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ABSTRACT
Keywords:
Journal of Small Business Strategy
2020, Vol. 30, No. 02, 17-25
ISSN: 1081-8510 (Print) 2380-1751 (Online)
©Copyright 2020 Small Business Institute®
www.jsbs.org
Introduction
1
Kennesaw State University, 1000 Chastain Road. Kennesaw, GA 30144, USA, bcowden@kennesaw.edu
2
University of Louisiana at Lafayette, 214 Hebrard Boulevard, Lafayette, LA 70503, USA, [email protected]
3
Kennesaw State University, 1000 Chastain Road, Kennesaw, GA 30144, USA, [email protected].edu
4
Kennesaw State University, 1000 Chastain Road, Kennesaw, GA 30144, USA, [email protected].edu
Unicorns and agency theory: Agreeable moral hazard?
Unicorns, Moral hazard, Agency theory, Disruption, Venture capital
APA Citation Information:
Cowden, B. J., Bendickson, J. S., Bungcayao, & Womack, S. (2020). Unicorns and agency theory: Agreeable
moral hazard? Journal of Small Business Strategy, 30(2), 17-25.
ventures that have been valued over $1 billion. Just a few
years ago, there were only a handful of these companies
in the world, which is why they are referred to as unicorns
(Schindehutte, 2016). As of the beginning of 2019, there are
328 ventures that would be considered unicorns, with antic-
ipation that more are quickly on the horizon (
2019). While it has been claimed that studying unicorns
are a distraction from understanding “real” entrepreneur-
ship (Aldrich & Ruef, 2018), this paper demonstrates that
unicorns represent a unique and new sample of ventures to
expand upon existing theory. From a theoretical standpoint,
scholars have argued that due to the congruence of goals
between investors and ventures to grow and make money,
agency problems are less applicable (Arthurs & Busenitz,
2003). While seemingly true in its traditional application,
we dissect a key element of agency theory, moral hazard, to
traditional ventures.
Agency theory states that problems will arise when
no longer align with the agent (entrepreneur), and where
the agent may not operate in the best interest of the princi-
pal (Eisenhardt, 1989; Jensen & Meckling, 1976) which is
widely known as the principal-agent problem (Bendickson
et al., 2016
varying alignment issues between the venture capital (VC)
-
-
ing higher than normal risk with the principal’s money. His-
torically, moral hazard has been seen negatively, providing
we agree with the negative connotation of moral hazard in
traditional settings, we introduce the concept of agreeable
moral hazard, providing a new perspective on moral hazard
in the unicorn population. Because of the overarching drive
a form of Schumpeterian shocks (Schumpeter, 1934) rather
than the theory of disruption (Christensen, 2006)—we ar-
gue that the investors desire for entrepreneurs to take higher
The number of unicorns, startups valued over $1 billion, has steadily risen over the past decade. The abnormally high valua-
tion of a unicorn from investors is based on their potential to disrupt a market and create a new paradigm. With this as the back-
-
cy theory. We argue that if principals and agents agree on the goal of disruption, then perhaps the agency problem that does
-
er than normal risks with their investment to disrupt a given market. From this phenomenon, we introduce the concept of agree-
able moral hazard and its use in the unicorn setting. Not only does the concept of agreeable moral hazard provide theoretical im-
plications for future research, but it also highlights the need for more research to test existing theory on the unicorn population.
Birton J. Cowden
1
, Joshua S. Bendickson
2
, Jerrica Bungcayao
3
, Simona Womack
4
B. J. Cowden, J. S.Bendickson, J. Bungcayao, & S. Womack Journal of Small Business Strategy / Vol. 30, No. 2 (2020) / 17-25
than normal risks with their money.
Where moral hazard is relevant is not necessarily that
the principal and agent agree to take higher than normal
risks, but in how that risk is operationalized in market ac-
tions. While investors, especially VCs, consider themselves
experts in the area they are investing in, the nature of dis-
ruption is fraught with uncertainty, raising questions about
the usefulness of previous market interactions. With no de-
-
tion asymmetry, where the venture has more information
about all of its market experiments than the investor. With-
out enacting atypical strategies and taking higher than nor-
mal risk, the entrepreneur cannot achieve disruption. With
this, the venture must make quick iterations in the market to
solidify its value proposition. Because of this quickness and
rush to disruption, consensus among all of the principals on
the proper strategic action cannot be achieved. Hence we
argue that there is a level of agreed upon moral hazard, or
agreeable moral hazard occurring in unicorns for goal con-
the venture is moving quickly and making many decisions
in its disruptive pursuit, we argue that investors want the
venture to take higher than normal risk with their money
and that the investors may not be aware of all of the market
actions of the venture and its associated risks. Yet, this is
uniquely acceptable by the investor in the unicorn context.
