That VCs’ screening and selection of startups is subject to biased decision-making is well-documented. Their subsequent funding decisions have, by contrast, always been assumed rational. A new study, available as open access article in the journal Industry and Innovation, questions this taken-for-granted assumption. The study’s results, which are based on data from 231 European IT-startups, suggest that a startup entrepreneur’s physical attractiveness and ethnic background significantly shape a VC’s funding approach. This finding is noteworthy, because a VC’s funding approach strongly influences a startup’s chances of survival and success.

Why a VC’s funding approach matters

Once selected, the startup entrepreneur and VC collaborate to make the startup a success. While an exciting phase for all parties involved, a VC is confronted with many questions that reflect the inherently uncertain nature of this phase: Will the startup live up to its promise? Is the entrepreneur as capable, trustworthy and ambitious as it appears to be? How will the market develop? Et cetera. The capital required to make the startup a success will, in view of these uncertainties, not be provided all at once but gradually disbursed as the startup develops (known as the staging of capital). This enables the VC to fund the startup while keeping the option to abandon the investment and minimize potential losses.

Previous research has shown that the way a VC stages the capital indicates the amount of trust and confidence he/she has in the respective startup. In case of great confidence and trust, granted funding disbursements on average tend to be of a higher amount and take place with longer time intervals in between. In case of doubts, however, the VC will seek more control over the startup, reflected by lower funding amounts and shorter time intervals between investment rounds. This enables the VC to keep the entrepreneur on a tight leash. To date, VCs have been assumed to determine their funding approach on rational grounds, weighing the costs of staging versus the costs of monitoring the venture, and benefiting from the information that comes available once the cooperation with the startup entrepreneur commences. Following this assumption, VCs’ funding decisions should be devoid of any biases.

There are nevertheless good reasons to question this rationality-assumption. Even though more information comes available after the screening and selection-phase, VCs still need to make up their minds in view of many known and unknown unknowns. Each investment round inherently introduces new uncertainties and risks, which effectively means VCs needs to make projections of an uncertain future. Moreover, as the investment unfolds, sunk costs are incurred, which affects VCs’ risk assessments. Also, VCs continue to face severe time-pressure and information discrepancies. All these factors combined increase the likelihood of biased decision-making.

How physical attractiveness and same ethnicity matter

To explore the potential for biased decision-making in VCs’ funding approaches, two factors were selected known to bias VCs’ selection decisions, namely entrepreneurs’ physical attractiveness and ethnic background. Physical attractiveness was selected to test for the presence of the halo-effect. The attractiveness-halo is known to bias peoples’ judgments of others during first encounters, but its relevancy beyond the initial encounter has hardly been researched before. Ethnicity was selected to capture potential similarity effects. People are known to have more positive attitudes towards others whom they perceive to be similar to themselves.

The findings show that, on average, physically attractive entrepreneurs enjoy longer time-periods between funding rounds, suggesting a more lenient stance of the VC toward startups led by handsome entrepreneurs. The same goes for startups led by entrepreneurs who share ethnic backgrounds with their VCs.

The findings become a bit more intricate when we consider the effects of physical attractiveness and ethnicity jointly. The figure below shows the effect of physical attractiveness on VCs’ funding approach for pairs of entrepreneurs and VCs who share ethnic backgrounds (co-ethnicity = 1), and for those who don’t (co-ethnicity = 0). The effect of physical attractiveness is steeper for the second group, which indicates that attractiveness becomes a more relevant cue for VCs with ethnic backgrounds different from the entrepreneurs they fund. The figure also shows that, overall, co-ethnic entrepreneurs enjoy more favorable and lenient funding conditions.

What does this mean for VCs and entrepreneurs?

The results put into question VCs’ assumedly rational funding approaches. From an entrepreneurial perspective, entrepreneurs’ attempts to benefit from biased decision-making may prove fruitful during the early funding stages. Entrepreneurs may particularly consider how to benefit from such biases during funding negotiations, but can also consider how to prevent adverse effects. For instance, entrepreneurs with ethnic backgrounds different from their VCs may need to consider other ways to signal trustworthiness and potential to secure more favorable funding conditions. From a VC-perspective, attempts to debias selection decisions may need to be transferred to the funding stage as well. Particularly, VCs should consider their stance toward entrepreneurs with different ethnic backgrounds or low physical attractiveness, for their ventures may suffer from the closer scrutiny they are subject to.

To conclude, venture capital investors stand for the challenging task of predicting a startup’s true potential in view of profound uncertainty. Given the large stakes involved, systematic, conscious, and effortful decision-making is much preferred. By uncovering factors that may bias VCs’ funding decisions, this study sought to create awareness and hopefully contributes to their improvement.

