Reputations and investment in new ventures

When the quality of a producers’ products are difficult to observe before an investment or purchase decision is made, actors can use the quality of past products as an indication of the quality of current or new products (Shapiro 1983). Reputation, in other words, refers to beliefs about the focal actor’s perceived qualities based on past performance. Reputation has economic importance because it helps decision-makers to make decisions in the absence of more complete information (Shapiro 1983; Fombrun and Shanley 1990; Podolny 1993). While products and individuals can have reputations, organizations can have corporate reputations (Fombrun 1996), which have an effect on the behavior of the organizational stakeholders, ranging from consumers to resource providers, such as investors. The effects of reputation on acquiring resources are seen most clearly in the case of new venture firms or entrepreneurs in search of financial resources.

New organizations, and especially organizations that are still in the process of being founded, suffer from a liability of newness (Freeman et al. 1983). While incumbents find their ability to obtain financial resources to be dependent on their reputation, new ventures are restricted in their access to financial resources due to a lack of reputation, (Milgrom and Roberts 1986; Fombrun and Shanley 1990; Stuart et al. 1999; Higgins and Gulati 2006; Kang 2008). However, new organizations do have members, and the composition of early membership can contribute to the organization’s corporate reputation. Musteen et al. (2010) show how the average tenure of outside directors has an impact on the corporate reputation of the firm. Pfeffer (1972) and Pfeffer and Salancik (1978) stress the extent to which the characteristics of individual directors can determine the firm’s ability to attract resources from external stakeholders. Busenitz et al. (2005) argue that the new venture founding team’s investment in their own venture functions as a signal to outside investors.

A crucial source of information for capital providers is the performance of the organizations in which these founding members of a new venture were involved in the past (Hsu 2007). Investors, in other words, will take the performance-based reputation of the core members of the new organization into account in their decision to provide startup capital. If founders of new organizations already set up other organizations in the past—so-called serial or habitual entrepreneurs (Westhead and Wright 1998)—potential investors will evaluate the new firm also on the basis of the prior performance of these earlier ventures. Likewise, prospective investors in project-based organizations (PBOs), organizations that dissolve once the project for which it was specifically set is finished (Jones 1996; DeFillippi and Arthur 1998), will evaluate the performance of the earlier PBOs in which the core members of the new PBO have been actively involved. In industries that are characterized by PBOs careers typically consist of a series of successive memberships in different PBOs.

Reputations, dimensions, and roles

A corporate reputation, however, can be scored along many dimensions. Organizations have reputations ‘…for something’ (Fisher and Reuber 2007: p. 57), for instance, for being well-managed, providing high product-quality, or excellence in customer service. Organizations can intentionally focus on building their scores along certain dimensions of reputation (Voss et al. 2000), for instance, to fit in administrative categories that make them eligible for receiving public or private grants and contracts, and, therefore, increase their chances of survival (DiMaggio and Powell 1983). Scoring high along a particular dimension of reputation functions as a form of categorization and can be expected to play a similar role in the decision-making processes of observers. With respect to firms, a tendency of focusing on a particular dimension of reputation will serve a similar purpose as using categories in a particular classification system, namely simplifying complex environments by focusing ‘on attributes that are particularly informative and predictive of organizational activities’ (Porac et al. 1995: p. 207), on the basis of which competitors are compared.

Because of their expected predictive value, investors in new ventures use reputational signals based on past performance of its individual founders as insurance for their current investments. Similar to corporate reputations, however, reputations of top management team members in new ventures in search of investment capital can derive from many sources. Earlier studies found a number of relations between the behavior of investors and the characteristics and personal background of an organization’s board (Deutsch and Ross 2003), differentiating between the CEO (D’Aveni 1990; Higgins and Gulati 2003, 2006; Cohen and Dean 2005) and other board members (Certo 2003; Musteen et al. 2010), the management team (Beckman et al. 2007; Beckman and Burton 2008) and the individual entrepreneur (Hsu 2007).

Although the individual reputations of board members or the entrepreneur turned out to be strong predictors of investor behavior, none of these studies looked at the value of particular dimensions of reputations in relation to individuals occupying particular roles and the concomitant responsibilities in the new organization. However, in their study of the film industry Baker and Faulkner (1991) found that individuals occupying particular roles are better able to attract resources such as investment capital (1991). They also show that if particular distributions of roles among the founding members of the organization were correlated with past success, new organizations with that particular distribution of roles were also more likely to attract investment capital. Yet Baker and Faulkner did not study the link between different dimensions of reputations in relation to individuals occupying particular roles and their concomitant responsibilities in these organizations. However, one might expect that it makes a difference to investors which dimensions of reputations are linked to which of the new venture’s top management team members and the role that they will perform. Especially with respect to new ventures and building on Porac et al., one might expect that investors categorize individual founding members of new ventures along the dimension of their reputation that is particularly informative, and which can serve as predictors of certain outcomes (Porac et al. 1995).

