1042-2587
© 2009 Baylor University
E T&P
Ethical Considerations
of the Legitimacy Lie
Matthew W. Rutherford
Paul F. Buller
J. Michael Stebbins
This article draws upon prior research and theory on the legitimacy threshold that suggests
entrepreneurs in start-up ventures will likely employ proactive strategies to gain initial
legitimacy with key stakeholders. We argue that these strategies may sometimes include
questionable ethical behaviors, including telling legitimacy lies—intentional misrepresentations of the facts. Based on a review of literature on ethical decision making, we then apply
two common ethical frameworks to explore the ethical boundaries of what may or may not
be acceptable behavior in seeking legitimacy. We conclude the article with some specific
guidelines for start-up entrepreneurs.
Introduction
Researchers have noted that overcoming the liabilities of newness and smallness is
the most difficult challenge that a start-up entrepreneur encounters (Hannan & Freeman,
1984; Singh, Tucker, & House, 1986; Stinchcombe, 1965). These challenges can be
essentially described as a quest for legitimacy by the new and small firm (Williamson,
Cable, & Aldrich, 2002; Zimmerman & Zeitz, 2002); until stakeholders view the firm as
a legitimate enterprise, the entrepreneur will have great difficulty acquiring the resources
(e.g., capital, employees, and suppliers) that the enterprise needs to survive. As a result,
many entrepreneurs feel that they must employ whatever strategies and tactics are necessary to overcome these liabilities and gain legitimacy. Since most new venture firms are
“opaque” with regard to information—meaning that it is difficult for outside participants
to ascertain the quality of a given venture—it is especially tempting and possible for
entrepreneurs to mislead social actors by engaging in legitimacy lies, or intentional
misrepresentations of the facts. This problem is compounded in many new ventures
because entrepreneurs have an advantage of information asymmetry—they know more
about certain aspects of the business (e.g., intellectual property) than outside stakeholders
do. It is important to point out that we are not suggesting that entrepreneurs are (or must
be) deceptive. However, we are operating under the assumption that entrepreneurs are at
least tempted to misrepresent the facts (and a good number of them actually do) in order
to gain initial legitimacy. While the issues addressed in this work are likely applicable to
a number of contexts, our focus here is on the new and small venture headed by a novice
entrepreneur.
Please send correspondence to: Matthew W. Rutherford, tel.: 804-828-1732; e-mail: [email protected].
July, 2009
DOI: 10.1111/j.1540-6520.2009.00310.x
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In this paper we hold that there exists in most firms an initial threshold, before which
the new venture will have high levels of smallness and newness liabilities; and after which
these liabilities have been mitigated significantly (Zimmerman & Zeitz, 2002). In most
firms, this threshold occurs when some significant stakeholder has legitimized them
(Rutherford & Buller, 2007). Because new ventures are generally cash starved at early
stages of development, it is most often a key customer or financier that grants this
legitimacy (Pfeffer & Salancik, 1978). The granting of this legitimacy sends a signal to
other stakeholders that the firm is something more than an untenable collection of
resources and is worthy of some level of trust—legitimacy begets legitimacy.
This condition causes most start-up entrepreneurs to face a simple ethical conundrum:
How to send the signal of legitimacy when, by definition, the organization is not yet
legitimate? A social judgment of legitimacy has not been made regarding the organization,
yet the organization must appear as if it has. Stories abound in which an aspiring
entrepreneur sets up a “sham” operation to convince a prospective stakeholder that the
organization is something more than it in fact is. Similar stories tell of entrepreneurs
making promises that they are not sure can be delivered on. The fact that these deceptive
actions are often celebrated by the popular press can cause ethical dilemmas in the mind
of start-up entrepreneurs (e.g., Kuemmerle, 2002). Strictly speaking, these actions are
lies—misrepresentations of the truth. These lies ultimately may result in violations of trust
between the entrepreneur and his or her stakeholders.
The purpose of this paper is to identify some of the ethical challenges that face
early-stage entrepreneurs as they attempt to gain initial legitimacy and to offer guidelines
for addressing these challenges. First, we define the legitimacy threshold (LT) and address
the specifics of the legitimacy lie in view of the relevant theoretical and empirical
literature. Next, we will broadly explore the nature of entrepreneurial ethics and ethical
decision making, with a special focus on the unique nature of ethical issues in the new
venture. We then present two common ethical frameworks that are appropriate for dealing
with this issue and apply them to several case examples. We conclude with some general
guidelines for entrepreneurs.
The Challenge of Seeking Initial Legitimacy and Lying
The legitimacy lie concept spans the intersection of legitimacy theory and ethics
theory—more specifically, at the intersection of new venture legitimacy theory and ethics
theory pertaining to lies. It essentially involves lies told before an adequate level of
legitimacy is attained, for the purpose of attaining legitimacy. These lies are generally
statements made or actions taken to counteract the liabilities of smallness and newness
that most entrepreneurs feel are unfairly placed on them by stakeholders. Legitimacy is
defined parsimoniously here as “. . . a social judgment of acceptance, appropriateness, and
desirability, [that] enables organizations to access other resources needed to survive and
grow” (Zimmerman & Zeitz, 2002). The legitimacy lie is defined as an entrepreneur’s
“intentional misrepresentation of the facts” in an effort to encourage various stakeholders
to deem them a legitimate entity.
