Signaling trustworthiness with the choice of a prosocial project: Theory and experiment

Abstract

This paper studies the conditions under which the choice of a prosocial project signals trustworthiness and thereby increases financial transfers by investors. Results from theory and a laboratory experiment show that when there is a choice between a purely financial project and a prosocial project, the choice of the latter leads to higher transfers from investors, higher engagement in the risky prospect, and higher returns to investors, making the prosocial behavior a valid signal of trustworthiness. The prosocial expense signals trustworthiness as long as it is not too costly. The fact that entrepreneurs reduce the prosocial expense when it is visible to investors suggests that they believe that too high a spillover may have a deterrent effect. Entrepreneurs who believe that the investor shares an interest in prosocial projects choose higher levels of prosocial spending. The experiment controls for the role of fiscal subsidies typically used to promote such prosocial projects as such extrinsic motivations may lead to signal dilution. The results show that fiscal subsidies are effective in increasing the propensity to choose such projects. Furthermore, under fiscal subsidies, the signaling mechanism remains at work, as the levels of prosocial expense are maintained which suggests concerns about potential signal dilution.