Where previous studies focus on either particular (combinations of) roles or (dimensions of) reputations as means of getting access to resources such as investment capital, we argue that it is important to link particular dimensions of reputation to the role of the individual to whom the reputation belongs. One might expect that there are different dimensions along which investors in a new venture score the performance of organizations and individuals, and that particular roles in the organization are strongly associated with particular dimensions of reputation. In a high-tech start-up, for example, the reputation for technological excellence will be linked more strongly to the individual reputation of the Chief Technical Officer, while the reputation for financial performance will be more strongly linked to the track record of the Chief Financial Officer. Alternatively, in the film industry, the most relevant dimensions of reputation are the artistic and the commercial ones that are predominantly linked to, respectively, the director and producer. Since corporate reputation along a particular dimension is expected to be closely linked to the individual reputation of the member of the organization whose role is most closely associated with that dimension, the arguments above suggest that the reputation scores of these individuals along these dimensions will have a strong impact on the behavior of investors toward the venture as a whole.

Hypothesis 1

There is a positive relation between the strength of role-congruent reputation of a founding member of a new organization and the size of investment in that organization.

The effects of having more than one good reputation

If an investor primarily determines the size of the investment based on the reputations of the involved individuals along the dimension that is role congruent (for the individual in a particular role), it would be interesting to study the effect of that individual also scoring favorably along another dimension of reputation that is not role congruent. Will favorable reputations always have a positive effect, even if they are not along dimensions that are linked to that specific role? Or does it detract from the extent to which the individual reputation contributes to the corporate reputation’s effect on behavior if the individual occupying that role also scores well along other dimensions at the same time?

There are two main arguments why there might be a negative interaction between the scores along the two dimensions. The first is that—in the particular environment in which the reputations are observed—the two dimensions are not considered to go well together or might even be considered incompatible, because the dimensions seem linked to different logics (Glynn and Lounsbury 2005). This would have the effect that individuals that score well along both dimensions of reputation will look less trustworthy to outside observers. The latter will, therefore, be less likely to base their decisions on this information. If one hears about an athlete who is great in weightlifting and in gymnastics, this sounds less trustworthy—because most people would assume that a body suitable to the one sport would be quite unsuitable for the other—than just hearing that she is a successful weightlifter.

It has often been noticed that in the cultural industries, there can be a strong tension between artistic and commercial objectives and performances (Caves 2000; Holbrook and Addis 2008) and the artistic and commercial logics to which they are linked (Glynn and Lounsbury 2005; Eikhof and Haunschild 2007). Although it is certainly not impossible—and there are notorious examples from each cultural industry—that a great artist also has a sound sense of business, this is not the expected state of affairs. Because of this, outside observers will be more hesitant to make decisions on the basis of a particular individual reputation if the individual also scores high along another dimension, while in the particular environment of the cultural industries performing along these two dimensions is considered to be likely to cause friction.

There could be a second argument why having a non-role-congruent reputation could affect the decisions of outside observers. A recent stream of literature studies the effects of belonging to more than one category—so-called category spanning (Zuckerman and Kim 2003; Zuckerman et al. 2003; Hsu and Hannan 2005; Hsu 2006; Hsu et al. 2009; Ruef and Patterson 2009). The main conclusion drawn from this literature is that, apart from producer-side effects of specialization (Hsu et al. 2009), having a clear identity increases visibility, makes it easer to get attention, and is helpful in gaining market entry. On the other hand, category spanning or complex identities will cause ambiguities, unclear expectations, and decreased legitimacy in the eyes of audiences, in turn resulting in lower evaluations and lower performance. A number of these studies were conducted in the empirical setting of the film industry with respect to the benefits and risks of actors and actresses being typecast (Zuckerman et al. 2003) and of producers making either single-genre or multi-genre films (Hsu 2006). Although the literature on category spanning and market identity focuses on product categories, and categories of organizational forms, we suggest that the underlying ideas may be just as well applicable to dimensions of reputation.

Since earlier research demonstrates the risk of unfocused identities or category spanning because it could lead to lower appeal or more negative evaluation (Zuckerman 1999; Zuckerman and Kim 2003; Zuckerman et al. 2003; Hsu 2006; Hsu et al. 2009), scoring favorably along multiple dimensions of reputation at the same time may also be risky. Thus, founding members of a new venture spanning reputational categories might be evaluated less positively, which will have a negative effect on the willingness of investors to provide start-up capital for the venture. Moreover, the negative effect due to the perceived lack of focus because of more than one strong reputation may be strengthened when there is a possible tension between different dimensions of reputation, such as the artistic and commercial dimensions (Caves 2000; Eikhof and Haunschild 2007). A professional with both a favorable artistic as well as a commercial reputation will have a less focused reputational identity than one who only scores well along the role-congruent dimension. Both arguments discussed here suggest a negative interaction effect. We, therefore, propose the following hypothesis:

Hypothesis 2

The positive relation between the strength of role-congruent reputation and investment in a new organization will be reduced by the strength of the non-congruent reputation of a founding member of that organization.