Initial Legitimacy
The notion that new and small businesses are different is at the heart of entrepreneurship research, regardless of the construct under study (Gartner, 1989). We submit
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here that a key underlying source of this difference is the fact that, unlike older and
larger firms, most start-ups do not possess a base level of legitimacy. Increasing subsequent incremental levels of legitimacy is far less difficult than attaining the initial base.
This leads to an important fact seldom expressed in the literature: for many new ventures, legitimacy—not financial performance—is the key outcome (Delmar & Shane,
2004). This is the case because, at this stage, legitimacy is a precursor to performance.
We utilize the notion of an LT (Carlisle & Flynn, 2005; Rutherford & Buller, 2007;
Zimmerman & Zeitz, 2002) to more fully convey this condition. Zimmerman and Zeitz
were the first to explicitly use and operationalize the LT. They define the LT as “[the
point] below which the new venture struggles for existence and probably will perish and
above which the new venture can achieve further gains in legitimacy and resources.”
They go on to state: “An organization must achieve a base level of legitimacy that is
dichotomous—it either does or does not meet the threshold” (Zimmerman & Zeitz, p.
427). In life cycle parlance, the LT can be thought of as a movement of a firm from the
birth stage to (at least having the potential to reach) the growth stage. Scott and Bruce
(1987) term this the “inception to survival crisis.”
There have been several typologies of legitimacy put forth in the literature (e.g.,
Hunt & Aldrich, 1996; Suchman, 1995), and the preponderance of this literature suggests that three types of legitimacy exist: regulative, normative, and cognitive. Regulative describes legitimacy that arises from maintaining proper behavior according to laws
and rules set forth by governments and industries. Normative legitimacy is attained by
complying with “softer” requirements set forth by key stakeholders in society. These
requirements would include performance measures, organizational structure considerations, adequate strategic planning, etc. Finally, cognitive legitimacy describes an even
more tacit form of legitimacy, in which stakeholders make legitimacy judgments about
an organization passively and not based on any sort of active evaluation. “From the
cognitive perspective of legitimacy, organizations are legitimate when they are understandable (that is there is greater awareness and therefore less uncertainty involved with
the organization) rather than considering when they are desirable” (Shepherd & Zacharakis, 2003, p. 151).
While no typologies have specifically addressed legitimacy in the new and small firm,
some notable studies have begun to specifically examine this relationship (e.g., Choi &
Shepherd, 2005; Shepherd & Zacharakis, 2003; Tornikoski & Newbert, 2007). While
there remains a lively debate around characteristics of the entrepreneur, many scholars
would argue that the field has moved away from this paradigm and toward a study of the
behaviors and activities of these individuals (e.g., Aldrich & Martinez, 2001). Tornikoski
and Newbert, for example, found that nascent ventures whose founders engaged in
activities meant to positively affect stakeholder perceptions increase formation chances.
Specifically, initiation of marketing efforts, the opening of a bank account, the development of a prototype, and the purchase of raw materials and equipment increased the
likelihood of starting a venture. Collectively the authors’ findings suggest that by undertaking these activities, which they term strategic legitimacy, nascent entrepreneurs
increase their chances of founding.
Delmar and Shane (2004) conceptualize activities in the start-up stage as consisting
of three separate activities: (1) activities that enhance reliability and accountability, (2)
activities that increase stakeholder relations, and (3) activities to control critical resources.
Their work provides support for the hypothesis that entrepreneurs should first work to
develop legitimacy through increasing reliability and accountability through activities
such as business plan creation and establishment of a legal entity. In doing so, the
entrepreneurs increase survivability chances for their ventures.
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In Aldrich’s (1999) work, he espouses the use of story telling by start-up entrepreneurs to communicate to stakeholders that they are operating in a “reasoned and trustworthy manner” (p. 322). Story telling is considered an effective legitimization tactic
because stories are rich, subjective, and not subject to external validation. Moreover,
research shows that good story telling enhances the new venture’s chances of survival
(Aldrich; Delmar & Shane, 2004; Fisher, 1985). It is not much of a stretch to suggest
that story telling, which most start-up entrepreneurs must engage in, could result in
misrepresentation.
These studies suggest that entrepreneurial activities are important in attaining legitimacy and eventual success. As attention shifts to such activities, we suggest that potential
misrepresentation by entrepreneurs is an activity that should be examined. It seems likely
that, among the activities taken to affect perceptions, legitimacy lies might be one. It may
also be that the activities discussed above are undertaken in such a way that stakeholders
are misled. As we work to understand these activities and the manner in which they are
undertaken, the ethical stance of entrepreneurs should be examined (Aldrich & Martinez,
2001).
