The Strength of Strong Ties in an Emerging Industry: Experimental Evidence of the Effects of Status Hierarchies and Personal Ties in Venture Capitalist Decision Making

• DOI: http://doi.org/10.1002/sej.1188
• Author: Rolf Wüstenhagen,Nina Hampl,Robert Wuebker
• Published date: 01 June 2015
• Date: 01 June 2015

THE STRENGTH OF STRONG TIES IN AN EMERGING

INDUSTRY: EXPERIMENTAL EVIDENCE OF THE

EFFECTS OF STATUS HIERARCHIES AND PERSONAL

TIES IN VENTURE CAPITALIST DECISION MAKING

ROBERT WUEBKER1*, NINA HAMPL2, and ROLF WÜSTENHAGEN3

1Department of Entrepreneurship and Strategy, David Eccles School of Business,

University of Utah, Salt Lake City, Utah, U.S.A.

2Department of Strategy and Innovation, Vienna University of Economics and

Business, Vienna, Austria

3School of Management, University of St. Gallen, St. Gallen, Switzerland

Drawing from social network theory, scholars have identified two ways in which social ties

influence venture capital investment decisions: directly through personal ties and indirectly

through status hierarchies. Previous research has examined these effects independently. Our

study is the first to perform a joint examination of the role of social ties and status hierarchies

in venture capital decision making. We examine the relative importance of these two mecha-

nisms through an adaptive choice-based conjoint experiment comprising of 3,132 investment

decisions made by 86 venture capitalists from the United States and Europe.Our experimental

context allows us to explore whether, under high levels of market uncertainty, strong personal

ties exert more influence over investment decisions than the presence of a high-status investor

in the deal. We also explore the moderating effects that market structure and experience

play in shaping these decision processes. Our findings reveal that personal ties are more

important in venture capital decision making when compared to the relative status of other

venture capital firms participating in the investment syndicate. Building on our main findings,

we show that the influence of personal ties is less pronounced in the European investment

community, as compared to more densely networked U.S. investors. We also find a U-shaped

relationship between venture capitalist experience and the influence of personal networks on

investment decisions. Copyright © 2014 Strategic Management Society.

‘Youwill become way less concerned with what other

people think of you when you realize how seldom

they do.’

—David Foster Wallace, Infinite Jest (1996)

INTRODUCTION

Venture capital decision making has been a topic of

longstanding scholarly interest. While the primary

focus of this literature has been on the decision poli-

cies of individual venture capitalists (e.g., Franke

et al., 2006, 2008; Muzyka, Birley, and Leleux,

1996; Riquelme and Rickards, 1992; Shepherd,

1999; Shepherd and Zacharakis, 1999; Shepherd,

Zacharakis, and Baron, 2003; Zacharakis,

McMullen, and Shepherd, 2007), a complementary

stream of research focuses on the role social

Keywords: venture capital; conjoint analysis; decision making;

uncertainty; entrepreneurship

*Correspondence to: Robert Wuebker,Department of Entrepre-

neurship and Strategy, David Eccles School of Business, Uni-

versity of Utah, 1645 East Campus Circle Drive Salt Lake City,

UT 84112-9304, U.S.A. E-mail: robert.wuebker@business.

utah.edu

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Strategic Entrepreneurship Journal

Strat. Entrepreneurship J., 9: 167–187 (2015)

Published online in Wiley Online Library (wileyonlinelibrary.com). DOI: 10.1002/sej.1188

Copyright © 2014 Strategic Management Society

networks play in influencing the relative weight and

importance of those factors (Sorenson and Stuart,

2001; Shane and Cable, 2002; Hochberg,

Ljungqvist, and Lu, 2007, 2010). Findings from

these studies suggest that investment decisions can

be influenced directly through personal ties (e.g.,

Shane and Cable, 2002; Hsu, 2007; Gompers,

Mukharlyamov, and Xuan, 2012) and indirectly

based on the relative status of other venture capital

firms (e.g., Hochberg et al., 2007; Ozmel, Reuer,

and Gulati, 2012; Dimov, Shepherd, and Sutcliffe,

2007).

