When it comes to entrepreneurs, youth isn't everything

While it is a widely held belief that youth and entrepreneurship go hand in hand, research finds that more successful entrepreneurs launch their enterprises in their 40s than in their 20s.
This is from the July 2018 issue of the NBER Digest. Alex Verkhivker gives a summary of the NBER working paper Age and High-Growth Entrepreneurship (NBER Working Paper No. 24489) by Pierre Azoulay, Benjamin Jones, J. Daniel Kim, and Javier Miranda.

Star innovators such as Bill Gates, who was 19 when he started Microsoft, Steve Jobs, 21 when he started Apple, and Mark Zuckerberg, 19 when he launched Facebook, have reinforced the longstanding impression that young people are the wellspring of entrepreneurship. Systematic data on firm founders, however, suggest that this impression is false.

In Age and High-Growth Entrepreneurship (NBER Working Paper No. 24489), Pierre Azoulay, Benjamin Jones, J. Daniel Kim, and Javier Miranda provide evidence that, on average, successful entrepreneurs are middle-aged. They analyzed administrative data from the U.S. Census Bureau on more than 2.7 million business founders whose companies subsequently hired at least one employee. The mean age of founders was 42. When looking at the highest-growth startups in the economy, the mean age at founding rose still higher — to 45.

The study explores not just the age of founders, but the factors that are correlated with firm success. Founders with prior work experience closer to the specific industry of the startup, and founders with longer experience in that industry, have substantially greater success rates. "For the 1 in 1,000 highest-growth firms, founders with three or more years of experience in the 2-digit industry see upper tail success at twice the rate" of founders with no experience in the 2-digit industry, the researchers report.

The study takes two approaches to examining growth-oriented startups. The first considers technology orientation, which can suggest the potential for high growth. The second considers the actual outcome for the firm, based on the three-, five-, or seven-year time window after founding.

Using third-party venture capital databases, the researchers determine whether a given company has received venture capital financing. They argue that such funding is suggestive of substantial growth potential. They also use employment growth and sales growth as defining characteristics of a high-growth new venture.

"...[C]omputing-oriented ventures as well as wireless telecom ventures appear to have the youngest founders," they write. "Yet even here the mean founder ages range from 38.5 to 40.8..."

The study also explores geographical heterogeneity, and separately considers California, Massachusetts, and New York. These three states account for the majority of high-growth startup activity in the U.S. Even in these states, successful entrepreneurs are still middle-aged. The youngest entrepreneurs in this part of the analysis, whose mean age was 38.7, were founders of venture capital-supported companies in New York.

When the set of 2.7 million founders was reduced to the 1,900 associated with companies that were both located in entrepreneurial hubs and received venture backing, the mean age of founders was 39.5.

The researchers conclude with a comment about current practices in the venture financing industry. "To the extent that venture capital targets younger founders, early-stage finance appears biased against the founders with the highest likelihood of successful exits or top 1 in 1,000 growth outcomes."

Business owners, employees and firm performance

Business Owners, Employees and Firm Performance is a new working paper, by Mika Maliranta and Satu Nurmi, from the Research Institute of the Finnish Economy (ETLA).

The abstract reads:

The novel Finnish Longitudinal OWNer-Employer-Employee (FLOWN) database was used to analyze how the characteristics of owners and employees relate to firm performance as determined by labor productivity, survival and employment growth. Focusing on the role of the owner’s formal education and previous experience as an employee, the results show that previous experience in a high-productivity firm strongly predicts high productivity and probability of survival for the entrepreneur’s new firm. This can be interpreted as evidence of knowledge spillover through labor mobility. Strikingly, firms established in times of intensive excess job reallocation were found to exhibit superior productivity performance in the later phases of their life cycles.

The conclusion to the paper includes,

The diversified paths of primary owners and their employees are reflected in future company performance. Previous employer quality, measured in terms of relative productivity, is transferred through owners and employees as knowledge spillover related, for example, to technology or management. High-quality owners create firms capable of achieving and maintaining sustained high performance in terms of productivity, survival and employment growth.