In sum, it is our contention that new ventures face significantly different conditions
with regard to legitimacy seeking than firms in other phases of existence; and these
conditions may encourage founders to lie or otherwise deceive. Specifically, the idea of
initial legitimacy essentially holds that external stakeholders accord the firm the clout to
grow. Legitimacy cannot be taken, rather it must be granted by influential stakeholders
(e.g., financiers, employees, suppliers, and consumers). These stakeholders, either analytically or tacitly, at some point decide that a given firm has the necessary influence to
interest them. For most stakeholders, this means having a feeling of relative permanence
from an organization—a feeling that it is not teetering on the edge of extinction (Aldrich
& Fiol, 1994). Because of liabilities of newness and smallness, the pre-threshold period is
a time filled with severe cash shortages, frustrating negotiations with more powerful
stakeholders, and ethical dilemmas as the entrepreneur attempts to convince others that
the firm is valid and valuable even though it has not yet been legitimized (Carroll &
Delacroix, 1982; Jahawar & McLaughlin, 2001; Morris, 2001).
The most common stakeholders misled at this early stage are customers and financiers. This is simply because these groups are the most critical at the early stage of a firm’s
life (Jahawar & McLaughlin, 2001; Rutherford & Buller, 2007). We begin by looking at
the legitimacy lie construct through the eyes of the financier, not because this is the most
important stakeholder for pre-threshold firms—in fact most research (Rutherford &
Buller; Shepherd & Zacharakis, 2003; Zimmerman & Zeitz, 2002) shows that the customer is key here—but because the literature on the subject is far more developed.
Financiers
Although they do not refer to it as such, the economics and finance literatures have
addressed the legitimacy lie possibly more completely than has any other field. The related
concepts of adverse selection, information opacity, and moral hazard comprise a rational
explanation of the pre-legitimate entrepreneur’s plight.
The pre-legitimate firm and its financiers will face, through a condition called adverse
selection, a lack of normative legitimacy. In a market where buyers cannot accurately
gauge the quality of the product they are buying, it is likely that the marketplace will
contain poor quality products (Akerlof, 1970). Since most financiers are very aware of this
fact, a high quality firm with no history or size (i.e., proof of desirability) is unlikely to be
endorsed by a given stakeholder—in this case a financier. Adverse selection exists, at least
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partly, because of moral hazard. Moral hazard is an agency problem that describes
the possibility that an entrepreneur in a given firm could engage in behavior that is not
in the best interest of the financier and that the financier would have a difficult
time discerning (Chaganti, DeCarolis, & Deeds, 1995). Stakeholders have a difficult time
observing this morally hazardous behavior because pre-legitimate firms are what some
financiers would call “opaque,” meaning that their actual quality is difficult to discern. As
a remedy, investors often use social ties to overcome this uncertainly. In other words, they
attempt to use proxy organizations or individuals to provide information about the new
venture under consideration (Aldrich & Zimmer, 1986; Uzzi, 1996). Many entrepreneurs
do not have the requisite social ties, and therefore must engage in behavior that encourages the financier to legitimize them (Aldrich & Baker, 2001; Shane, 2003).
The literature is fairly definitive on this point. The existence of this, somewhat
tautological, condition for pre-legitimate firms is proven by their higher cost of capital
(Ang, Cole, & Lin, 2000; Diamond, 1991; Scherr & Hulbert, 2001). In other words,
financiers “punish” the pre-legitimate entrepreneur by charging her more for the use of
capital (e.g., higher rates, monitoring fees, etc.) (Shane, 2003). The ethical dilemma is
clear: the cost is built-in whether the entrepreneur lies or not. It may seem to many
entrepreneurs that, like players in a friendly game of poker, they are almost expected to lie.
Customers
While the marketing literature is not as precise on this issue, a similar condition exists
with respect to prospective customers. A review of the literature reveals, somewhat
surprisingly, that marketing scholars have yet to fully embrace the difficulty of the new
venture with regard to legitimacy. Most of the limited work on the intersection of
marketing and new venture legitimacy has been carried out by entrepreneurship researchers and coalesces around the construct of cognitive legitimacy (Aldrich & Fiol, 1994;
Shepherd & Zacharakis, 2003; Suchman, 1995; Williamsom, 2000). As discussed, a firm
is cognitively legitimate when customers are knowledgeable users of the firm’s products
or services. While there appear to be certain tactics that a start-up entrepreneur can employ
to expedite this process, the attainment of cognitive legitimacy is largely a function of time
(Carroll & Delacroix, 1982; Hannan & Freeman, 1984). Consequently, the entrepreneur
may be tempted to misrepresent the respective newness and smallness of his firm by lying
to customers.
Customers, like financiers, have trouble discerning the quality of pre-legitimate firms;
they must make a determination about whether or not to “invest” significant risk in
purchasing the company’s products or services. Compared to financiers, they are less
overt and more passive in their processes, but the end result is the same. Customers are far
more likely to purchase products and services from firms they perceive to be legitimate
(Aldrich & Fiol, 1994; Shepherd & Zacharakis, 2003). Similar to our discussion above
regarding financiers, founders cannot base initial legitimacy building strategies on objective external evidence. Instead, they must concentrate on framing the unknown in such a
way that it becomes believable (Aldrich, 1999).