This paper provides implication to both theory and
practice. By introducing the idea of agreeable moral hazard,
we extend agency theory beyond its largely negative impli-
-
-
may be able to achieve disruption. By having principals
willing to have agents take higher than normal risks with
their money allows a platform for those agents to try to dis-
disruption, the outcome of disruption will not occur. The
following sections will explore existing thought on agen-
cy theory and moral hazard, along with understanding how
we introduce the concept of agreeable moral hazard and its
implications.
Literature Review
Agency Theory
Agency theory describes a problem that arises when
one party (the principal) hires another party (the agent) to
perform a service in which the agent has decision-making
responsibilities (Jensen & Meckling, 1976). The theory op-
erates under the assumption that both parties in the agen-
cy relationship are utility maximizers acting in their own
self-interests (Eisenhardt, 1989; Jensen & Meckling, 1976).
As a result, the agency problem arises in the relationship
when the goals and interests of the agent and principal di-
verge, when it is challenging for the principal to monitor
or check the behavior of the agent, and when the princi-
2016; Eisenhardt, 1989). Agency theorists use a contract as
the unit of analysis to describe the relationship between the
principal and agent, thus, maximizing the optimal contract
is essential to mitigate opportunistic behavior.
which occurs when the agent’s actions are self-serving, such
as shirking (Gomez-Mejia & Balkin, 1992). Moral hazards
are likely to emerge in environments with high informa-
tion asymmetry and managerial freedom (Gomez-Mejia
& Balkin, 1992). Adverse selection, another aspect of the
agency problem, refers to a misrepresentation of the agent’s
abilities (Arthurs & Busenitz, 2003). Moral hazards and
adverse selection can emerge as a result of asymmetric
information—when one party in the agency relationship
possesses knowledge that the other party does not. Accord-
ingly, agency theory suggests the implementation of moni-
toring devices and incentive structures to reduce these agen-
cy costs (Tosi Jr & Gomez-Mejia, 1989
hazard.
Moral Hazard
The term moral hazard was originated from the in-
surance literature (Rowell & Connelly, 2012; Zeckhauser,
1970), but also became popular in economic probability
and decision-making (Dembe & Boden, 2000; Hale, 2009;
Holmstrom, 1979
is said to be present because insurance is perceived as an
incentive for people to behave carelessly (Dembe & Boden,
2000). For example, moral hazard is present when an indi-
vidual can be reckless with a rental car if he or she paid a
small amount of money for complete insurance on the ve-
hicle. The deposit insurance literature suggests that moral
hazard may arise in the banking industry because banks
may be more inclined to “gamble” or engage in risk-tak-
ing behaviors at a cost to taxpayers (Yilmaz & Muslumov,
2008
takes higher than normal risk with the principal’s money.
and be to the detriment of the principal. With a negative con-
notation, moral hazard has been described as hidden actions
by agents (Arrow, 1984), unobservable behaviors resulting
in consequences that are observable (Mirrlees, 1999
the organization literature, moral hazard has been viewed
B. J. Cowden, J. S.Bendickson, J. Bungcayao, & S. Womack Journal of Small Business Strategy / Vol. 30, No. 2 (2020) / 17-25
through the lens of agency issues surrounding risk and in-
formation (Mitnick, 1992). The foundation of this concept
is rooted in economic logic, attributing moral hazard and
adverse selection to issues with monitoring and incentiviz-
ing agent behavior in the principal-agent relationship. Since
the best interest of the principal, moral hazard can be prob-
lematic without the appropriate controls, incentives, and re-
wards in place.
Traditional VC Literature and Moral Hazard
While entrepreneurs almost always have some stake in
in pursuit of starting an entrepreneurial venture, funding
-
ing less risk (Murad, 2015). While VCs typically under-
stand risk due to their often extensive industry experiences,
because the venture capitalist may not be able to monitor
or verify how the entrepreneur allocates the funds, and take
advantage of the knowledge, moral hazard emerges leaving
the venture capitalist unaware of some of the risks taken
(Bergemann & Hege, 1998). Additionally, moral hazard un-
folds as the entrepreneur could shirk and use the invested
capital for other expenditures (Bergemann & Hege, 1998).
moral hazard: 1) staged investments and 2) board positions.