Our results lend support to the view that employees’ entrepreneurial skills nurtured in high-productivity firms can be transferred to achieve higher productivity, especially in entrepreneur-owner firms. First, there is a strong positive relationship between the productivity level of the previous firm (where the owner worked as an employee) and the productivity level of the firm where the owner now works. Second, there is evidence of considerable employee mobility from high-productivity firms to ownership of a new firm (where the owner also works). These findings are consistent with the view that the transition of employees from high-productivity firms to entrepreneurship is an important business dynamic, driving knowledge spillover in the economy. Our results also indicate intensive employee mobility from low-productivity firms toward new and young firms, representing an important element of creative destruction. The reallocation of employees in creative destruction means that a greater share of the employees provide labor inputs to productively managed firms

and

Our results demonstrate the importance of considering owner and employee characteristics separately but in parallel in any analysis of firm performance, as owner and employee background and skills may play different roles in the development of employment and productivity. In addition, this analysis indicates a need to deal separately with entrepreneur-owner and pure owner firms. In entrepreneur-owner firms, an owner’s technically orientated education was found to impact positively on productivity performance and survival probability, but no such relationship was found in pure owner firms. One explanation for this difference is that closer owner links to production are needed to successfully exploit technical education and previous experience. In contrast, the potential contribution of pure owners pertains to factors that cannot be captured by measures of education and experience.

One interpretation of this is the perhaps not too surprising result that the human-capital of an entrepreneur-owner matters for the performance of a newly created firm. Knowledge gained from experience as an employee of a high productivity firm can be transferred to the firm of the entrepreneur-owner. Newer firms have relatively younger and more educated human capital but are more dependent on the older firms for an inflow of know-how.

Peter Klein on entrepreneurs and firms

In a recent article Peter Klein talks about Why entrepreneurs need firms, and the theory of the firm needs entrepreneurship theory. He writes,

And yet, there is much less work in this tradition explaining the emergence of the firm. Where do firms come from? Most are established by entrepreneurs, and indeed, the most common definition of “entrepreneur” for academics and practitioners is “one who forms a new business organization.” One would then think that entrepreneurship theory would be part of the theory of the firm. Put differently, entrepreneurs are individuals who establish, operate, reconfigure, dissolve, and otherwise work through firms; hence economic theories of the firm – as well as theories of the firm drawn from psychology, sociology, operations research, and so on – might be considered applications of entrepreneurship theory. Alas, neither is true; for the entrepreneurship field has its own research literature, largely divorced from the literatures on firm organization and firm strategy. The entrepreneurship literature focuses mostly on individuals, not organizations, and on firm creation, not firm operation.

There is much truth in what Klein says. The standard theory of the firm literature looks at three basic questions to do with Why firms exist, What the boundaries of firms are and What determines the internal organisation of firms. What it, by and large, doesn't consider is where firms come from. This is where the role of the entrepreneur is important.

But all is not lost. In Walker (forthcoming) I briefly discuss two recent attempts to integrate the theories of the firms and entrepreneurship, including work by Klein himself. These attempts are Spulber (2009) and Foss and Klein (2012). The Foss and Klein approach to the firm, like that of Spulber but unlike the more standard approaches, emphasises the role of the entrepreneur. Foss and Klein wish to explain the formation of, determination of the boundaries of and the internal organisation of the firm. The things that set Foss and Klein apart from the mainstream are the importance given in their theory to the entrepreneur and they develop their theory utilising a combination of Knightian uncertainty and Austrian capital theory. Spulber seeks to explain why firms exist, how firms are established, and what firms contribute to the economy. He sets out to create an approach to microeconomics in which entrepreneurs, firms, markets, and organisations are all endogenous. An even more recent contribution in this area is Bylund (2015). This paper attempts to explain how firm emerge and the role of firms in the market structure using the productive power of specialisation. The basic idea is that emergence is based on productivity efficiencies developed through technological specialisation. This approach leads an to understanding of the firm's function to the entrepreneur and its internal organisation and capabilities.

The Bylund, Foss and Klein and Spulber contributions open important new lines of inquiry for the theory of the firm since Hamlet really does need the Prince of Denmark.

Refs.:

• Bylund, P.L. (2015). "Explaining firm emergence: Specialization, transaction costs, and the integration process", Managerial and Decision Economics, 36(4): 221-38.
• Foss, Nicolai J. and Peter G. Klein (2012). Organizing Entrepreneurial Judgment: A New Approach to the Firm, Cambridge: Cambridge University Press.
• Spulber, Daniel F. (2009). The Theory of the Firm: Microeconomics with Endogenous Entrepreneurs, Firms, Markets, and Organizations, Cambridge: Cambridge University Press.