Legitimacy Lies
It seems that recent work is advising entrepreneurs to actively manipulate an audience’s perception. While active manipulation does not necessarily imply lying, we argue
that it may at times cross the line by including deliberate misrepresentations of the
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entrepreneur and/or her company. At the same time, the fact remains that active manipulation probably does lead to increased chances of survival, and entrepreneurs are left
without sense-making tools with which to navigate this slippery slope. As noted, we define
the legitimacy lie as an entrepreneur’s “intentional misrepresentation of the facts” in an
effort to encourage stakeholders (financiers and customers) to deem them a legitimate
entity. By “intentional misrepresentation of the facts,” we mean not only the actual
conveying of information or other kinds of meaningful communication (e.g., actions) in a
manner intended to deceive, but also the deliberate withholding of information or other
kinds of meaningful communication that might, if conveyed, lead a stakeholder to correct
a mistaken assumption, conclusion, or impression.
Ethical Decision Making
Previous theory and empirical evidence suggests that entrepreneurs engage in cognitive and behavioral processes that affect the probability that they will engage in legitimacy
lies. The literature on ethical decision making provides one relevant framework for our
analysis. Rest (1986) proposed that ethical decision making progresses through four basic
steps: awareness (identifying the moral nature of an issue), judgment (making a moral
judgment), intent (establishing moral intent), and behavior (engaging in moral action).
Subsequent theory and research have proposed and examined a number of factors that may
influence each of these four steps.1 In general, two sets of independent variables (individual factors and organizational or situational factors) have been examined in their
relationship to one or more of the ethical decision-making steps (as dependent variables).
Most previous studies have examined the relationship of individual factors on ethical
awareness and ethical judgment. There are fewer studies that have analyzed the relationship of individual and/or situational factors on ethical intent and/or behavior. We will
briefly summarize the relevant findings of previous studies and note their importance to
our examination of the legitimacy lie.
While a variety of individual factors have been examined in relation to ethical
decision making (e.g., age, gender, nationality, religion, work experience, education,
moral philosophy, and cognitive moral development), few individual difference variables
have consistently been shown to have a strong correlation with any of the steps in the
ethical decision-making process. However, there are several findings relevant to our
analysis. For example, O’Fallon and Butterfield (2005) concluded that previous studies of
the relationship between moral philosophy and ethical decision making have been quite
consistent. Personal philosophies such as idealism and deontology are positively related to
ethical decision making (primarily awareness); philosophies of relativism and consequentalism are negatively related. An individual’s level of cognitive moral development has
also been found to be positively associated with ethical decision making (Bass, Barnett, &
Brown, 1999; Green & Weber, 1997). Other individual factors such as religion, years of
education, and years of work experience also generally have been found to be positively
related to ethical decision making (O’Fallon & Butterfield).
The effects of organizational or situational factors on ethical decision making have
also been examined in previous research. These contextual factors include codes of
conduct, ethical climate or culture, type of industry, organizational size, reward systems,
1. See literature reviews by Solymossy and Masters (2002) and O’Fallon and Butterfield (2005); Loe, Ferrell,
& Mansfield (2000).
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and significant others. The findings of several studies are relevant here. Greenberg (2002)
found that individuals who worked at an office with a code of ethics stole less than
individuals who worked in an office without such a code. Similarly, Somers (2001)
observed that unethical behavior was less prevalent in organizations that had a code of
ethics versus those that did not. Ethical climate or culture has also been found to be
positively related to ethical behavior (Peterson, 2002). Reward systems also have an
impact on ethical decision making; rewarding ethical behavior tends to increase such
behavior, while sanctioning unethical behavior tends to decrease it (Loe et al., 2000). The
influence of significant others (both positive and negative) has also been found to be
related to ethical decision making. The empirical relationships between ethical decision
making and other contextual factors such as organizational size and type of industry have
generally been inconclusive.
While most of the previous research on ethical decision making has focused on ethics
in business (and not specifically entrepreneurship) contexts, it is reasonable to assume that
the findings are applicable to entrepreneurs in start-up ventures. However, since situational variables have been shown to be important in influencing ethical decision making,
we must exercise some caution in generalizing these findings to an entrepreneurial
context. In fact, recent reviews of the literature conclude that there is a need for more
research examining ethical decision making specifically in entrepreneurship (Loe et al.,
2000; O’Fallon & Butterfield, 2005).
In summary, the ethical decision-making literature suggests that individual factors
such as an entrepreneur’s personal moral philosophy and/or level of moral development
may positively influence her ethical awareness, judgment, intent, and behavior. In addition, situational or organizational factors in a new venture such as a code of ethics, ethical
culture, reward system, and significant others can also have an effect on ethical decisionmaking. We will incorporate these individual and contextual factors in our discussion and
conclusions below.
Ethical Frameworks
As noted above, one’s personal moral philosophy is an important determinant of
sound ethical decision making. Here we discuss two commonly understood ethical philosophies that can be applied to entrepreneurial decision making. While no reputable
ethical theory condones lying as such, most theories allow it under certain conditions. The
relevant question here is: are there conditions under which the legitimacy lie is ethically
permissible? A number of ethical theories, such as pragmatism, virtue ethics, and various
types of leadership ethics, might also be useful in attempting to answer this question. In
order to keep our discussion from getting too abstruse, however, we will limit ourselves
to examining the two ethical theories that are most commonly referred to in the business
ethics literature—namely, utilitarianism and deontology.
