The founding and expansion of new firms is central to innovation and economic growth, but the determinants of a new idea’s success are difficult to ascertain. The decision to form a new firm and its ultimate outcome are impacted by ownership structure, financing options, governance, as well as the ability to later sell a project. Each of these aspects is highly affected by the state of the financial market. My research examines the entire lifecycle of a firm—birth, governance, and sale—and the extent to which the current financial market environment affect the firm at each point in its life. Overall, my work contributes to an understanding of the conditions that help entrepreneurs build the firms that commercialize new innovations. These issues are not only important to entrepreneurs and managers, but also to their venture capital and private equity backers.
Birth: Conventional wisdom and much popular literature associate 'hot' startup environments with the financing of lower quality ideas, often denigrated as “money chasing deals.” My work shows that while startups funded in hot markets were more likely to fail completely, they were also more likely to be extremely successful, both in terms of the nature of their innovation as well as their financial valuation. These findings suggest venture capital investors are more willing to experiment with commercializing extremely novel technologies at times when financing risk is low, rather than just funding worse companies, and provides a different, more positive interpretation on the greater failure rates of VC-backed firms that are observed in certain times. The finding that venture capital firms seem to systematically change their investment patterns across the cycle, also led me to ask whether these investment choices and their success stemmed from individual partners’ human capital or from aspects of the VC firms where partners worked. Moreover, the distinction between partners and their firms relates to my research on how the principal-agent problem within a venture capital firm affects deal pricing. In all of this work, the use of unique venture capital data allowed progress on fundamental questions in economics on the birth of entrepreneurial companies.
Governance: Anecdotal evidence and recent theoretical work suggests that overvaluation during booms may cause 'bad' managerial behavior. My work proposes that, if so, then any positive effects of better governance should be more important when firms become overvalued. My work in this vein has documented that governance matters much more for overvalued firms and in overvalued industries. In fact, the effects are so strong that the previously determined relationships between good governance and out-performance do not exist in correctly or undervalued firms. In related work I examine how irrational shareholders may directly affect firm decisions such as the CEO fire/retain decision. I also explore how governance is affected by competition rather than valuation, and find results that help to reconcile two opposing literatures. My work establishes variation in the effects of governance finding both costs and benefits of ‘better’ governance, as well as times when it seems to matter and not matter for firm outcomes.
Sale: If firms become overvalued during booms, then logically these firms would like to use overvalued stock as an acquisition currency. But why would targets accept? My work provides an explanation for the longstanding puzzle relating to why equity valuation levels seem linked to acquisition activity. My research also uncovers and explains a relationship between debt market mistakes and private equity activity. Furthermore, these papers develop novel measures of both equity and debt market overvaluation to find empirical support for the ideas. This empirical work finds similarities between targets and acquirers that led me to propose, in related research, an alternative to the classical view of merger activity that higher-quality firms purchased poorly run firms in order to redeploy their assets. Building on the theory of the firm, I theorized why, and demonstrated that in the data, there is assortative matching between acquirers and targets that increased in boom times when the search for targets arguably became easier.
Overall, my work shows how valuation levels impact when mergers occur, who buys whom, when private equity firms are active, what types of innovations venture capitalists fund, and even the benefits of better governance. Given the importance of innovative new companies and private equity investments in driving the process of creative destruction in the economy, understanding the links between investment cycles and the commercialization of new technologies is a central issue for academics, policy makers and practitioners.