By Saad Khan, Queen’s University

On Thursday, June 14th, 2018, the Smith School of Business at Queen’s University hosted the Organizational Economics Conference. The conference covered a broad range of topics of particular interest to policy decisions related to the organization of businesses. The topics were as follows:  [1] growth prospects of franchises versus independent businesses, [2] the performance of serial entrepreneurs, [3] the effect of acquisitions designed to preempt competition on the continuation of the acquired project, [4] the effect of middle management treatment of employees on worker turnover and productivity, and [5] the optimal design of wage contract. This article summarizes the main findings of three papers presented at the conference and comments on policy implications.

 

[1] Brighter Prospects? Assessing the Franchise Advantage using Census Data.

Francine Lafontaine’s paper (with Marek Zapletal and Xu Zhang) investigates whether starting a business as a franchise has significant benefits versus ‘going it alone’, where the benefits are measured in terms of higher survival rate for franchises.  The question is important given the major role of franchising in multiple sectors of the economy such as restaurant and food services, grocery and electronic stores.

The ‘micro’ census data used for empirics is from the U.S. Census Bureau’s Survey of Business Owners (SBO) and Longitudinal Business Database (LBD).  The SBO identifies whether a business is started as a franchise or as an independent entity along with additional demographic variables which serve as controls. The LBD provides survival status of businesses. The empirical model used is a linear probability model to predict the effect of franchising on survival probability, conditional on demographic controls, e.g. race and educational level of the business owner.

The main findings of the papers suggest that the benefit of franchising is an increase in the probability of survival of 6.4 percent during the first year. However, conditional on having survived the first year of business, the survival probability advantage of franchising  is negligible in subsequent years. Lafontaine suggests that her findings can be explained by higher initial capital requirements imposed by franchisor on franchisee.

For policy implications, Lafontaine’s paper suggests that the decision to franchise or start as an independent business requires diligent investor cost benefit analysis (CBA). In additional, the investor may need to be educated on the large fees associated with operating a franchise versus the perceived benefit of owning a franchise. While franchises do have lower probability of failure on average, they also have higher capital requirements at startup which in itself reduces chances of failure. Lafontaine also finds that survival benefits of franchises may not be persistent beyond the first year of business.

 

[2] The Intangible Capital of Young Serial Entrepreneurs

Kathryn Shaw (with Anders Sorensen) examine the performance of serial entrepreneurs using data on 216,524 newly founded Danish firms for the years 2001-2013. The authors find that serial entrepreneurs ‘learn on the job’ and therefore build intangible capital resulting in 65 percent higher sales and 90% higher productivity at the start of second business. This study is important given the importance of entrepreneurs for the growth of an economy.

The data used for empirics is from Statistics Denmark and contains characteristics such as race, age and education from 191,053 entrepreneurs that established 216,524 new firms during 2001-2013. This data set serves as control for entrepreneur’s skills. This data set is further linked to sales, employment and profits. The empirical modelling approach of this paper is a regression of sales, profits and labour productivity on dummy variables identifying if the firm is the first or second business of the entrepreneur. The regression also includes controls for entrepreneur skills.

The findings of this papers suggest that not only do serial entrepreneur have superior business skills, but they also gain intangible capital from their first business. In particular, regression results show that, on average, the second business a serial entrepreneur starts has 90 percent higher productivity and 65% higher productivity than the start of their first business. This suggest that serial entrepreneurs ‘learn on the job’. The paper further finds that young serial entrepreneurs learn more than other serial entrepreneurs and tend to be more educated.

The policy implications of this paper suggest that subsidized training for young serial entrepreneurs may be beneficial for economic growth, and in particular for the economic growth of developing countries. The paper provides evidence to suggest that young serial entrepreneurs are most likely to build human capital and use this capital to start subsequent businesses which tend to be highly productive ventures.

 

[3] Killer Acquisitions

Colleen Cunningham (with Florian Edererz and Song Ma) address an important issue predominant in the pharmaceutical industry, namely “killer acquisition” which is an acquisition of a competitor project by a market incumbent specifically for the purpose of discontinuing it.  Conservative estimates from the paper report that 7 percent of all acquisitions in their sample are killer acquisitions. This paper raises an important incentive problem for creative innovation. The incentive problem highlights lower incentive for innovators if the potential exists for the less innovative incumbent to acquire the innovation only to destroy the project while still in the process of development. This translates to a deadweight loss for the economy.

The paper contributes to both methodology and theory. The proposed theoretical model consists of two types of players: (1) multiple incumbents and (2) a single entrepreneur.  At the initial period, each of the incumbent firms decide whether to acquire the entrepreneur’s project. In the next period, the incumbent decides to continue the project or kill it. Finally, in the last period all uncertainty in payoffs is revealed. The main outcome of the theoretical model dictates that the higher the market share of the incumbents (i.e. smaller number of existing incumbents in the market), the larger is the incentive for one of the incumbents to acquire the entrepreneur’s project and kill it while still in the development process. The data used in the empirics is from three sources, (1) Merger and

Acquisition data from Thomson Reuters, (2) Thomson Reuters RecapIQ which focuses on the biotechnology industry (3) SDC VentureXpert which covers early startups. The empirical model is a panel regression of drug continuation indicator on the acquired status of the project along with project specific controls. The results suggest that acquired project have a 1.9 percent smaller post-acquired probability of being continued.

In a policy framework, this paper suggest that the pharmaceutical industry where the incumbents may have a large market share are particularly vulnerable to killer acquisitions. These acquisitions are designed to kill an innovative project and therefore are a deadweight loss to the economy. Potential regulation to protect innovation from killer acquisitions needs to be examined.

 

References

[1] Lafontaine, Francine, Marek Zapletal, and Xu Zhang. “Brighter Prospects? Assessing the Franchise Advantage using Census Data.” (2017).

[3] Cunningham, Colleen, Florian Ederer, and Song Ma. Killer Acquisitions. Mimeo, 2018.

[4] Georgiadis, George, and Balazs Szentes. Optimal Monitoring Design. mimeo, 2018.