Silence of the Lambs: Effect of Perverse Incentives on Entrepreneurial Venture Outcomes
This study investigates the impact of perverse incentives among entrepreneurs on the financing opportunities of innocent startups. We leverage misconduct allegations appearing in the mainstream newspaper for two key reasons: (a) misconducts often stem from entrepreneurs' perverse incentives, exemplified by strategies like "fake it till you make it", and (b) allegations by newspapers offer an exogenous informational event to capture investors' decision. To do this, we consider all reported misconduct cases affecting US startups during 1998-2020 and employ a stacked differences-in-differences model. We show that startups developing similar technologies as the misconduct perpetrators become less likely to obtain financing and raise smaller amounts after the misconduct event is reported in the news, relative to startups developing dissimilar technologies located outside the perpetrators' state. The strongest negative effects of misconduct are found to be associated with technological misconduct and sexual harassment; whereas, financial fraud and economic espionage have a statistically insignificant impact. We attribute these results to investors' reputational concerns, which lead to forced terminations and strategic abandonment of innocent startups. Moreover, we demonstrate that investors taking greater reputational risks by investing in non-core sectors are more likely to abandon investments in innocent startups with technological similarities to misconduct perpetrators. Interestingly, this effect does not extend to exit market opportunities, as innocent startups related to misconduct perpetrators are no less likely to be acquired than unrelated startups.