December 9, 2016
Antoinette Schoar of MIT and Josh Lerner of Harvard University, Organizers

Taxation and Entrepreneurship

Zhao Chen, Fudan University; Zhikuo Liu, Shanghai University of Finance and Economics; and Juan Carlos Suárez Serrato and Daniel Yi Xu, Duke University and NBER

Notching R&D Investment with Corporate Income Tax Cuts in China

Governments around the world encourage R&D investment based on the belief that economic growth is highly dependent on innovation. This paper analyzes the effects of a large fiscal incentive for R&D investment using a novel link between administrative and survey data of Chinese firms. The fiscal incentive is part of the InnoCom program, which awards a lower average corporate income tax rate to qualifying firms. The program generates a notch, or jump, in after-tax firm values since qualifying firms are required to maintain their ratio of R&D-to-sales above a given threshold. This sharp incentive varies over time and across firm characteristics. Chen, Liu, Suárez Serrato, and Xu exploit this policy variation to implement a cross-sectional "bunching" estimator that is novel in the R&D literature, to analyze potential evasion responses, and to estimate the effects of R&D on productivity. They find that this program led a large number of firms to locate at the qualifying R&D intensity threshold. The researchers find that a substantial fraction of this response is due to tax evasion, and that accounting for evasion is crucial when estimating the effect of R&D on productivity.

Juanita Gonzalez-Uribe and Daniel Paravisini, London School of Economics

How Sensitive is Investment to the Cost of Outside Equity? Evidence from a UK Tax Relief

Gonzalez-Uribe and Paravisini estimate the sensitivity of investment to the cost of outside equity for young firms. For estimation, they exploit differences across firms in eligibility to a new tax relief program for individual outside equity investors in the U.K. On average, investment increases 1.6 percent in response to a 10 percent drop in the cost of outside equity. This average conceals substantial heterogeneity: 1 percent of eligible firms issue equity in response to a subsidy that would have doubled investors' returns, implying large fixed issuance costs for the majority of firms. Conditional on issuing new equity, however, firms invest eight times the issued amount. The results imply a large complementarity between outside equity and other funding sources.

Private Equity

Michael Weisbach, Ohio State University and NBER; Berk Sensoy, Ohio State University; and Daniel Cavagnaro and Yingdi Wang, California State University Fullerton

Measuring Institutional Investors' Skill from their Investments in Private Equity (NBER Working Paper No. 22547)

Using a large sample of institutional investors' private equity investments in venture and buyout funds, Cavagnaro, Sensoy, Wang, and Weisbach estimate the extent to which investors' skill affects their returns. They first consider whether investors have differential skill by comparing the distribution of investors' returns to a bootstrapped distribution that would occur if funds were randomly distributed across investors. The researchers find that the variance of actual performance is higher than that of the bootstrapped distribution, suggesting that higher- and lower-skilled investors consistently outperform and underperform. The researchers then extend the Bayesian approach of Korteweg and Sorensen (2015) to estimate the incremental effect of skill on performance. The results imply that a one standard deviation increase in skill leads to about a three percentage point increase in returns, suggesting that variation in institutional investors' skill is an important driver of their returns.

Aleksander Andonov, Erasmus University; Yael Hochberg, Rice University and NBER; and Joshua Rauh, Stanford University and NBER

Political Representation and Governance: Evidence from the Investment Decisions of Public Pension Funds

Andonov, Hochberg, and Rauh examine how political representatives affect the governance of organizations. Their laboratory is public pension funds and their investments in the private equity asset class. Representation on pension fund boards by state officials or those appointed by them — often determined by statute decades past — is strongly and negatively related to the performance of private equity investments made by the fund. This underperformance is driven both by investment category allocation and by poor selection of managers within category. Funds whose boards have high fractions of members who were appointed by a state official or sit on the board by virtue of their government position (ex officio) invest more in real estate and funds of funds, explaining 20-30 percent of the performance differential. These pension funds also choose poorly within investment categories, overweighting investments in small funds, in-state funds, and in inexperienced GPs with few other investors. Lack of financial experience contributes to poor performance by boards with high fractions of other categories of board members, but does not explain the underperformance of boards heavily populated by state officials. Political contributions from the finance industry to elected state officials on pension fund boards are strongly and negatively related to performance, but do not fully explain the performance differential.

Small Businesses

Morten Bennedsen, INSEAD; Margarita Tsoutsoura, University of Chicago; and Daniel Wolfenzon, Columbia University and NBER

Drivers of Effort: Evidence from Employee Absenteeism

Bennedsen, Tsoutsoura, and Wolfenzon analyze determinants of employee effort. They use detailed information on absent spells of all employees in 2,600 firms in Denmark as a proxy for effort in specifications in which they control for important determinants of absenteeism like age, gender and health status. Using movers the researchers decompose absent days into an individual component (e.g., motivation, work ethic) and a firm component (e.g., incentives, corporate culture). They find the firm component to be significant in explaining differences in absenteeism across firms. Moreover, they find the firm component to be correlated with family firm status with family firms causing a decrease in absenteeism. Finally, the researchers analyze the mechanisms behind this effect.

Sabrina T. Howell, New York University

Learning in Entrepreneurship

New venture competitions offer a laboratory to study high-growth entrepreneurship. Howell uses novel application and judging data from nearly 100 competitions to examine which founder and venture characteristics are associated with success. She focuses on whether the ability to learn is important. Two exercises demonstrate that judge ranks are relevant information for entrepreneurs. First, independently of winning, ranks predict subsequent venture external financing and employment. Second, a quasi-experimental design finds that negative feedback increases the probability that an entrepreneur abandons his venture. Howell then shows that learning, measured as raw score or rank improvement, predicts success. These findings are consistent with a view of entrepreneurship as experimentation. Ventures likely to have a lower cost of experimentation, such as software and student-run ventures, learn more. However, founders with degrees from highly ranked schools are less responsive to feedback than their counterparts. This behavior appears rational for elite college graduates, but seems to reflect overconfidence among elite MBA graduates.

William Mullins, University of Maryland, and Patricio Toro, Central Bank of Chile

Credit Guarantees and Credit Constraints

Credit guarantee schemes for bank loans are at the heart of most governments' strategies to help firms, and often direct vast volumes of credit. This paper examines Chile's credit guarantee scheme for bank loans to small and medium enterprises (SMEs) using a regression discontinuity design around the eligibility cutoff. Mullins and Toro find that credit guarantees have large positive effects on firms' total borrowing without large increases in default rates, in contrast to the (limited) existing evidence. The scheme also has an amplification effect: firms increase borrowing from other banks in the eighteen months following a loan guarantee. Moreover, the researchers show that the guarantees are used to build new bank relationships, a process which is not well understood in the literature. Finally, they show that firms use the credit increase to significantly scale up their operations. These results provide evidence that credit constraints can be important even for relatively large firms in the SME category, and even in "normal" times in a well-developed financial system.

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