Skip to main content

Initial coin offerings, asymmetric information, and loyal CEOs

Small Business Economics volume 57, pages 975–997 (2021)Cite this article

Abstract

A defining feature of initial coin offerings (ICOs) is that entrepreneurs bear the full marginal investment cost but profit only partially from the marginal investment payoff. This design may exacerbate agency conflicts inherent in corporate finance. As a consequence, signals of entrepreneurial quality such as CEO loyalty, which is an established concept in social psychology and can easily be linked to potential agency conflicts in corporate settings, might be a first-order determinant of economic outcomes in the ICO market. Consistent with this, I find that loyal CEOs have to offer lower financial incentives to attract investors and are still able to raise more proceeds, conduct ICOs more thoroughly, and are less likely to fail. The findings are consistent with the hypothesis that asymmetric information between entrepreneurs and investors entail agency costs that are decreasing in CEO loyalty.

This is a preview of subscription content, access via your institution.

Access options

Buy single article

Instant access to the full article PDF.

USD 39.95

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Notes

  1. I refrain here from providing a more detailed explanation of what ICOs are and how they work because there are many excellent references that provide comprehensive discussions. For a technical classification of tokens and coins, see Amsden and Schweizer (2018). For a discussion of the different token types and ICO mechanisms, see Momtaz (2019b) ICO and token design options are discussed in Howell et al. (2018). A comprehensive ICO market overview with detailed summary statistics is shown in Momtaz et al. (2019). The ICO process from the first idea to the completion of an ICO and the token listing is presented in Momtaz (2018). Thorough comparisons of ICOs to other financing instruments available to start-ups are available in Blaseg (2018), Momtaz (2018), and Lipusch (2018). The geography of ICOs is discussed in Huang et al. (2018). Fisch (2019) also presents a holistic overview of ICOs.

  2. For excellent recent surveys of these more traditional entrepreneurial financing methods, see Cumming and Groh (2018) and Wallmeroth et al. (2018).

  3. An empirical overview of the ICO market evolution since 2013 is provided in Momtaz (2020b). A detailed count of ICOs is available at icobench.com and icoalert.com. The website https://etherscan.io/tokens provides a current count of the number of tokens created on the Ethereum blockchain.

  4. In other words, tokens can be viewed as profit-sharing contracts. Hence, once an entrepreneur raises funds, he or she pays for all investments from the raised funds, while the profits from the investment have to be shared with the tokenholders. This may create a disincentive for optimal investments.

  5. Other token types include security and cryptocurrency tokens (Amsden and Schweizer 2018; Momtaz et al. 2019) However, most ICOs are designed to issue utility tokens. Utility tokens can be used to pay for products and services of platforms yet to be developed.

  6. The legal status of utility tokens is determined, in the USA, by the Howey test. If a token fails the Howey test, and most tokens are deliberately designed to fail it, then it is not subject to securities laws and falls into a legal gray zone, in which investors effectively cannot regress claims on regulations as investors in traditional asset classes could. See, for a discussion of the Howey test and its consequences, Howell et al. (2018), Momtaz (2018), and Zetzsche et al. (2018).

  7. The initial sample contains more than 2000 ICOs, although the full set of control variables is available only for a smaller subset of about 300 ICOs.

  8. See, for example, https://www.quora.com/What-do-you-look-for-in-an-ICO-team for a practice-oriented discussion.

  9. Importantly, note that I sample CEOs’ employment histories only from sources that are under the CEOs’ control. This guarantees that having information or not is by the CEOs’ choice, and not involuntarily, which would lead the selection correction logic ad absurdum. I thank one of the anonymous referees for pointing this out.

  10. To ensure the robustness of the results irrespective of whether I include inverse Mills ratios (IMRs) or not, I re-estimate all models without IMRs and report the CEO loyalty coefficients and the corresponding marginal effects in Table 12 in the Appendix.

  11. It is noteworthy that the dummy-variable regressions in columns 2 to 4 do not pick up any outlier effects. Winsorizing each tail by 1 or 2.5% does not materially change the parameter estimates for CEO loyalty, as I confirm in robustness checks.

  12. Note that even controlling for hard or soft caps, which are fundraising targets in ICOs, does not change the overall results. This finding from a robustness check is consistent with the results reported in Fisch (2019).

  13. Note that the econometrically more precise model specification would employ a random-effects time-to-event model (Momtaz 2020a). However, as Colombo et al. (2020) show, unobserved cluster-level heterogeneity at the industry or headquarter-country level is hardly existing in the international ICO context; therefore, my model specification used here produces robust results.

