Information asymmetry occurs when one party has more or better information than the other party. Asymmetry and fraud will sour investor interest in the field.
Elizabeth Holmes of the blood testing company Theranos, who is being tried for 12 charges of wire fraud and conspiracy to commit wire fraud, serves as a sobering reminder of the importance of due diligence.1 Theranos’s many esteemed investors were not unscrupulous, just unaware. Holmes’s case is one of information asymmetry, in which 1 party has information that the other does not. Holmes knew she was selling snake oil; her investors did not.
Information asymmetry is considered by economists as a major source of market failure.2 Therefore, while we are buoyed to see exponential increases in investment in brain health technologies in the past years, this field needs sustained investment increases over the coming decades to seriously tackle multi-trillion dollar global brain health challenges.3-5 Approaches to understand and then minimize information asymmetry between technical entrepreneurs and investors are key.
This asymmetry creates an imbalance of power and can lead to negative results, spanning from poor decision making on the part of the less informed party, all the way to providing an opportunity for exploitation and unethical behavior (Table 1).
The opportunity for information asymmetry to lead to fraud is particularly alarming. According to PwC’s Global Economic and Fraud Survey, 47% of companies experienced fraud in the past 24 months, and more than $4.5 trillion are lost to fraud each year globally.6 Concerning startups, fraud is most prevalent among small companies. According to the Association of Certified Fraud Examiners’ (ACFE) 2018 report, organizations with fewer than 100 employees see the largest share of fraud cases and lose nearly twice as much per scheme compared to organizations with more than 100 employees.7
We believe that brain health technologies will add monumental value to human society in the coming decades. However, if entrepreneurs and investors are not on the same page, information asymmetry could impede development of the brain health technology company space.
The problem of information asymmetry is exacerbated by ever-growing information overload. In 1971, before the advent of the internet and social media, the prominent Nobel Prize winning economist Herbert A. Simon, PhD, noted “information…consumes the attention of its recipients…a wealth of information creates a poverty of attention and a need to allocate that attention efficiently among the overabundance of information sources that might consume it.”8 This problem has become increasingly apparent in our daily lives as a cacophony of online media competes for our attention. Every minute today, there are more than 474,000 tweets, 400 hours of new video on YouTube, 3 million new posts on Facebook, 3.5 million Google searches, and over 15 million text messages delivered.9
The problem of information overload is particularly acute in brain health technology investing. There has been a rapid increase in technological breakthroughs; basic, translational, and clinical neuroscience discoveries; and brain health technology company formations.10 Likewise, there has been substantial growth in investments—venture investors poured a record-setting $1.5 billion into brain health-related startups by the year-end of 2020.3 The brain health technology sector urgently needs sustained investment over decades. Further, the brain health technology market has the opportunity to tap into the $40.5 trillion in global assets with environmental, social, and governance investment imperatives that could be harnessed by the brain health space if the market continues to mature.11
The effect of such information overload is to amplify information asymmetry. Sunstein, in Too Much Information argues that less is often more, highlighting that in many cases, abundant information is neither necessary nor welcome, and can be an impediment to effective decision making.12 People typically make decisions by distilling redundant information rather than adding unnecessary complexity.
Insufficient Due Diligence
Because of the immense complexity of neuroscience, it is particularly vulnerable to such asymmetry. Complex neuroscience principles, technology, and black-box algorithms may be poorly understood by advisors, employees, and investors without a relevant technical or clinical background.13 Additionally, it is especially hard to develop an accurate sense of the product’s capabilities and scientific validity when it lacks peer review.
As a result, investors and customers are arguably more reliant on views of others and are consequently vulnerable. Who do nontechnical investors turn to when evaluating a neuroscience company? In some cases, they may consult experts in the field. Often, however, they may simply trust the due diligence of earlier investors. Current capital markets and funds (private equity and venture capital) have so much money that free riding is increasingly common. Large firms count on the due diligence of smaller funds (or early-stage investors), who in turn count on the reputation of the big firms. Thus, mistakes and oversights from early investors might not always be rectified in future investment rounds.
Moreover, the rapidity of the current market environment maximizes asymmetries. Building a trusting and robust relationship with founders over time used to be the usual way for an investor to gain access to reliable and accurate information. Over time, investors observe consistencies and inconsistencies in narratives and presented factors and data. However, deals are closed so quickly and fear of missing out is widespread among investors, therefore effective diligence cannot be completed.
The relationship between marketing and the product is another source of information asymmetry. Overemphasis on marketing without product development—a staple of the Silicon Valley “fake it till you make it” mentality—may distract from an unvalidated or poorly validated product. In some cases, as with Theranos, “the emperor has no clothes,” and the product is nonfunctional. Of course, when communications to customers and investors paints a rosier picture than the truth of product development, this leads to further information asymmetry. From a product-market fit perspective, there are many novel market segments and a rapidly evolving brain health landscape. Only select people may understand these product-market fit dynamics, enabling information asymmetry to arise between key stakeholders.