Utilitarianism assesses the rightness or wrongness of an act in terms of the harms and
benefits it produces: “[A]n act is right if and only if it or the rule under which it falls
produces, will probably produce, or is intended to produce at least as great a balance of
good over evil as any available alternative; an act is wrong if and only if it does not do
so” (Frankena, 1973, p. 14; italics in original). The point to be emphasized here is that
utilitarians do not see particular actions as being right or wrong in themselves; the
criterion for judging their rightness or wrongness is the net benefit or harm of the
consequences that flow from them. Lying, therefore, is not seen as wrong in and of itself.
Still, as J. S. Mill, the most famous of the utilitarian theorists, warned, the harms caused
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by lying, including long-term damage to the character of the person who lies and to the
ability of society to function effectively, usually outweigh any good that lying might
produce (Mill, 2001). Nevertheless, utilitarianism does permit lying in those cases in
which it actually does produce more good or less harm than telling the truth would. In fact,
on utilitarian criteria, in those cases it is actually right to lie.
The distinguishing mark of deontology is its insistence that certain actions are intrinsically good (right) or bad (wrong), regardless of their consequences (Frankena, 1973,
pp. 15, 23–28). Goodness and badness are seen as qualities of the actions themselves.
Thus, telling the truth, keeping promises, and treating people justly are good in and of
themselves; lying, breaking promises, and treating people unjustly are inherently bad in
and of themselves. As the Greek root deon (duty) suggests, one has a duty or obligation to
refrain from actions that are inherently bad, even if from a utilitarian perspective they
produce a surplus of good over harm. The sternest versions of deontological theory, most
notably Kant’s, prohibit lying in absolutely every case; but most versions, though they
consider lying to be prima facie wrong, permit it in those cases in which one is forced to
choose between lying and another intrinsically wrong action that is even worse (e.g.,
betraying one’s family or country).
There is also, of course, the possibility of unintentionally misrepresenting the facts.
Due to their high level of enthusiasm and self-confidence or to their lack of skills or
information, entrepreneurs may unwittingly misrepresent facts about a company and its
prospects. In general, neither of the two ethical theories we are discussing would consider
unintentional misrepresentation a violation of their respective ethical criteria. Nonetheless, the issue of unintentional misrepresentation does have ethical implications—a topic
to which we will return shortly.
The model in Figure 1 illustrates the ethics of the legitimacy lie from the perspective
of utilitarianism and deontology. The framework has two dimensions: Misrepresentation
of the facts, either intentional or unintentional, and net consequences for stakeholders,
either positive or negative. Using this model, there are four general possibilities regarding
legitimacy lies:
Figure 1
Legitimacy Lie Framework
DEONTOLOGY
Wrong
(prima facie)
Wrong
(prima facie)
Not wrong
Not wrong
Positive
Negative
Consequences for Stakeholders
956
II
Right
Wrong
III
IV
Unintentional
Unintentional
III
I
II
Intentional
Intentional
Misrepresentation of Facts
I
UTILITARIANISM
IV
Not wrong
Positive
Not wrong
Negative
Consequences for Stakeholders
ENTREPRENEURSHIP THEORY and PRACTICE
1.
2.
3.
4.
Intentional misrepresentation that leads to net positive outcomes for stakeholders.
Intentional misrepresentation that leads to net negative outcomes for stakeholders.
Unintentional misrepresentation that leads to net positive outcomes for stakeholders.
Unintentional misrepresentation that leads to net negative outcomes for stakeholders.
Ethics and the Legitimacy Lie
Of the two theories, utilitarianism would be more likely to provide grounds for
acceptability of the legitimacy lie. Deontology in its more lenient versions merely tolerates lying as an occasionally necessary evil, and it is extremely doubtful that the legitimacy lie would ever meet the deontological criterion; how often would an entrepreneur
be faced with a situation in which he or she had to lie to stakeholders in order to avoid
carrying out an act that intrinsically was even worse? On the other hand, from the
utilitarian point of view, one can imagine situations in which it could plausibly be argued
that the net benefit resulting from the legitimacy lie would be positive, and in fact more
positive than the net benefit resulting from telling the truth. Indeed, one argument put forth
is that a “fake it till you make it” strategy is acceptable for pre-legitimate entrepreneurs
(e.g., Kuemmerle, 2002).
But the point of this article is not to encourage entrepreneurs to rely on utilitarianism
to justify their use of intentional deception. As Mill’s caveat indicated, even from a
utilitarian standpoint one usually reaches the conclusion that lying is wrong. Although
utilitarian logic suggests that an entrepreneur’s deliberate lying to a financier (e.g., about
the company’s financial status) is ethical when it apparently leads to more benefits than
harms (e.g., financing allows the company to survive and ultimately hire more employees), this situation may have a long-term negative impact on the level of trust between the
entrepreneur and the financier and possibly other stakeholders. If the financier discovers
he has been intentionally deceived, and especially if his ethical perspective is deontological, he will likely perceive the entrepreneur as untrustworthy. Moreover, even if the
financier in question does not know about the deception, perhaps other stakeholders do,
such as the entrepreneur’s partners or employees. These other stakeholders may deem the
entrepreneur to be untrustworthy—a conclusion that clearly will affect the long-term
quality of their relationship with the entrepreneur (Brass, Butterfield, & Skaggs, 1998;
Ladkin, 2006).