According to Wang and Zhou (2004, p. 1) “key characteris-
of capital and preserving the option to abandon the project.”
To reduce moral hazard, staged investments are used to
guide decision makers to produce an advantageous outcome
for VCs (Gompers, 1995
-
development process, such as completion of design, pilot
a second product” (Cornelli & Yosha, 2003, p. 1). Entre-
preneurs may occasionally withhold negative information
regarding the status of the project to avoid putting the ven-
to improve their reputation at a cost to the VC (Gompers,
1995-
al hazards, VCs monitor the entrepreneur’s progress and, if
necessary, threaten to terminate funding, (Wang & Zhou,
2004).
Similarly, the board of directors examine risks close-
ly to reduce moral hazard in relation to the use of inter-
nal and external resources (Singh & Harianto, 1989). The
board’s decision-making guides the overall performance
of the company (), and research has
shown that board members take a more active role in the
Fried et
al., 1998). VCs take a board position in order to monitor
Rosenstein et al.,
1993). Thus, traditional literature indicates that investors in-
crease their mentoring and control function as the venture
becomes more risky (e.g. Khanin & Turel, 2013). However,
does this still apply to unicorns?
Proposition Development
Unicorns
Traditionally, VCs look for businesses that can multi-
ply their investment (i.e. 10x), with the logic that they have
already proven a market, and with this investment they can
the investors (Gompers, 1995; Sullivan, 2017). While uni-
corns may not be void of needing similar logic as a basis,
the bigger goal is disruption of a market, which provides a
hope that even more money can be made beyond estimates
based on historical market conditions. Not unlike the inno-
higher values (Dyer et al., 2011), there is perhaps a disrup-
tion premium that VCs are willing to pay to be part of the
of this disruption focus, we argue that VCs and ventures en-
act nontraditional strategies, such as giving ventures a lon-
are helpful, but not necessary for a $1 billion company, this
sample of ventures may need their own theoretical evalua-
tions.
Why Unicorns Dier
-
corns, and most often, they are lumped into venture capital
conversations (Bellavitis et al., 2017; Kenney & Zysman,
2018). While unicorns do utilize venture capital, there are
are valued so much higher than other venture-backed start-
2018)
found that only 1% of startups funded by VCs ever reach
unicorn status, further illustrating its distinctiveness from
other venture types. Unicorns receive much higher valua-
existing large industries by creating a paradigm shift. This
goal of disruption separates unicorns from other ventures
and is how large investors get attracted to the venture. These
investors put up the capital in the hopes that their unicorn
B. J. Cowden, J. S.Bendickson, J. Bungcayao, & S. Womack Journal of Small Business Strategy / Vol. 30, No. 2 (2020) / 17-25
(). Thus, both the investors and the
venture have goal congruence on disruption.
The intent of disruption can be viewed as a Schum-
peterian shock (Schumpeter, 1934; 1942), where unicorns
typically add technology in hopes to create a new market,
displace existing competitors in an industry, and/or dis-
place existing businesses in many segments by providing a
product that consolidates industries. Unicorns tend to cou-
ple technology with an innovative business model that re-
and costs (Chesbrough, 2007; 2010; Zott & Amit, 2007).
-
What is more important is that most unicorns are compet-
ing in already competitive markets, resulting in disruption
of the status quo. For example, businesses like Dropbox,
Uber, and Zillow provide new ways to do things consumers
were already doing; save electronic documents, get a taxi,
or buy a house, yet easier with fewer transaction costs. For
investors, it is the hope that these ventures become the new
market paradigm, which could generate unforeseen wealth
ocean strategy (Kim, 2005), where a venture is able to dis-
rupt many industries at once, making it nearly impossible
for incumbents to respond. With this, the principals will get
to experience monopolistic-like rents for their investment
for an extended period of time.