Returns to innovation

Recently Tim Worstall has been reminding us of a 2004 paper on Schumpeterian Profits in the American Economy: Theory and Measurement by William D. Nordhaus. The point of the paper is that entrepreneurs gain less than 3% of the social returns to their innovation. The paper's abstract reads:

The present study examines the importance of Schumpeterian profits in the United States economy. Schumpeterian profits are defined as those profits that arise when firms are able to appropriate the returns from innovative activity. We first show the underlying equations for Schumpeterian profits. We then estimate the value of these profits for the non-farm business economy. We conclude that only a minuscule fraction of the social returns from technological advances over the 1948-2001 period was captured by producers, indicating that most of the benefits of technological change are passed on to consumers rather than captured by producers.

Back in 2004 Don Boudreaux blogged on the paper at the Cafe Hayek blog. He said,

In a recent NBER working paper – “Schumpeterian Profits in the American Economy: Theory and Measurement” – Yale economist William Nordhaus estimates that innovators capture a mere 2.2% of the total “surplus” from innovation. (The total surplus of innovation is, roughly speaking, the total value to society of innovation above the cost of producing innovations.) Nordhaus’s data are from the post-WWII period.

The smallness of this figure is astounding. If it is anywhere close to being an accurate estimate, the implication is that “society” pays a paltry $2.20 for every $100 worth of welfare it enjoys from innovating activities.

Why do innovators work so cheaply? One possible reason is alluded to by Nordhaus himself: excess optimism. Nordhaus suggests that over-optimism might explain the late 1990s tech-market equity bubble. The social gains from innovation were in fact very large, but the ability of investors to capture more than a small sliver of these gains – rather than see these gains flow to consumers in the form of lower prices and improved products – proved undoable.

Another possible explanation for why innovators work so cheaply is that the prospects, few as they might be, for capturing gargantuan shares of the gains from innovation are sufficiently attractive that even rational, well-informed entrepreneurs and investors perform and fund innovating activities, each hoping that he or she will be among the tiny but inordinately lucky handful of entrepreneurs and investors who personally do capture a much-much-greater-than-normal share of the value of their innovative endeavors.

Whatever the reason, Nordhaus’s empirical evidence supports (at least my) casual observation that innovative economic activity yields benefits that are both enormous and widespread.

Boudreaux has now added an Addendum to the above blog posting noting the implications of Nordhaus's paper for the current debate about income inequality. He writes,

Nordhaus’s findings are relevant also to discussions of income inequality. His findings show that successful entrepreneurs have already, in the very process of succeeding in the market and becoming wealthy, increased the wealth of ‘society’ – have ‘given’ to others – far more than each successful entrepreneur has increased his or her own individual wealth. This process of enhancing the economic well-being of countless others through successful market innovation is neither intended nor choreographed by government, but this fact doesn't make the results any less real or significant.

True, in a society in which people are not all equally innovative and driven and risk-tolerant, the measured monetary results of such successful innovation are that some individuals (the successful entrepreneurs) gain more wealth than is gained by other individuals (those who passively prosper simply by being a consumer and worker in an innovation-filled market economy). Measured monetary incomes, therefore, do become less equal.

But why do we so seldom never hear from the fairness-obsessed, we’re-all-in-this-together crowd any expressions of concern about the great inequality of net contributions to total wealth? Where is the concern over this “unfairness”? Compared to successful market entrepreneurs, people who choose to consume much leisure or who remain consistently afraid to risk their wealth on entrepreneurial ventures enjoy over their lifetimes a higher ratio of wealth-increases to their own contributions-to-wealth. If we are to be concerned with cosmic fairness or “social justice” or “inequality,” why is this inequality one that is or ought to be ignored?

I still find, like Boudreaux, the smallness if the 2.2% figure astounding. This does tell us that "society" gets a very good deal out of entrepreneurs and thus instead of complaining about the absolute size, in terms of the number of dollars, of the 2.2% we should just be very happy with our 97.8%. Incentives matter and such a small percentage is a small price to pay for the incentive it gives for the generating of innovation and growth.