Rationalization is another issue that must be considered (Bok, 1978). When one’s
dreams and money are on the line, it can be very difficult to evaluate objectively the
potential harms and benefits stemming from one’s actions. One tends to overestimate
the importance of one’s own plans and goals. Moreover, the tendency of utilitarians to use
quantitative measurements to assess outcomes can lead them to evaluate effects in terms
of their quantity rather than their gravity. There is a great deal of ambiguity and subjectivity in evaluating so-called “objective” outcomes. In short, appeals to utilitarianism in
the heat of battle can easily lead to a distorted evaluation of harms and benefits. As noted
earlier, consequentalist orientations, like utilitarianism, have been found to be negatively
related to ethical decision making (O’Fallon & Butterfield, 2005).
Finally, to refer again to Mill’s statement (which invokes a central theme of virtue
theory), one has to be concerned about the effect that lying has on the character of the
entrepreneur. As with any decision, the choice to lie has the potential to shift the probabilities regarding one’s subsequent choices. The choice to lie on one occasion could well
make a person less reluctant to lie the next time they are faced with a difficult situation;
over time, the snowball effect of repeated choices to lie could have the effect of creating
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in the entrepreneur a settled habit of dishonesty. This self-harm is certainly one of the
consequences that an entrepreneur must take seriously when deciding between telling the
truth and misrepresenting it.
As shown in both frameworks in Figure 1, unintentional misrepresentation of the facts
(quadrants III and IV) is generally not considered an ethical violation. Business journals
are replete with tales of entrepreneurs who “over promised” but eventually delivered
because of their supreme self-confidence, hard work, ingenuity, and persistence. Before
assuming that such behavior is ethically neutral, however, two caveats should be noted.
First, overconfidence and the tendency to “over promise” may be rooted in an entrepreneur’s lack of self-knowledge, an unrealistic assessment of the facts in the situation (e.g.,
lack of due diligence), or negligence that leads to inaccuracies. In these cases, one could
argue that the entrepreneur is “out of touch” with reality as a result of being careless, and
therefore should be held ethically accountable for misrepresenting the truth. Second,
misrepresenting the truth, even unintentionally, may undermine trust in the relationship
with the stakeholders involved, especially when the consequences are negative. In this
case, the stakeholders will likely lose trust in the entrepreneur who, in his or her exuberance, misrepresented the facts, unless the stakeholders truly believe that the entrepreneur
acted in good faith. If the stakeholders believe the entrepreneur did not intend to mislead
them, they might be willing to give him or her a second chance.
Applying the models in Figure 1 to some of the examples in Table 1 will help
illustrate the ethical considerations regarding legitimacy lies. In applying the models, it is
important to define the context in which the entrepreneur is operating in these examples
(Cavusgil, 2007). First, we assume that the entrepreneur is launching her first venture (i.e.,
is not a serial entrepreneur), and therefore does not have a previous track record or
reputation for success. Further, we assume that the entrepreneur is at the pre-legitimacy
stage of the new venture; she has not yet secured that key customer and/or financier that
signals the firm’s legitimacy. Finally, we assume that the customers in the example are
business to business (B2B) customers and that the financiers are early angel investors or
bankers (i.e., beyond the initial family, friends, and fools). These assumptions are characteristic of pre-legitimate start-up ventures.
Examples A, B, C, and D clearly involve attempts to intentionally deceive key
stakeholders and therefore would be unethical according to deontological standards.
However, assuming that these actions led to greater benefits than harms, they could be
viewed as ethical according to the utilitarian criterion. For example, these actions might
allow the company to increase sales (Example A, B, and C) or improve cash flow
(Example D) that would allow the company to eventually succeed and to benefit existing
and future stakeholders. As noted earlier, however, some utilitarian interpretations would
argue that these legitimacy lies are still wrong because they ultimately damage the
character of the entrepreneur and the ability of the company, and more broadly of society,
to function effectively (Mill, 2001). Intentional deceptions can undermine trust in social
relationships with key stakeholders (Brass et al., 1998). As Solymossy and Masters (2002)
observed: “When the trust and emotional involvement of one actor for another are not
reciprocated fully by the other, the resulting asymmetry increases the potential for unethical behavior” (p. 234).
Examples E, F, and G also involve intentional misrepresentations of the facts. These
cases, meant to make the company appear bigger or more well-established than it is, seem
rather innocuous at first glance. Nonetheless, the entrepreneur is intentionally deceiving
potential customers or other stakeholders. From a deontological perspective these actions
would be considered wrong. They may be acceptable from a utilitarian standpoint,
provided that the benefits to stakeholders do in fact outweigh the harms. Again,
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Table 1
Examples of Possible Legitimacy Lies
References
A.
B.
C.
D.
E.
F.
G.
H.
I.
J.
“When a leasing agent told an entrepreneur that to be considered for a space in the mall the
company needs to be ‘established,’ the entrepreneur took that to mean that he needed to
have been in business for at least two years. ‘So we manipulated our financials and we
lied our way through that and said yes we have, even though we had actually been in
business for six months.’ ”
“It is common in our industry for sales people to ‘load’ the dealer with too much product,
because he won’t want to push the competitor’s product until he gets rid of yours first.