  14. Note, however, that the results are materially unchanged if inverse Mills ratios from the Heckman (1979) sample correction are omitted.

  15. In other words, I test whether CEO loyalty is a valid proxy for long-term agency costs.

  16. In this study, CEO loyalty is defined as the ratio between a CEO’s number of positions held previously and his or her cumulative overall professional experience in years.

References

  • Adhami, S., Giudici, G., & Martinazzi, S. (2018). Why do businesses go crypto? An empirical analysis of initial coin offerings. Journal of Economics and Business, 100, 64–75.

    Article  Google Scholar 

  • Ahlers, G. K. C., Cumming, D., Günther, C., & Schweizer, D. (2015). Signaling in equity crowdfunding. Entrepreneurship Theory and Practice, 39, 955–980.

    Article  Google Scholar 

  • Akerlof, G. A. (1983). Loyalty filters. The American Economic Review, 73, 54–63.

    Google Scholar 

  • Akerlof, G. A., & Kranton, R. E. (2000). Economics and identity. The Quarterly Journal of Economics, 115, 715–753.

    Article  Google Scholar 

  • Akerlof, G. A., & Kranton, R. E. (2005). Identity and the economics of organizations. Journal of Economic Perspectives, 19, 9–32.

    Article  Google Scholar 

  • Amsden, R., and Schweizer, D. (2018). Are blockchain crowdsales the new ‘gold rush’? Success Determinants of Initial Coin Offerings.

  • An, J., Duan, T., Hou, W., & Xu, X. (2019). Initial coin offerings and entrepreneurial finance: the role of founders’ characteristics. The Journal of Alternative Investments, 21, 26–40.

    Article  Google Scholar 

  • Benedetti, Hugo, and Leonard Kostovetsky (2018). Digital tulips? Returns to investors in initial coin offerings, Working paper, Boston College.

  • Blaseg, Daniel (2018). Dynamics of voluntary disclosure in the unregulated market for initial coin offerings, Working paper, Goethe University Frankfurt.

  • Brown, R. (1988). Group processes: dynamics within and between groups. (Basil Blackwell).

  • Catalini, C., and Gans, J. S. (2018). Initial coin offerings and the value of crypto tokens, working paper 24418, National Bureau of Economic Research.

  • Chod, J., and Lyandres, E. (2018). A theory of ICOs: diversification, agency, and information asymmetry, Working paper, Boston University.

  • Cohen, L. (2008). Loyalty-based portfolio choice. The Review of Financial Studies, 22, 1213–1245.

    Article  Google Scholar 

  • Colombo, M. G., Fisch, C., Momtaz, P. P., and Silvio Vismara (2020). The CEO beauty premium, Working paper, UCLA Anderson School of Management.

  • Connelly, B. L., Trevis Certo, S., Duane Ireland, R., & Reutzel, C. R. (2011). Signaling theory: a review and assessment. Journal of Management, 37, 39–67.

    Article  Google Scholar 

  • Cumming, D., & Groh, A. P. (2018). Entrepreneurial finance: unifying themes and future directions. Journal of Corporate Finance, 50, 538–555.

    Article  Google Scholar 

  • Demsetz, H. (1962). The effect of consumer experience on brand loyalty and the structure of market demand, Econometrica: Journal of the Econometric Society 22–33.

  • Drobetz, W., Momtaz, P. P., & Schroeder, H. (2019). Investor sentiment and initial coin offerings. The Journal of Alternative Investments, 21, 41–55.

    Article  Google Scholar 

  • Farrell, D. (1983). Exit, voice, loyalty, and neglect as responses to job dissatisfaction: a multidi-mensional scaling study. Academy of Management Journal, 26, 596–607.

    Google Scholar 

  • Felix, Thijn (2018). Underpricing in the cryptocurrency world: evidence from initial coin offerings, Working paper, University of Groningen.

  • Fisch, C. (2019). Initial coin offerings (ICOs) to finance new ventures. Journal of Business Venturing, 34, 1–22.

    Article  Google Scholar 

  • Fisch, C., and Momtaz, P. P. (2020). Institutional investors and post-ICO performance: an empirical analysis of investor returns in Initial Coin Offerings (ICOs).

  • Fry, J. N., Shaw, D. C., Von Lanzenauer, C. H., & Dipchand, C. R. (1973). Customer loyalty to banks: a longitudinal study. The Journal of Business, 46, 517–525.

    Article  Google Scholar 

  • Heckman, J. J. (1979). Sample selection bias as measurement error. Econometrica, 47, 153–161.

    Article  Google Scholar 

  • Hellmann, T., & Puri, M. (2002). Venture capital and the professionalization of start-up firms: empirical evidence. The Journal of Finance, 57, 169–197.

