Preemptive Signaling and the Emergence of Trust in Entrepreneurial Investments

Abstract

Principal-agent interactions in which the principal signals prosociality may achieve higher levels of trust and reciprocity if both parties care about social esteem. However, it is unclear whether such a separating equilibrium exists when the agent sends the signal first. This is relevant because in interactions such as entrepreneurial investments, the agent, i.e., the entrepreneur, has incentives to signal prosociality first in order to attract investment. To establish conditions for an equilibrium in which prosocial individuals engage in higher levels of trust and reciprocity, we extend Berg et al.’s (1995) trust game by incorporating a preemptive move in which the agent decides how much to donate to third parties. We apply the social esteem model of Ellingsen and Johannesson (2008) and show that, in addition to social esteem and altruism toward the other player, the feasibility of separating equilibria depends crucially on altruism toward third parties and the size of the donation.

Keywords: Trust, Trustworthiness, Trust game, Signaling, Venture financing

JEL Classification: D01, D64 D82, L26