With that in mind, some companies invent elaborate schemes to get the dealers to buy
more than they need—their salespeople overstate demand, exaggerating how well their
product is going to sell or how big a promotion is.”
Bhide and Stevenson (1990) described the deceptive tactics employed by Philippe Kahn,
founder of software maker, Borland International. At a critical early stage the company
was attempting to place an ad in an industry magazine, BYTE. Borland could not afford
the ad and BYTE would likely not extend credit to such a high risk company. Kahn
described how he solved the problem: “. . . before the ad salesman came in—we existed
in two small rooms, but I had hired extra people so we would look like a busy,
venture-backed company—we prepared a chart with what we pretended was our media
plan for the computer magazines. On the chart, we had BYTE crossed out. When the
salesman arrived, we made sure the phones were ringing and the extras were scurrying
around. Here was this chart he thought he wasn’t supposed to see, so I pushed it out of
the way. He said, ‘Hold on, can we get you in BYTE?’ I said, ‘Frankly, our media plan is
done, and we can’t afford it.’ So he offered us good terms . . .”
One entrepreneur’s technique for stringing out suppliers involved “using a check embosser
to imprint amounts on a blank check and typing ‘certified check’ on it so the delivery
person would leave the inventory for which he was supposed to get cash or a certified
check. That would give [the entrepreneur] a couple of days to actually get some money in
the bank. When the vendor got their check, they’d call and ‘Hey, this is a regular check,’
and we’d say, ‘Oh, I’m sorry. Just send it back and we’ll send you a cashier’s check.’ ”
“When customers called, I would tell them ‘Steve is in the warehouse,’ which meant he was
in the garage.”
“No space in the apartment—I always met people at the airport, said I was leaving on a
flight, then waited until they had gone to go back home.”
A 23-year-old American entrepreneur of a start-up computer distribution company was
pursuing a potentially large deal with a Japanese manufacturer to be a U.S.-based
distributor. The entrepreneur’s father was an early investor in the company and was on the
company’s Board. The young entrepreneur, knowing that the executives of the Japanese
company would be more likely to do business with a more experienced (and senior)
individual, “appointed” his father as C.E.O for the trip to Japan to negotiate the deal.
Once the deal was successfully completed, the young entrepreneur resumed his duties as
the company’s C.E.O.
“Hewlett and Packard named their first product the Model 200A ‘because we thought the
name would make us look like we’d been around for a while. We were afraid that if
people know that we’d never actually developed, designed, and built a finished product,
they’d be scared off.’ ”
“We described the future of the company as if it were the present and maintained an air of
being bigger than we were by producing quality brochures and sales materials and a
professionally designed logo.”
An entrepreneur approached an angel group for funding to assist in product development
and marketing of an innovative computer keyboard. The entrepreneur had successfully
demonstrated a rough prototype to several large potential customers who expressed strong
interest in the product. He feels pretty confident that with some further refinements in the
product, he can secure a contract with at least one of these large customers, and quite
possibly more. Based partly on the feedback from the potential customers, he presents the
angel group with a business plan that is optimistic regarding future sales of the product.
July, 2009
(Seglin, 1998)
(Cook, 1992)
(Bhide & Stevenson,
1990, pp, 122–123.)
(Seglin, 1998)
(Bhide, 2000)
(Bhide, 2000)
(Bhide, 2000)
(Bhide, 2000)
959
entrepreneurs should seriously consider the implications of even these apparently “minor”
deceptions on the quality of the relationships they create with various stakeholders. Trust
between the entrepreneur and her or his employees, customers, financiers, suppliers, and
other stakeholders may be damaged when they observe or discover these seemingly
harmless legitimacy lies.
Examples H, I, and J are cases in which the company is deliberately attempting to
present an image or appearance of being legitimate, even though they have not crossed
the LT. In these cases, the company is using creative, but in our judgment acceptable,
means for representing the company and/or its products. There does not appear to be any
intentional misrepresentation of the facts and so there are no ethical violations from either
a deontological or utilitarian perspective. Of course, there is nothing inherently wrong
with entrepreneur or new ventures “putting their best foot forward.” For example, using
glossy brochures, a company logo, or an optimistic business plan does not necessarily
involve misrepresentation, but rather could be considered a wise investment that demonstrates the quality, professional approach, and potential of the company.
Conclusions and Recommendations
In this paper we have argued that entrepreneurs in start-up companies must overcome
liabilities of newness and smallness to gain legitimacy in the eyes of key stakeholders,
primarily customers and financial providers. Such legitimacy is crucial if start-ups are to
survive and have the potential for moving into the growth stage. Further, descriptive
stakeholder theory (Jahawar & McLaughlin, 2001) suggests that entrepreneurs will likely
employ proactive strategies to gain legitimacy with these key stakeholders. These proactive attempts to gain legitimacy may sometimes lead to questionable ethical behaviors.
The academic literature regarding ethics and entrepreneurship, especially with respect to
legitimacy issues, is not well developed. We have reviewed the ethical decision-making
literature to identify the major factors that influence ethical decision making in business.
