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New Firm Performance and the Replacement of Founders

New Firm Performance and the Replacement of Founders. Jing Chen Copenhagen Business School Peter Thompson Emory University. 12th Roundtable for Engineering Entrepreneurship Research Georgia Institute of Technology November 10, 2012. Motivation.

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New Firm Performance and the Replacement of Founders

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  1. New Firm Performance and the Replacement of Founders Jing Chen Copenhagen Business School Peter Thompson Emory University 12th Roundtable for Engineering Entrepreneurship Research Georgia Institute of Technology November 10, 2012

  2. Motivation • Thoery on founder turnover (Holmes and Schmitz 1990) • Distinct comparative advantage embodied by entrepreneurs and CEOs • Entrepreneurs specialize in new business creation • Professional managers specialize in managing existing ventures • Research gap in the empirical literature • Literature on leadership (CEO)change in established firms (Carroll 1984, Haveman and Khaire 2004) • Not exactly an entrepreneurial (startup) context • Literature on founder turnover in startups with transformational growth • VC-financed (Hellmann and Puri 2002) • Small samples of high-tech startups (Wasserman 2003, Boeker and Wilbank 2005) • No framework to understand founder turnover in a broader population of firms

  3. This Paper • Purpose/contribution • a large representative sample of startups • little involvement of VC • Research questions • Initial / prior startup performance • Subsequent performance after founder turnover • Labor market outcome of departing founders • The matching model • Individual level: U-shaped relationship between founder ability and turnover • Firm level: mismatching between founder ability and quality of business idea • Can the U-shaped relationship be carried over for startup preformance and founder turnover • What is the correlation between the first and second-period performance with/without turnover

  4. A Two-Period Model (I) • Business output is given by , : the quality of business idea at time t (technology, fit to the market, public knowledge, etc) : founder’s general innate ability • and are complements in both periods • is known upon entry • is a random draw from , is a random draw from • Profit in period 1 : the opportunity cost of the founder’s time

  5. A Two-Period Model (II) • In Period 2, • is observed • An option to choose between the founder and an outside CEO to maximize • An outside CEO is hired if : ability of the outside CEO c :is the transition cost of replacing the founder • Maximized profit in period 2 where

  6. Figure 1. Second period payoffs; c > 0. Payoff with an outside CEO A startup with a very low-quality idea exits the market in the 2nd period Payoff with the founder The founder stays if his ability is matched with the quality of business idea. • Mismatch arises because the founder’s abiltiy is relatively lower than the quality of business idea. • The founde is replaced with a CEO with higher ability. • Mismatch arises because the founder’s abiltiy is relatively higher than the quality of business idea. • The founde is replaced with a CEO with lower ability.

  7. Figure 2. Founder Ability vs. Second-Period Idea Quality, by Outcome Baseline Simulations, 5000 observations

  8. Figure 3. First-Period vs. Second-Period Performance among Surviving Firms, by Outcome VC story Baseline Simulations, 5000 observations

  9. Data • Entrepreneurship in Denmark • Business start-up rate in 2000: 2.99% (13/21 countries in GEM) • Venture capital investment in 1999: 0.04% of GDP (Denmark) vs. 0.52% of GDP (US) • Three databases maintained by Statistics Denmark • The Entrepreneur Database (1996-2006) • New businesses created in Denmark • Unique identifiers (firm, plant, and one individual) • the focus on 1999 and 2000 cohorts due to availability of accounting data • The Firm Database (1995-2008) • Employment information for all workers at all firms in Denmark • Identify possible co-founders • The Integrated Database for Labor Market Research (1980-2008) • Employer-employee matched panel • Labor market information at firm, plant, and individual level • Demographic information of employees

  10. Data • Original founder • Formed a startup in 1999 or 2000 as a sole proprietor • Currently working at the new business • At least one employee working at the business as his/her primary occupation (minimum economic activities) • Firm outcomes • Survival : same firm ID from previous year appears in the current year • Ownership change : Different firm ID, same establisment (plant) ID • Exit : All establishments of the firm are no longer found in the data • Founder status at the original startup • Stay: as employee or employer • Exit: due to turnover, business exit or ownership change

  11. Figure 5. Status Change of Startups by Year 1999 cohort (1,588 startups) 2000 cohort (2,584 startups)

  12. The Samples • Subsample 1: Startup performance and founder turnover • 1,784 startups survived during the observation window between founding year and 2005 • Subsample 2: Founder turnover and startup future performance 1999 2000 2001 2002 2003 2004 • 2,349 startups remain in subsample 2

  13. Table 1. The Effect of Startup Performance on the Probability of Founder Turnover • Sales in thousand DKK. z-scores are in parentheses. Significance levels: *** 0.01, ** 0.05, * 0.1.

  14. Figure 3. First-Period vs. Second-Period Performance among Surviving Firms, by Outcome

  15. Table 2. Founder Turnover and Future Performance of Startups Columns (1) - (3): t statistics in parentheses. Columns (4) - (6): z scores in parentheses. The omitted category in columns (3) and (6) is the top quartile of the log of initial sales. All regressions include controls for industry. Significance levels: *** 0.01, ** 0.05, * 0.1.

  16. Table 3. Survival and Turnover Z-scores in parentheses. Industry controls included. Significance levels: *** 0.01, ** 0.05, * 0.1.

  17. Table 4. Founder’s Occupational Choice after Turnover z scores are in parentheses. Significance levels: *** 0.01, ** 0.05, * 0.1.

  18. Conclusions • Summary of findings • Founder turnover is more likely in the tails of the performance distribution • Founder turnover has less impact on improvement of performance in starups at the upper end of the initial performance distribution (support the matching story) • Future earnings of departing founders are positively correlated with the performance of their previous startups • There is no evidece that they are more likely to choose entrepreneurship over other occupations after departure. (not consistent with Holmes and Schmitz’ theory) • Future research • How do owners decide between selling a business and hiring a CEO (Founder turnover vs. Business turnover) • Assess whether founder-CEO paris differ across startups that is consistent with the mismatching model

  19. Descriptive Summaries • Subsample 1 • 1,784 startups survived during the observation window between founding year and 2005

  20. Descriptive Summaries • Subsample 1 • 1,784 startups survived during the observation window between founding year and 2005

  21. Descriptive Summaries • Subsample 2

  22. Descriptive Summaries • Subsample 3 Descriptive Summary of Subsample 3 (Mean Values Reported)

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