great hope for tremendous wealth due to disruption includes
a willingness from the investors for unicorns to experiment
-
give leeway to the ventures if the venture stumbles, as it
fact, the larger valuations and investments are there to pro-
vide a cover for the venture to survive tough times while
should they try to outspend the new venture. For example,
investors of SpaceX understand that they will not see a re-
years as the venture builds out the private space exploration
industry (Sheetz, 2018). Additionally, with disruption be-
ing the key driver and knowing that this could take several
years to start paying back dividends, a longer timeframe is
-
stantially backed by VCs, arguably be too big to fail, it is
Ken-
ney & Zysman, 2018
create their technology, the platform, and develop the mar-
ketplace that currently does not exist in the existing orga-
Zietsma & Lawrence, 2010). As seen with
the freemium model (Kumar, 2014), the drive is to grow a
able to attract a loyal customer base with a freemium model,
as that base grows, the venture will have a more accurate
understanding of what those customers may be willing to
pay for, or the data from those customers may be even more
valuable. For example, prior to achieving unicorn status,
Slack, a business software company, attracted thousands of
users on a weekly basis. Consequently, the company was
-
ation of $1 billion (). VC money
gives the unicorns deep pockets to survive the transforma-
tion from being a peripheral threat to a direct competitor
(Greenwood & Hinings, 1996) while the venture discovers
its sustainable business model.
Lastly, the disruptive nature of unicorns is not without
-
es rarely sit idly by as they get disrupted by a new entrant.
With this, existing market leaders will utilize market and
governmental forces to protect themselves from disrup-
tive forces. For example, Airbnb’s disruption of the hotel
of Uber, Travis Kalanick, stated “You’re changing the way
cities work, and that’s fundamentally a third rail. We’re in
a political campaign, and the candidate is Uber and the op-
ponent is an asshole named Taxi” (Swisher, 2014, para 4).
With focus on disruption, the venture and its owners are in
culture that everyone can rally behind to achieve the “im-
possible.” With VCs often sitting on boards, the function
of the board of directors to provide independent and bal-
anced guidance may be compromised (Hillman & Dalziel,
2003; ; ; Westphal &
Zajac, 1997; ). To make their invest-
ment worth it, principals of unicorns may not only be more
agreeable to founders taking nontraditional paths in order
along the way in achieving their audacious visions. For ex-
ample, one investor of SpaceX told a reporter, “they are not
-
vested for the chance to play a small part in one of the very
few private companies that will likely change the course of
history” (Sheetz, 2018, para 3). This sentiment is not com-
B. J. Cowden, J. S.Bendickson, J. Bungcayao, & S. Womack Journal of Small Business Strategy / Vol. 30, No. 2 (2020) / 17-25
Agreeable Moral Hazard
most situations, moral hazard is negative so that the prin-
cipal does not get taken advantage of while the agent reaps
propose that principals of unicorns accept some element of
to successfully disrupt a market. While there is never a ful-
ly blank check, founders need a level of autonomy and the
ability to experiment to test potentially radical ideas in the
market (Dew et al., 2009; Lumpkin et al., 2009). Without
the ability to enact non-traditional strategies, the unicorn
will not be able to take the necessary experimental steps to
unearth a disruptive and sustainable business model (Brush
et al., 2015; ; Smith et al.,
2010; Zott & Amit, 2007
governance mechanisms take hold, having the principals
concerned about preventing moral hazard, the process will
encourage traditional thinking and action versus something
that might be paradigm shifting (Fisher, 2012).
Theranos, the now defunct unicorn focused on revolu-
tionizing the blood diagnostics industry (Carreyrou, 2018),
is an example demonstrating that agreeable moral hazard
can be detrimental to the principals. Theranos proposed
a proprietary single stick method for testing hundreds of
medical tests. Their proposed technology and methodology
for a fraction of what traditional testing methods cost. After
-
tober of 2015 by the Wall Street Journal called into question
stories about the company (Carreyrou, 2015). FDA regula-
-
ing quality, vetting suppliers, and handling customer com-
plaints (FDA, 2015).
When asked about these issues, Theranos founder Eliz-
abeth Holmes frames them as a communication failure. She
says that the company has been so focused on building the
technology that they have failed to communicate important
truths about phlebotomy and the blood diagnostics industry.
For instance, blood tests are not subject to FDA regulation
-
that Theranos is blazing a trail. Further, she argues that just
because regulators have not caught up yet, it does not mean
their tests are invalid.
With this trailblazing argument, the investors rallied
behind Theranos and even more investors joined to help the
company disrupt the market. Elizabeth Holmes fraudulently
sold the impossible vision to investors that had very little
-
vestors asked very few questions to validate the venture’s
claims, and solely focused on being part of this venture that
could “change the game” in healthcare (McKenna, 2018).
These investors wanted Theranos to take higher than nor-
mal risk with their money in the hope that much greater
wealth would be created. However, Elizabeth Holmes took
advantage of agreeable moral hazard, resulting in a loss of
nearly $700 million (McKenna, 2018).
