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May 2010 Digest
The Kauffman Firm Survey (KFS) Digest summarizes recent working papers or journal articles that utilize KFS data in their analyses, and which are of exceptional interest, timeliness, and newsworthiness.
In this Issue:
(1) High Technology and Regions in an Era of Open Innovation
Recent research shows a shift toward open innovation and away from large companies’ internal research and development labs. This study explores how the concept of open innovation and the economic role of innovation affect entrepreneurship and nascent firms. Results suggest that a nascent firm’s internal R&D capacity influences its likelihood of selling its own innovations or adopting outside innovations, and that regional factors – including education level – increase the probability of young firms using open innovation strategies.
(2) R&D and the Export Decision of New Firms
As entrepreneurial firms increasingly enter the global marketplace, it is important to identify characteristics that affect their decisions to compete internationally. This study suggests that strong R&D will enhance both a nascent company’s likelihood of exporting, and the intensity of those exports. Further, when young companies participate in R&D, there is a greater chance they will sell abroad because they have been influenced by the innovation of neighboring “globally relevant” firms.
(3) Beg, Borrow, and Deal? Entrepreneurship and Financing in New Firm Innovation
This paper analyzes the role of debt, and bank loans in particular, in a nascent high-technology firm’s early financing, and determines the relationship between the entrepreneur’s initial choice of financing and the new firm’s subsequent innovation trajectory. Results show that banks are more willing to lend to high-tech firms as the companies’ riskiness and information asymmetry decrease, suggesting that banks target the firms, over time, with higher growth potential. In addition, the data imply that startup companies’ increasing financial leverage over time may enable innovation.
KFS Research Abstracts
(1) High-Technology and Regions in an Era of Open Innovation
- Darrene Hackler, George Mason University and the Information Technology and Innovation Foundation
How innovations are commercialized seems to be changing, according to recent research (Chesbrough). Closed innovation, where internal research and development (R&D) labs of large companies control future discoveries, has faded. Instead, innovations appear to be evolving outside the commercializing firm because of open-innovation activities, such as licensing agreements. Although this changing dynamic can create large opportunities for small business and entrepreneurs, how nascent entrepreneurs utilize open innovation and how the regional social and economic environment affects this process is understudied in our time of global and regional competition.
The ideas emerging from Chesbrough’s concept of open innovation and innovation’s role in the economy provide fertile ground for exploration of how these ideas affect entrepreneurship and the nascent firm. If certain regions are more innovative, does this contribute to a distinctive firm innovation strategy for all firms, as well as the high-technology industry? This paper attempts to unravel these relationships by identifying nascent firm and regional characteristics that are likely to create a more open-innovation strategy in firms.
Research suggests two primary conclusions. First, young, high-technology firms are not all engaged in open-innovation activities. For nascent firms, internal firm R&D capacity (such as investment in R&D or R&D employees) influences a firm’s likelihood of taking up outside innovations (licensing in), as well as selling them off. Hackler also finds evidence in examining entrepreneurial human capital that only the owner’s age and education have significantly positive effects on the probability of a firm’s innovation strategy being more open, indicating that older and more-educated principal owners are most active at this level of open innovation. The second primary conclusion is that regional factors influence a high-technology firm’s likelihood of utilizing more open-innovation strategies, with educational attainment, and at least one measure of those for patents and income, increasing the probability of more open innovation.
Further understanding of these regional factors’ effects on open-innovation dynamics will assist local, state, and federal public policymakers in crafting economic development policies. The findings suggest benefits for paying greater attention to higher education policies and creating a suitable environment for those that create and those that buy ideas and innovation. How the exposure to external ideas and technologies create beneficial regional knowledge networks warrants further analysis. In addition, it remains essential to utilize data from nascent firms, like the KFS, to understand whether open innovation enables the firm to also enhance its own innovativeness and how regional policy can assist and support this dynamic.
(2) R&D and the Export Decision of New Firms
- Charles Braymen, Kansas State University
- Kristie Briggs, Creighton University
- Jessica Boulware, Kansas State University
With entrepreneurial firms’ growing entrance into an ever-expanding global economy, it becomes increasingly important to identify characteristics that influence a new firm’s decision to compete in international markets. This paper examines how new firms’ R&D impacts their export decisions, and whether “globally relevant” innovation by neighboring firms creates spillovers that enhance the likelihood that these new firms will sell abroad. The results suggest that R&D by new firms is a robust and critical characteristic of their export decisions and the intensity of their exports. Innovation spillovers from neighboring firms only impact the export decision of new firms that engage in R&D. This is likely because new firms—whose resources often are more limited than existing and/or multinational firms’ are—are less capable of absorbing innovation spillovers from neighboring firms unless they themselves are engaging in R&D.
(3) Beg, Borrow, and Deal? Entrepreneurship and Financing in New Firm Innovation
- Sheryl Winston Smith, Temple University
Financing affects innovation outcomes in two ways: Access to capital directly mitigates liquidity constraints, which impede reaching innovation milestones; and the entrepreneur’s choice of financing can provide incentive or disincentive to undertake risky innovation. Debt financing places the new firm’s risk squarely with the entrepreneur, who must repay regardless of outcome. Equity financing spreads the risk between the entrepreneur and the investor, but also dilutes the owner’s control. This paper analyzes the role of debt, and bank loans in particular, in the very early financing of new firms, and determines the relationship between financing choice and the new firm’s subsequent innovation trajectory.
The evidence in this paper suggests that information asymmetry, combined with technical risk, influences entrepreneurial companies’ ability to secure bank financing. Banks, unlike equity finance providers, do not share in a high-growth firm’s potential upside. However, there is evidence that, as information asymmetry is lessened over subsequent periods, banks are more likely to lend to high-tech firms. Likewise, they are more likely to provide loans as high-tech firms’ riskiness decreases, suggesting the likelihood of business bank loans targeting the firms, over time, with higher growth potential. This is consistent with the literature on bank lending to new ventures, and, in particular, the role of monitoring and risk reduction in bank lending to entrepreneurs.
Other early results in this paper suggest that increasing financial leverage over time might provide nascent technology entrepreneurs with financial slack that may enable innovation. An important analytic and econometric concern is the potential endogeneity of the financing choice and innovation outcomes. In a novel strategy, this paper exploits the role of entrepreneurial optimism to discern the relationship between debt financing and innovation outcomes, conditional on the endogenous choice of financing.
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