World Encyclopedia of Entrepreneurship
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World Encyclopedia of Entrepreneurship

Edited by Léo-Paul Dana

This comprehensive reference work, written by some of the most eminent academics in the field, contains entries on numerous aspects of entrepreneurship.
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Chapter 45: Signalling

Uschi Backes-Gellner and Arndt Werner


Uschi Backes-Gellner and Arndt Werner Start-ups and their respective market partners are faced with severe problems of asymmetric information due to their lack of prior production history and reputation. Entrepreneurial signalling (for example, via education or patenting) can help entrepreneurs to signal their true abilities to relevant market partners like banks, new customers or prospective employees. Reversing Spence (1973), who argues that workers signal unobservable productivity to an employer by acquiring an educational degree, the idea of entrepreneurial signalling is that, likewise, entrepreneurs, who are assumed to be fully aware of their own productivity potential, signal unobservable entrepreneurial productivity by observable characteristics to potential employees, or lenders, customers, and so on. Since the market partners of entrepreneurs cannot readily observe the quality of their venture, they have an incentive to approximate that information via reliable entrepreneurial signals. According to Spence (1973) educational degrees have to meet two additional criteria to become valid as a signal separating high-quality from low-quality employees. In the original model, where employees signal their unobserved productivity, the degree first must be closely related to the type of productive capability employers are looking for in filling a particular job vacancy (for example, if a company is looking for a creative and trendy hairdresser it might not be best to hire someone with a PhD just because he has the highest educational degree among the applicants). Secondly, in order to guarantee a separating equilibrium, the cost to the employee of obtaining the degree must be strongly negatively correlated...

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