New Firm Performance and the Replacement of Founders

New Firm Performance and the Replacement of FoundersJing Chen Copenhagen Business School Peter Thompson Emory University

12th Roundtable for Engineering Entrepreneurship ResearchGeorgia Institute of TechnologyNovember 10, 20121MotivationThoery on founder turnover (Holmes and Schmitz 1990)Distinct comparative advantage embodied by entrepreneurs and CEOs Entrepreneurs specialize in new business creationProfessional managers specialize in managing existing ventures

Research gap in the empirical literatureLiterature on leadership (CEO)change in established firms (Carroll 1984, Haveman and Khaire 2004)Not exactly an entrepreneurial (startup) contextLiterature on founder turnover in startups with transformational growthVC-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

2This PaperPurpose/contributiona large representative sample of startupslittle involvement of VC

Research questionsInitial / prior startup performanceSubsequent performance after founder turnoverLabor market outcome of departing founders

The matching modelIndividual level: U-shaped relationship between founder ability and turnoverFirm level: mismatching between founder ability and quality of business ideaCan the U-shaped relationship be carried over for startup preformance and founder turnoverWhat is the correlation between the first and second-period performance with/without turnover

3A Two-Period Model (I)4A Two-Period Model (II)5

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

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

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Baseline Simulations, 5000 observations

Figure 3.First-Period vs. Second-Period Performance among Surviving Firms, by OutcomeVC storyDataEntrepreneurship in DenmarkBusiness 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 DenmarkThe Entrepreneur Database (1996-2006)New businesses created in DenmarkUnique 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 DenmarkIdentify possible co-founders

The Integrated Database for Labor Market Research (1980-2008)Employer-employee matched panelLabor market information at firm, plant, and individual levelDemographic information of employees 9DataOriginal founderFormed a startup in 1999 or 2000 as a sole proprietorCurrently working at the new businessAt 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 yearOwnership change : Different firm ID, same establisment (plant) IDExit : All establishments of the firm are no longer found in the data

Founder status at the original startup Stay : as employee or employerExit : due to turnover, business exit or ownership change 101999 cohort (1,588 startups)2000 cohort (2,584 startups)Figure 5. Status Change of Startups by Year11The SamplesSubsample 1: Startup performance and founder turnover1,784 startups survived during the observation window between founding year and 2005

Subsample 2: Founder turnover and startup future performance

200020012002200320041999Turnover by 2002Turnover after 2002No TurnoverExited or acquired by 2002Exited or acquired after 2002Survived to 2004122,349 startups remain in subsample 2Dept Var: = 1 if founder replaced in year tUsing sales in year t-1Using sales in founding year(1)(2)(3)(4) Log of sales-0.940***-0.966***-1.159***-1.270***(-5.08) (-5.10) (-3.30) (-3.43) (Log of sales)20.072***0.076***0.084***0.095***(5.71) (5.87) (3.36) (3.61) Founder characteristics Founder age__-0.017*** __-0.019***(-3.05) (-3.40) College educated = 1__-0.235* __-0.090 (-1.38) (-0.54) Male = 1__-0.154 __-0.104 (-1.28) (-0.86) Married = 1__-0.331*** __-0.303***(-3.25) (-2.98) Firm characteristics Firm age-0.366***-0.340***-0.324***-0.288***(-10.39) (-9.47) (-9.68) (-8.46) Cohort dummy (= 1 if founding year = 2000)0.130 0.10 30.0950.069(1.34)(1.04)(0.96)(0.69) Controls for industryNoYesNoYesAve Log Likelihood-0.239-0.235-0.241-0.237No. of observations7,3577,3487,3057,305Table 1. The Effect of Startup Performance on the Probability of Founder TurnoverSales in thousand DKK. z-scores are in parentheses. Significance levels: *** 0.01, ** 0.05, * 0.1.13

14Figure 3.First-Period vs. Second-Period Performance among Surviving Firms, by OutcomeDept Var: log of sales in 2004Surviving FirmsOLSAll FirmsTobit(1)(2)(3)(4)(5)(6)Log.sale00.437***0.453***__0.724***0.817***__(18.8)(18.6)(5.92)(6.12)Turnover0.336***1.524***__-5.00***-1.032__(4.15)(2.80)(-14.4)(-0.45)Log.sale0*turnover__-0.165**____-0.552*__(-2.21)(-1.73)log.sale0 percentile: