financial project. In the presence of tax, entrepreneurs internalize that a too high spillover could scare away investors. The mechanisms behind investors believing that socially-oriented entrepreneurs will be more trustworthy is that the mere project type is insufficient and information about the effective societal impact is necessary; making that quantitative information visible allows investors to differentiate between investment opportunities.
Keywords: Trust, Signaling, Visibility, Impact Investment, Entrepreneurial financing
JEL Classification: C92, G41, L31
Suggested Citation: Suggested Citation