    Article  Google Scholar 

  • Howell, Sabrina T, Marina Niessner, and David Yermack (2018). Initial coin offerings: financing growth with cryptocurrency token sales, Working paper, National Bureau of Economic Research.

  • Huang, W., Meoli, M., & Vismara, S. (2018). The geography of initial coin offerings. Small Business Economics, 1–26.

  • Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3, 305–360.

    Article  Google Scholar 

  • Li, J., and Mann, W. (2018). Initial coin offering and platform building, Working paper, UCLA Anderson School of Management.

  • Lipusch, N. (2018). Initial coin offerings—a paradigm shift in funding disruptive innovation, Working paper, Kassel University.

  • Malinova, K., and Park, A. (2018). Tokenomics: when tokens beat equity, Working paper, McMaster University.

  • Momtaz, P. P. (2018). Initial coin offerings, Working paper, UCLA Anderson School of Management.

  • Momtaz, P.P. (2019a). CEO emotions and firm valuation in initial coin offerings: an artificial intelligence approach, Working paper, UCLA Anderson School of Management.

  • Momtaz, P. P. (2019b). Token sales and initial coin offerings: introduction. The Journal of Alternative Investments, 21, 7–12.

    Article  Google Scholar 

  • Momtaz, P. P. (2020a). Debiasing time-to-event models in entrepreneurship, Working paper, UCLA Anderson School of Management.

  • Momtaz, P. P. (2020b). The pricing and performance of cryptocurrency, The European Journal of Finance, in press.

  • Momtaz, P. P. (2020c). Entrepreneurial finance and moral hazard: evidence from token offerings. Journal of Business Venturing, in press

  • Momtaz, P. P., Rennertseder, K., & Schroeder, H. (2019). Token offerings: a revolution in corporate finance? Journal of Financial Transformation, 49 in press.

  • Sockin, M., and Xiong, W. (2018). A model of cryptocurrencies, Working paper, Princeton University.

  • Vismara, S. (2016). Equity retention and social network theory in equity crowdfunding. Small Business Economics, 46, 579–590.

    Article  Google Scholar 

  • Vismara, S. (2018a). Information cascades among investors in equity crowdfunding. Entrepreneurship Theory and Practice, 42(3), 467–497.

    Article  Google Scholar 

  • Vismara, S. (2018b). Signaling to overcome inefficiencies in crowdfunding markets, in The Economics of Crowdfunding, 29–56 (Springer).

  • Wallmeroth, J., Wirtz, P, Groh, A. P., et al. (2018). Venture capital, angel financing, and crowdfunding of entrepreneurial ventures: a literature review, Foundations and Trends in Entrepreneruship.

  • Zetzsche, D.A., Buckley, R. P., Arner, D. W., and Fohr, L. (2018). The ICO gold rush: it’s a scam, it’s a bubble, it’s a super challenge for regulators, Working paper, University of Luxembourg.

Download references

Acknowledgments

The author extend his thanks to Alexander Groh, the co-editor, two anonymous referees, Daniel Blaseg, Dmitri Boreiko, Lars Hornuf, Winifred Huang, and other seminar participants at the 6th Crowd investing Symposium on Blockchain and Initial Coin Offerings at the Max Planck Institute for Innovation and Competition for their helpful comments.

Funding

I acknowledge financial support for this research project from the Price Center for Entrepreneurship and Innovation at UCLA.

Author information

Authors and Affiliations

  1. Anderson School of Management, UCLA, 110 Westwood Plaza, Suite C402, CA, Los Angeles, 90055, USA

    Paul P. Momtaz

Authors
  1. Paul P. Momtaz
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Paul P. Momtaz.

Ethics declarations

Conflict of interest

The author declares that he has no conflict of interest.

Additional information

Publisher’s note

Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.

Appendix

Appendix

Table 12 Robustness checks: CEO loyalty coefficients without inverse Mills ratios
Full size table
Table 13 Correlation matrix
Full size table

Rights and permissions

Reprints and Permissions

About this article

Verify currency and authenticity via CrossMark

Cite this article

Momtaz, P.P. Initial coin offerings, asymmetric information, and loyal CEOs. Small Bus Econ 57, 975–997 (2021). https://doi.org/10.1007/s11187-020-00335-x

Download citation

  • Accepted:

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s11187-020-00335-x

Keywords

  • Entrepreneurial finance
  • Initial coin offerings
  • Asymmetric information
  • Agency theory
  • CEO loyalty
  • Human capital

JEL classifications

  • G30
  • L26
  • M12
  • M13