Entrepreneurship Working Group Meeting

December 11, 2009
Andrea Frazzini and Kent D. Daniel, Organizers

Thomas Astebro, HEC Paris; Jose Mata, Universidade Nova de Lisboa; and Luis P. Santos-Pinto, Faculty of Business and Economics, University of Lausanne
Preference for Skew in Lotteries: Evidence from the Laboratory

Using a laboratory experiment, Astebro, Mata, and Santos-Pinto investigate how skewness influences choices under risk. They find that subjects make significantly riskier choices when the distribution of payoffs is positively skewed, these choices being driven in part by the shape of the utility function but also by subjective distortion of probabilities. A utility model with probability distortion calibrated on laboratory data is able to explain why most gamblers in public lotteries buy only a small number of tickets.

Robert Fairlie, UC, Santa Cruz;Kanika Kapur, School of Economics and Geary Institute University College Dublin and RAND; and Susan Gates,RAND
Is Employer-Based Health Insurance a Barrier to Entrepreneurship?

The focus in the United States on employer-provided health insurance may restrict business creation. Fairlie, Kapur, and Gates address the limited research on this topic of "entrepreneurship lock" using recent panel data from matched Current Population Surveys and difference-in-difference models to estimate the interaction between having a spouse with employer-based health insurance and the potential demand for health care. They find a larger negative effect of the demand for health insurance on the probability of entrepreneurship for those without spousal coverage than for those with spousal coverage. The researchers also take a new approach to the question by exploiting the discontinuity created at age 65 through the qualification for Medicare. Using a novel procedure of identifying age in months from matched monthly CPS data, they compare the probability of business ownership among male workers in the months just before turning age 65 and in the months just after turning age 65. They find that business ownership rates increase from just under age 65 to just over age 65, whereas they find no change in business ownership rates from just before to just after for other ages between 55 and 75. Their estimates provide some evidence that "entrepreneurship lock" exists, which raises concerns that the bundling of health insurance and employment may create an inefficient allocation of which, or when, workers start businesses.

Ola L. Bengtsson, University of Illinois; and Avri Ravid, Rutgers University
Geography and Financial Contracts Geography and Financial Contracts Geography and Financial Contracts

Bengtsson and Ravid show that geographical and regional elements can form an essential component of contract design in addition to more "traditional" ingredients including information and agency problems, as well as legal and other formal institutions. Contracts between U.S. venture capitalists (VCs) and entrepreneurial companies include significantly fewer investor-friendly cash flow contingencies if the company is located in California and, in particular, in Silicon Valley. Contract solutions also carry over between markets. Contracts tend to be less investor friendly if a VC is located in California, or if a non-California VC has had large exposure to investments in California. In further tests, the authors control for previously discussed agency and contract theory variables, and find that a larger concentration of VCs and venture-backed companies in a region is associated with more entrepreneur-friendly contracts. They also find that contracts include fewer cash flow contingencies when the geographical distance between the VC and the company is shorter. This latter finding supports the view that parties that are geographically close can contract more efficiently, because monitoring can be performed better and soft information can be acted upon. However, the "California effect" persists even after controlling for these important factors. Finally, the authors show that control rights are not substitutes for lower cash flow rights. In fact, California contracts are more entrepreneur friendly on both counts.

Xuan Tian, Kelley School of Business Indiana University; and Tracy Wang, Carlson School of Management University of Minnesota
Tolerance for Failure and Corporate Innovation

Tian and Wang examine whether tolerance for failure spurs corporate innovation based on a sample of venture capital (VC) backed IPO firms. The researchers develop a novel measure of VC investorsÂ’ failure tolerance. They find that IPO firms backed by more failure-tolerant VC investors are significantly more innovative. A rich set of empirical tests shows that this result is not driven by the endogenous matching between failure-tolerant VCs and startups with high ex-ante innovation potentials. Further, they find that being financed by a failure-tolerant VC is much more important for ventures with high innovation potential than for those with low potentials. The researchers also find that the effect of failure tolerance on innovation persists long after VC investors exit the IPO firms, and is even more persistent if the startup firms begin to interact with the VCs in the firmsÂ’ early development stages. Such persistence suggests that VC investorsÂ’ attitudes towards failure have likely been internalized by the startup firms and become part of their culture.

Amitay Alter, Washington University
The Organization of Venture Capital Firms

Alter studies the economic factors determining the size and composition of venture capital (VC) firms. He constructs a novel panel data set documenting California VC firms' composition and investments and derives statistical relationships between firm size, its partners' experience, and industry trends. To interpret these empirical findings, he develops a model which highlights firms' roles in facilitating the training of junior professionals and supporting a more efficient use of their time by senior professionals. He examines alternative views about the role and organization of firms and demonstrates that the model o ffers a more complete and compelling explanation for the findings.

Mercedes Delgado-Garcia, Temple University; Michael Porter, Harvard University; and Scott Stern, Northwestern University and NBER
Clusters and Entrepreneurship

Delgado, Porter, and Stern evaluate the role of regional clusters on entrepreneurship in regional industries. They focus on the distinct influences of convergence and agglomeration on the rate of growth in the number of start-up firms and in employment by start-up firms. While reversion to the mean and diminishing returns to specialization within a location can result in a convergence effect, the presence of complementary economic activity creates externalities that enhance incentives and reduce barriers for new business creation. Clusters are a particularly important channel by which location-based complementarities are realized. Using a novel panel data set, there is significant evidence for the impact of clusters on entrepreneurship, after controlling for the impact of convergence at the region-industry level: industries located in regions with a large presence of related industries (that is, strong clusters) experience higher growth in new business formation and start-up employment. Furthermore, strong clusters contribute to the level of employment in young start-ups in regional industries.

Meghana Ayygari, George Washington University; Asli Demirguc-Kunt, The World Bank; and Vojislov Maksimovic, University of Maryland
Are Innovating Firms Victims or Perpetrators? Tax Evasion, Bribe Payments and the Role of External Finance in Developing Countries

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