The Theranos example demonstrates that agreeable
moral hazard has a limit and is dependent on the intentions
of the founders. However, mature unicorns, such as Airb-
of agreeable moral hazard when not taken advantage of.
Collectively, these three ventures are now worth roughly
$123 billion, and are anticipated to keep growing as they
continue their disruption of markets and sustain their rev-
enue streams. While Elizabeth Holmes crossed the line to
take advantage of investors, arguably, Elon Musk, founder
of Tesla and SpaceX, has found a way to optimize agreeable
higher than normal risks and pushing ideas to their limit
(De Lea, 2018). Musk and his investors have found agree-
involved. Thus, we propose:
Proposition 1.
ventures (a) desire and (b) aid those ventures to take higher
than normal risks (c) to a certain point (inverted-U relation-
ship) with their investments to disrupt markets.
Proposition 2. The above relationships (i.e. agreeable
moral hazard) do not occur in traditional venture-backed
(non-unicorn) startups.
Implications and Conclusion
This article introduces the concept of agreeable moral
hazard, while also subsequently demonstrating the need for
moral hazard provides a pathway for scholarship to under-
stand the relationship between principals and agents in a
setting focused on disruption. Because there are congruent
goals on disruption between the two, we propose that oppo-
site forces occur from the traditional principal-agent costs,
where principals expect agents to take higher than normal
risks with their money to create a paradigm shift in existing
markets. This agreeable moral hazard is required for found-
ers to test new ideas in the market. Additionally, the VCs
that have invested high dollar amounts into the unicorns
B. J. Cowden, J. S.Bendickson, J. Bungcayao, & S. Womack Journal of Small Business Strategy / Vol. 30, No. 2 (2020) / 17-25
need these ventures to successfully create a paradigm shift
worth the gamble. Without agreeable moral hazard, tradi-
tional governance perspectives hold, and will most likely
not result in moon shot disruption.
This also shows that these moon-shot investments are
This paper points out the fallacy in lumping the unicorns
e.g.
Bendickson et al., 2015). However, by exploring the con-
-
ditional agency theory, our article points out that unicorns
are a unique population to test existing theory. Just as the
Chinese setting provided the outlet to test existing theory
in that unexplored setting (e.g. Tang et al., 2017), unicorns
provide a similar population to contradict, extend, or create
theory.
Another implication of this article is that agreeable
argue that any organization focused on reducing agency
cannot ever experiment, disruption will rarely occur (Fish-
er, 2012-
nizational governance structures form a board to protect the
principals’ investments and prevent moral hazard through
three primary roles (Singh & Harianto, 1989; Zahra &
). The three major roles boards play are service,
strategy and control ( ). The board’s
control role is to ensure that the agents are performing in a
manner that will protect the shareholders’ interest (Chapin,
1986). How this is setup in the organization has been shown
by the organization (Baysinger et al., 1991
estimate market demand when considering disruption. With
-
partments to approve projects to go any further than just an
pursue disruption without agreeable moral hazard.
may lead to fruitful areas of future research. First, while
we present our ideas for propositions theoretically, we did
not conduct a study to test these. Scholars could look to
empirically test these ideas by collecting data on risk-taking
at unicorns (and soon to be unicorns) to better understand
by collecting preferences for risk in smaller startups (i.e.,
comparisons and conclusions could be further explained.
Related, in terms of smaller startups, scholars may want
to assess whether these propositions apply when VCs are
involved and/or would they also apply to an entrepreneur
seeking other types of funding (e.g. seed funding)?
Secondly, in practice, it can be observed that certain
public companies seem to be responding to market con-
Amazon not only think about, but quickly execute on more
Google and Facebook span into other realms? While path
dependency plays a role (Greener, 2002; Sydow et al., 2009;
Vergne & Durand, 2010), future research can further expand
upon the practical implications of agreeable moral hazard.
For instance, what role do lawyers and their power in the
-
From a theoretical standpoint, more must be under-
stood about agreeable moral hazard. What are the boundary
conditions of agreeable moral hazard? What environments
create agreeable moral hazard, and what elements make it
What role does trust play in this relationship, and what indi-
vidual-level variables matter, as in the Theranos example?
Christensen’s (2006 -
ation literature (Sarasvathy, 2001
hope to launch a starting point for further research and dis-
cussion as there is certainly more to unpack in regards to
agreeable moral hazard.
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