In particular, market activities are often overplayed by entrepreneurs. It is important for investors to discern the difference between conversations in the market, unpaid pilots, paid pilots, commercial contracts, and revenue from commercial contracts. However, entrepreneurs often inaccurately portray these activities in conversations with investors (eg, claim unpaid or one-off pilots as commercial contracts). Entrepreneurs may have a monopoly of knowledge over the different market activities and thus spin or even withhold relevant and accurate information.
The disconnect between revenue and valuation may also present information asymmetry between founders and employees. Potential employees without a comprehensive understanding of startups may not understand how a brain health technology company may be worth millions or billions of dollars, and yet have minimal or no revenue. Entrepreneurs also may charismatically explain inaccurate revenue projects and withhold information from potential employees. Subsequently, potential employees may accept jobs and take on more risk than they would otherwise feel comfortable with if they comprehensively understood the current state of the startup.
Finally, we would be remiss not to mention that cognitive biases may worsen information asymmetries. For instance, overconfidence could have a negative impact on our field in the long run.14 The increasingly high and speculative valuation dynamics embolden founders as well as investors to think that they have “got it.” It is important that overconfidence does not lead to insufficient diligence, and insufficient operational and governance activities.
Action is required to mitigate information asymmetry in brain health companies, or else brain health technology could suffer. For one, the field should encourage more advertising of failures and accurate analysis of how they could have been avoided. Additionally, to mitigate cognitive biases like overconfidence, training in cognitive distortions, judgement biases, and associated self-reflection may be useful.14,15 Finally, information needs to be disseminated in a manner that is clear, simple and accurate, and minimizes jargon. We have developed a Brain Health Executive model that may apply in this situation to equip people to be more effective investors and board members.16 Specialist investment funds should be established in niche areas with highly skilled investors, operators, clinicians and scientists (eg, Dementia Discovery Fund). Engaging clinicians and scientists with deep domain expertise, as independent experts, is additionally key to ensure investors and brain health practitioners are aligned.17 Material incentives, reputation incentives, control incentives, and stock option incentives have also been found to be effective measures to reduce information asymmetry, improve decision making, and lessen the investment risk of investors and entrepreneurs.2 Further details around these solutions are outlined in Table 2.
To work toward addressing the current global brain health challenges, continued investment and interest is needed in the brain health space. We cannot afford to turn a blind eye to problems stemming from information asymmetry. As with the case of Theranos, information asymmetry and fraud in one company can sour investor interest in the space for years to come.18 The brain health technology space cannot afford to be set back by information asymmetry and fraud due to the urgent need for innovation and sustained investment. The decisions made now to understand and mitigate information asymmetry between key stakeholders in brain health technology companies will have repercussions for decades to come.
Ms Smith is a director at the PRODEO Institute, an Atlantic Fellow in Brain Health Equity at the Global Brain Health Institute (GBHI) at the University of California, San Francisco (UCSF) and a Thiel Fellow at Stanford University. Mr Heinemeyer is cofounder of the PRODEO Institute and CEO of PRODEO. Dr Wolfe is a Senior Clinical Advisor for Cohen Veterans Bioscience’s Trauma Research Programs. She serves as Strategic Advisor co-leading CVB’s Suicide Strategy Initiative. Mr Asher is an undergraduate studying neuroscience at Dartmouth College. Dr Abbott is a corporate attorney, a professor of law at University of Surrey and an adjunct professor with the UCLA David Geffen School of Medicine. Dr Hynes isa senior advisor to the Organisation for Economic Co-Operation and Development (OECD) Secretary General, head of the New Approaches to Economic Challenges Unit (NAEC), and co-lead of the OECD-PRODEO Institute Neuroscience-inspired Policy Initiative (NIPI).Dr Aragam is Chief Commercial Officer with Stanford University’s Brainstorm Lab and adjunct faculty with the Massachusetts General Hospital, affiliated with Harvard University. Dr Fu is a technologist, venture capitalist and an adjunct professor in engineering at Stanford University. Mr Veron is venture capitalist, founder and managing partner at Newfund Capital. Dr Berk is Alfred Deakin Professor of Psychiatry at Deakin University and director of IMPACT at Deakin University (Institute for Mental and Physical Health and Clinical Translation). Ms Chen is a venture capitalist and an adjunct faculty member at UC Berkeley and Singularity University. Dr Lyons is a venture capitalist, managing director at Newline Ventures and Adjunct Professor in Management Science & Engineering and Civil & Environmental Engineering, Stanford University. Mr Ellsworth is an undergraduate studying computer science at Stanford University. Dr Eyre is cofounder of the PRODEO Institute, colead of the OECD NIPI, and holds adjuncts roles with IMPACT at Deakin University, GBHI at UCSF and Baylor College of Medicine.
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