Robert W. Fairlie
The “Great Recession” resulted in many business closings and foreclosures, but what effect did it have on business formation? On the one hand, recessions decrease potential business income and wealth, but on the other hand they restrict opportunities in the wage/salary sector leaving the net effect on entrepreneurship ambiguous. The most up-to-date microdata available—the 1996 to 2009 Current Population Survey (CPS)—are used to conduct a detailed analysis of the determinants of entrepreneurship at the individual level to shed light on this question. Regression estimates indicate that local labor market conditions are a major determinant of entrepreneurship. Higher local unemployment rates are found to increase the probability that individuals start businesses. Home ownership and local home values for home owners are also found to have positive effects on business creation, but these effects are noticeably smaller. Additional regression estimates indicate that individuals who are initially not employed respond more to high local unemployment rates by starting businesses than wage/salary workers. The results point to a consistent picture – the positive influences of slack labor markets outweigh the negative influences resulting in higher levels of business creation. Using the regression estimates for the local unemployment rate effects, I find that the predicted trend in entrepreneurship rates tracks the actual upward trend in entrepreneurship extremely well in the Great Recession.
Eren Inci and Simon C. Parker
We study entrepreneurs’ start-up financing from banks and local financiers. An informal network, whose membership cannot be observed by outsiders, conveys the good signals it gets about the hidden types of network entrepreneurs to local financiers, which are then reflected in different loan terms. We show that there are winners and losers as a result of the network even among its members. Because all projects have positive net value, it is efficient to finance them even in the absence of a network. Thus, the formation of the network is inefficient as entrepreneurs incur networking costs for purely redistributive gains in the form of better loan terms as network members.
This paper empirically investigates the effect of the Bankruptcy Reform Act of 2005 on entrepreneurial activity. We find that this act had virtually no noticeable effect on the overall level of entrepreneurship, measured by self-employment, partly because potential entrepreneurs were more likely to seek limited liability to offset the reduction in wealth protection imposed by the new law. That is, the incorporation rate increased for small businesses after the new law was enacted. This increase emphasizes that limited liability provided by incorporation is an important strategic variable that potential entrepreneurs utilize in response to changes in personal bankruptcy law. This study implies that incorporation is an important parameter to consider in understanding the relationship between bankruptcy law and entrepreneurial activity. The policy implication of this study is that entrepreneurs do respond to changes in personal bankruptcy law, even though it is intended for consumers, so this potential side effect should be considered when designing a new law.
There is substantial evidence that serial entrepreneurs outperform de novo entrepreneurs. But is this positive association between prior experience and performance the result of learning by doing or of selection on ability? This paper proposes a strategy that combines the fixed-effects model and IV estimations to distinguish empirically selection effects from learning. Using panel data from the NLSY79, I find that selection on ability is the more important determinant of serial business formation and the early performance of new businesses. In contrast, the effects of learning by doing are apparent only when the analysis focuses on founding new startups in sectors closely related to entrepreneurs’ previous ventures.
Ola Bengtsson and John R. M. Hand
Despite the central role played by human capital in entrepreneurship, little is known about how employees in entrepreneurial firms are compensated and incentivized. We address this gap in the literature by studying 18,935 non-CEO compensation contracts across 1,809 privately held venture-backed companies. Our key finding is that employee compensation varies with the degree to which VCs versus founders control the business. We show that relative to founder-controlled firms, VC-controlled firms pay their hired-on (i.e., nonfounder) employees higher cash salaries, provide stronger cash and equity incentives, and have more formal pay policies in place. We also observe that founder employees earn less cash pay and face weaker cash incentives than do hired-on employees, but have stronger equity incentives. We propose that the compensation differences we identify arise because the preferences and capabilities of controlling shareholders significantly influence the quality of the human capital attracted and retained by the firm.
Annamaria Conti, Marie Thursby, and Frank T. Rothaermel
We present a theoretical model of startup signaling with multiple signals and potential differences in external investor preferences. For a novel sample of technology incubator startups, we empirically examine the use of patents and founder, friends, and family (FFF) money as such signals, finding that they are jointly endogenous to venture capital and business angel investment in the startups. For this sample, venture capitalists appear to value patents more highly than FFF money, while the reverse is true for business angels. Moreover, the impact of patents on venture capitalists is larger than the impact of FFF money on business angels.
Robert W. Fairlie and Aaron K. Chatterji
The economic expansion of the late 1990s created many opportunities for business creation in Silicon Valley, but the opportunity cost of starting a business was also high during this period because of the exceptionally tight labor market. A new measure of entrepreneurship derived from matching files from the Current Population Survey (CPS) is used to provide the first test of the hypothesis that business creation rates were high in Silicon Valley during the “Roaring 90s.” Unlike previous measures of firm births based on large, nationally representative datasets, the new measure captures business creation at the individual-owner level, includes both employer and nonemployer business starts, and focuses on only hi-tech industries. Estimates indicate that hi-tech entrepreneurship rates were lower in Silicon Valley than the rest of the United States during the period from January 1996 to February 2000. Examining the post-boom period, we find that entrepreneurship rates in Silicon Valley increased from the late 1990s to the early 2000s. Although Silicon Valley may be an entrepreneurial location overall, we provide the first evidence that the extremely tight labor market of the late 1990s, especially in hi-tech industries, may have suppressed business creation during this period.
Massimo G. Colombo and Luca Grilli
Why do some entrepreneurial ventures rapidly switch from flat organizations composed of owner-managers and line workers to deeper organizations that also include a middle-management level? The aim of this paper is to investigate this issue and to test the predictions of different streams of the theoretical economic literature on organizational design. We use the estimates of survival data analysis models to examine the determinants of the addition of a middle-management level to the corporate hierarchy of a large sample of Italian high-tech entrepreneurial ventures. The econometric results lend support to the view proposed by the “information processing” stream that the information overload problems engendered by a highly competitive and unpredictable business environment are key drivers of the creation of a middle-management level. Moreover, in accordance with the “knowledge hierarchy” literature, the greater the human capital of firms’ owner-managers, the more likely the appointment of a middle manager. Conversely, we fail to provide evidence consistent with theoretical predictions inspired by the “decentralization of incentives” stream. Lastly, transaction costs and adverse selection problems in the managerial labour market are found to have a large negative effect on the likelihood of the appointment of middle managers.
Manju Puri and David T. Robinson
This paper studies the attitudes of entrepreneurs, both how they differ as a group from others in the economy, as well as how they differ from one another according to the mode of entry into entrepreneurship and whether or not the firm is a family business. We use data from the Survey of Consumer Finance to measure and isolate the enjoyment of private benefits, attitudes toward risk, and optimism for these groups. Entrepreneurs are more optimistic and enjoy the nonpecuniary benefits of work more than wage earners. They embrace risk, but perhaps less so than commonly believed, as their risk-bearing is tempered by longer planning horizons. Family business owners share optimism and nonpecuniary benefits with other entrepreneurs; their tolerance for risk is not different than wage earners. In contrast, those who inherit businesses are significantly less risk tolerant than nonentrepreneurs, are no more optimistic than nonentrepreneurs, but seem to derive more nonpecuniary benefits from work than others. Simply possessing these entrepreneurial traits translate into actions, increasing the amount of time spent at work, even among those who are not entrepreneurs.