Signaling Endorsement Legitimacy: A Signaling Theory Approach to VC Investment Decision Making

This research applies the multifaceted approach of signaling theory (Spence, 1973) to the domain of VC. Since the unequivocal success factors generally studied, such as the management team, market, and product offering are often ambiguous at the time of evaluation, signaling theory would maintain that VCs likely substitute a number of alternative, objective signals that have yet to be considered. To demonstrate the potential of this approach, we introduce Higgans and Gulati’s (2006) conceptualization of endorsement legitimacy as an unexplored signal that may influence VC investment decisions. In doing so, we draw on related disciplines and anecdotal evidence to suggest that varying levels of interorganizational associations and endorsements (i.e., the endorsement legitimacy) of a young venture may serve as an indicator of intrinsic venture quality - influencing the willingness of VC investment. We also present a series of moderating propositions to delineate the boundary conditions around this posited relationship by suggesting that more idiosyncratic signals, such as endorsement legitimacy, become less important when greater information is known about the management team, or the munificence of the intended market, or the product offering. By illustrating how endorsement legitimacy may influence decisions through the lens of signaling theory, these findings, and their associated implications make a number of contributions to the literature. Broadly, this paper serves as an impetus to begin moving beyond the established funding determinants to a wider set of influential signals, bringing us one step closer to more comprehensively understanding the investment decision process in VC.