Preemptive signaling and the emergence of trust in entrepreneurial investments

Abstract

Experimental and theoretical evidence suggests that 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 what the characteristics of a separating equilibrium would be if the agent were to signal first. This is pertinent to interactions such as entrepreneurial investments, where the agent has incentives to signal prosociality first in order to secure financing. 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 allowing the agent to choose the size of a donation to third parties in the initial move. We apply the social esteem model of Ellingsen and Johannesson (2008) and show that, in addition to social esteem and altruism towards the opponent, the separating equilibrium crucially depends on altruism towards third parties and the size of the donation.