Sustainability reporting –  from exception to expectation

‘What gets measured gets managed’ is a management wisdom (or platitude) typically accredited to management guru Peter Drucker. Interestingly, what Drucker actually said was ‘What gets measured gets managed – even when it’s pointless to measure and manage it, and even if it harms the purpose of the organization to do so.’[1] Based on an extensive study of Dutch sustainability reporting, recently published in Organization & Environment, we examine the tensions that exist around measurement.

Sustainability reporting, a type of corporate disclosure in which organizations communicate about their economic, social and environmental impacts, emerged over 30 years ago. We show in our study how reporting by now is an expectation rather than an exception as it transformed from a morally inspired values-based practice into a financialized value-based one that has Board level attention. We highlight how commensuration played an important role in this development. That is, as reporting professionalized and standardized, previously disparate (qualitative) elements increasingly became quantitatively measured into a standard or unit. We explain how this process helped to propel reporting to normality, but also highlight the pitfalls that accompany introducing measurement in domains (such as sustainability) that are typically less familiar with this.

Based on over 100 interviews with stakeholders and extensive document analysis, we map the history of sustainability reporting. At first, reporting was mostly focused on the environment and driven by NGOs and political pressure as transparency was considered a sign of good corporate citizenship. Around the turn of the century, and under impetus of consultants and standard setters, the ‘moral case for sustainability’ transformed into the ‘business case for sustainability’. Firms started to consider the potential value of sustainability and soon reporting standards, indicators, and benchmarks started to appear. Over the last decade, the investment community and accountants have become interested and the demarcation between financial and non-financial reporting started to blur as integrated reporting was introduced. Sustainability was no longer a nice story peripheral to strategy and value creation, but an integral part of this, highlighted by a focus on determining financial firm value through a limited selection of (quantified) strategic indicators.

What numbers cannot tell …

On the one hand, this development has simplified reporting and made it more concrete, manageable and focused on strategic matters. As such, the focus on measurability and quantification could be an explanation for reporting’s growth and regarded a success for transparency. After all, ‘what gets measured gets managed’. However, both managers and policy makers do well to consider whether the opposite may ring true as well: ‘what gets not measured gets not managed’? We highlight two main risks of commensuration, namely its tendency to narrow what is considered valuable and its potential to erode or crowd out moral questions.

As for the former, consider commensuration’s consequence of facilitating the integration of non-financial (or ESG) data in investor information systems. On the one hand, this is positive for the inclusion of (sustainability) issues previously not considered by investors. However, as what we measure determines our vision and reality, it runs the risk of rendering invisible issues irrelevant. For instance, we know from US law schools that the introduction of rankings and ratings (a good example of commensuration) has affected the focus of these schools in terms of what is considered important and valuable to be managed[2]. As for the latter argument of crowding out of moral questions, this was pointedly explained by one informant in our study:

“if you restrict yourself to reporting the standardized information, and I think that is cause for concern, at least for me, then you risk that you stop the thinking”

There is a risk here of conveniently ignoring dilemmas that litter the road towards sustainability and paying insufficient attention to what sustainability actually means for an organization. Belgian ethicist Luc Bouckaert[3] argues in this respect that when a practice such as sustainability reporting becomes part of ‘business-as-usual’, the risk of the resulting crowding out of morality is that this can in fact lead to more opportunistic behavior in business.

To be sure, such tensions will not be universal and most likely arise when claims about incommensurables are strong. Still, reflecting on commensuration is important not only because commensuration is a prevalent phenomenon but also because it spreads into different spheres of life. In our case, the commensuration of reporting has created effects that are increasingly relevant in other societal domains. NGOs, for instance, are asked to attach specific (often financial) indicators to measuring their work in order to meet standards of evidence-based funding. Similarly, commensuration enters the legal sphere as sustainability reporting is increasingly influenced by regulation (e.g. the upcoming CSRD EU directive on non-financial reporting) and actors such as the Dutch State face litigation over taking insufficient action against climate change.

In sum, managers do well to continue to ask questions about what it actually means to be a sustainable organization and address the resulting dilemmas that they find on their sustainability journey. Peter Drucker would therefore probably have agreed with the famous words of another guru of sorts (Albert Einstein), who proclaimed that ‘not everything that counts can be counted, and not everything that can be counted counts.’ Managers and policy makers do well to remember.

[1] www.theguardian.com/business/2008/feb/10/businesscomment1

[2] See for instance Espeland, W.N. and Sauder, M., (2016) Engines of Anxiety: Academic Ranking, Reputation, and Accountability, Russell Sage Foundation, New York.   

[3] Bouckaert, L. (2006), “The ethics management paradox”, in Zsolnai, L. (Ed.), Interdisciplinary Yearbook of Business Ethics, Peter Lang Publishers, Oxford, pp. 199-202