However, while these two mechanisms are known

to influence investment decisions, they have been

examined independently. As a result, surprisingly

little is known about their joint influence or relative

effect. And while we know that market structure and

investor experience are important intervening factors

in early-stage investment (Dimov and Shepherd,

2005; Sorenson and Stuart, 2001), we do not know

how these elements interact to influence investment

decisions. Questions about the role and relative

influence of social ties and status hierarchies are an

issue of increasing interest to entrepreneurship and

strategy scholars (e.g., Folta, 2007), as these factors

influence investment decisions, firm organization,

and control rights (Alvarez and Barney, 2007, 2008;

Agarwal, Audretsch, and Sarkar, 2007; Stuart and

Sorenson, 2007).

The purpose of this article is to improve our

understanding of how social networks influence

investment decisions by conducting a joint test for

the influence of personal ties and status hierarchies.

The context for our study is venture capital invest-

ment, where formal and informal social systems

coordinate exchanges in environments characterized

by high levels of uncertainty and information prob-

lems. The venture capital context, composed of

dense interpersonal networks segmented by geogra-

phy (Hochberg et al., 2010), allows us to explore the

moderating effect of individual experience and

market differences. In so doing, we aim to broaden

our understanding of network governance (Jones,

Hesterly, and Borgatti, 1997). We focus on the

screening phase of the venture capital decision,

where we employ an adaptive choice-based conjoint

(ACBC) experiment involving 3,132 investment

decisions made by a sample of 86 venture capital

investors from the United States and Europe. Our

experimental findings suggest that both direct and

indirect social ties have a measurable influence on

venture capital investment decision making;

however, in the context of market uncertainty, for

example, an emerging industry in which traditional

risk/return parameters are more difficult to deter-

mine, personal ties—specifically, whether or not the

deal came from a trusted referral in the investor’s

network—are more important than the reputation of

the lead investor present in the deal.

Building on our main findings, we also examine

the influence of market structure (in particular,

network density) and experience as moderating

effects, finding that the influence of personal ties is

less pronounced in the European investment commu-

nity compared to more densely networked U.S.

investors. We also find that experience plays a mod-

erating role in this process. Our results show a

U-shaped relationship between the experience of the

venture capitalist and the influence of strong ties.

THEORY AND HYPOTHESIS

DEVELOPMENT

There are two explanations for how social networks

influence investment decisions. The first explana-

tion, drawn from social network theory, explores an

indirect mechanism for influence: the relative status

of the lead investor in the deal. Results from previous

studies suggest that the investments of highly repu-

table venture capital firms may convey information

that influences the investment decisions of other

firms (Lee, Pollock, and Jin, 2011). Venture capital

firms evaluating a deal may infer information about

the quality of the investment based on the network

position or reputation of the venture capital firm

(Hochberg et al., 2007; Hsu, 2004; Lynn, Podolny,

and Tao, 2009; Washington and Zajac, 2005).

Venture capital firms are accorded their status in two

ways: through their social positions in the exchange

network of syndicate partnerships (Hochberg et al.,

2007; Gould, 2002; Wilson, 1985) and as a result of

their investment performance (Lee et al., 2011).

Social status, therefore, may simplify decision

making for a prospective investor, who can piggy-

back on a higher-reputation firm’s decision pro-

cesses, while also providing additional network

benefits (Ozmel et al., 2012), such as signaling.

A second explanation for the influence of social

networks on organizational outcomes draws from

organizational theory and explores a direct mecha-

nism: the personal network of the venture capital

investor. This perspective emphasizes the role per-

sonal ties play in financial decision making (Shane

168 R. Wuebker, N. Hampl, and R. Wüstenhagen

Copyright © 2014 Strategic Management Society Strat. Entrepreneurship J.,9: 167–187 (2015)

DOI: 10.1002/sej