One important individual factor that appears to be important is the entrepreneur’s personal
ethical philosophy. In this regard, we have applied the common ethical frameworks of
utilitarianism and deontology to explore the boundaries of what may or may not be
acceptable behavior in seeking legitimacy.
Our analysis concluded that, regardless of which ethical philosophy is used, unintentional misrepresentation of the facts in seeking legitimacy is generally not wrong. There
may be some ethical questions in cases where the entrepreneur has not done adequate due
diligence in gathering the facts, has made careless errors, or has “over promised” due to
an unrealistic self-understanding. However, many entrepreneurs have high levels of selfconfidence and enthusiasm and do ultimately achieve goals that many stakeholders might
deem unattainable. Indeed, this outcome is one of the attributes that we associate with, and
celebrate about, successful entrepreneurs.
Intentional misrepresentation of the facts, on the other hand, is always prima facie
wrong from a deontological perspective. From a utilitarian perspective, intentional misrepresentation is clearly unethical when it leads to more harm than benefits, but is
acceptable and even right when it can be determined that the benefits of doing so outweigh
the costs. Of course, we have pointed out that an appeal to utilitarian logic can be
problematic because the evaluation of harms and benefits is often subjective and incomplete, and there can be a tendency on the part of entrepreneurs to rationalize unethical
behavior. We have also argued that deliberately misrepresenting a company’s products or
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ENTREPRENEURSHIP THEORY and PRACTICE
finances, even when this leads to positive outcomes, may cause a lack of trust between an
entrepreneur and various stakeholders.
We believe that the models in Figure 1 can provide a useful framework for examining
the ethical ramifications of an entrepreneur’s attempts to gain legitimacy. Building on the
ethical decision-making literature and the preceding discussion, we offer the following
practical suggestions. First, entrepreneurs should make every effort to gather appropriate
and accurate information (e.g., product, financial, operations, etc.) as they represent their
venture to various stakeholders.
Second, entrepreneurs would benefit by careful reflection about their own and their
company’s strengths and weaknesses. Realistic self-awareness would include an examination of one’s personal moral philosophy and, if necessary, educating oneself about
various ethical frameworks. In this regard, the literature suggests that moral philosophies
of idealism or deontology are positively associated with ethical decision making. In
addition, the entrepreneur should develop a thorough knowledge of the company and its
capabilities. This enhanced personal and company knowledge may moderate the tendency
of entrepreneurs to oversell or over promise. We are not suggesting that entrepreneurs tone
down their vision, enthusiasm, and self-confidence. We argue only that entrepreneurs can
potentially make better ethical choices if they are more consciously aware of themselves,
their ethical values, and their ventures.
Third, we argue that, while possibly acceptable according to utilitarian criteria,
deliberate misrepresentations of the facts to stakeholders may be problematic. Entrepreneurs should exercise caution in assessing harms and benefits of their actions and be
cognizant of the tendency to rationalize. Even when so-called “legitimacy lies” produce
more benefits than harms, they may ultimately undermine the character of the entrepreneur and the trust needed to maintain good relationships with stakeholders. It is a good
practice for would-be deceivers to put themselves in the place of the deceived and ask,
“Would I want to be on the receiving end of this misrepresentation?”
Fourth, the entrepreneur would benefit from developing organizational supports for
sound ethical decision making that leads to ethical behaviors. For example, from the
firm’s inception, the entrepreneur could create a clear code of ethics that would signal
appropriate ethical behaviors to employees and other stakeholders. The entrepreneur is
key in establishing and maintaining an organizational climate or culture that reinforces
ethical behavior. This can be done first and foremost by setting the example, and then
through hiring, training, and rewarding for ethical behavior as the firm grows. In addition,
prior to taking action, it would be useful for entrepreneurs to consult with significant
others, such as an advisory board, employees, or other trusted advisors about potential
ethical issues and possible courses of action.
In summary, this paper has examined the literature on the LT in an attempt to define
some of the unique challenges facing an entrepreneur in a start-up, pre-legitimate firm.
Specifically, entrepreneurs must overcome the liabilities of newness and smallness in
order to gain legitimacy, especially from financiers and customers who are critical to the
firm’s survival. Moreover, entrepreneurs tend to use proactive strategies to achieve
initial legitimacy with these key stakeholders. These attempts to gain legitimacy may
include legitimacy lies, or deliberate attempts to misrepresent the facts surrounding the
entrepreneur or various aspects of her company. The literature on ethics and ethical
decision making was reviewed to explore the ethical boundaries of the legitimacy lie.
Two well-known ethical frameworks, utilitarianism and deontology, were described and
applied to several case examples. Our paper concludes with several recommendations
for entrepreneurs as they attempt to deal with the ethical challenges posed by the LT.
We believe that, by implementing these recommendations, entrepreneurs will be better
July, 2009
961
equipped to successfully navigate the ethical boundaries in their attempts to gain initial
legitimacy. However, as noted earlier, further research is needed to identify the specific
individual and situational factors that determine the ethical decision-making practices of
entrepreneurs of early stage new ventures.
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Matthew W. Rutherford is an Associate Professor of Management at Virginia Commonwealth University,
Department of Management, Richmond, Virginia.
Paul F. Buller holds the Kinsey M. Robinson Chair in Business Administration at Gonzaga University,
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