Ramana Nanda

Democratizing Entry: Banking Deregulations, Financing Constraints, and Entrepreneurship

We examine entrepreneurship and creative destruction following US banking deregulations using Census Bureau data. US banking reforms brought about exceptional growth in both entrepreneurship and business closures. The vast majority of closures, however, were the new ventures themselves. Although we do find evidence for the standard story of creative destruction, the most pronounced impact was a massive increase in churning among new entrants. We argue that creative destruction requires many businesses failures along with the few great successes. The successes are very difficult to identify ex ante, which is why democratizing entry is an important trait of well-functioning capital markets.

Investment Cycles and Startup Innovation

We find that venture capital-backed startups receiving their initial investment in hot markets are more likely to go bankrupt, but conditional on going public, are valued higher on the day of their initial public offering, have more patents, and have more citations to their patents. Our results suggest that VCs invest in riskier and more innovative startups in hot markets (rather than just worse firms). This is particularly true for the most experienced VCs. Furthermore, our results suggest that increased capital in hot times plays a causal role in shifting investments to more novel startups by lowering the cost of experimentation for early stage investors and allowing them to make riskier, more novel, investments.

Diasporas and Domestic Entrepreneurs: Evidence from the Indian Software Industry

This study explores the importance of cross-border social networks for entrepreneurs in developing countries by examining ties between the Indian expatriate community and local entrepreneurs in Indias software industry. We find that local entrepreneurs who have previously lived outside India rely significantly more on diaspora networks for business leads and financing. This is especially true for entrepreneurs who are based outside software hubs - where getting leads to new businesses and accessing finance is more difficult. Our results provide micro-evidence consistent with a view that cross-border social networks play an important role in helping entrepreneurs to circumvent the barriers arising from imperfect domestic institutions in developing countries.

A Darker Side to Decentralized Banks: Market Power and Credit Rationing in SME Lending

We use loan-level data to study how the organizational structure of banks impacts small business lending. We find that decentralized banks—where branch managers have greater autonomy over lending decisions—give larger loans to small firms and those with “soft information.” However, decentralized banks are also more responsive to their own competitive environment. They are more likely to expand credit when faced with competition but also cherry pick customers and restrict credit when they have market power. This “darker side” to decentralized banks in concentrated markets highlights that the level of local banking competition is key to determining which organizational structure provides better lending terms for small businesses.

Seeking the Roots of Entrepreneurship: Insights from Behavioral Economics

There is a growing body of evidence that many entrepreneurs seem to enter and persist in entrepreneurship despite earning low risk-adjusted returns. This has lead to attempts to provide explanations—using both standard economic theory and behavioral economics—for why certain individuals may be attracted to such an apparently unprofitable activity. Drawing on research in behavioral economics, in the sections that follow, we review three sets of possible interpretations for understanding the empirical facts related to the entry into, and persistence in, entrepreneurship. Differences in risk aversion provide a plausible and intuitive interpretation of entrepreneurial activity. In addition, a growing literature has begun to highlight the potential importance of overconfidence in driving entrepreneurial outcomes. Such a mechanism may appear at face value to work like a lower level of risk aversion, but there are clear conceptual differences—in particular, overconfidence likely arises from behavioral biases and misperceptions of probability distributions. Finally, nonpecuniary taste-based factors may be important in motivating both the decisions to enter into and to persist in entrepreneurship.

Venture Capital Investment in the Clean Energy Sector

We examine the extent to which venture capital is adequately positioned for the rapid commercialization of clean energy technologies in the United States. While there are several startups in clean energy that are well-suited to the traditional venture capital investment model, our analysis highlights a number of structural challenges related to VC investment in the sector that are particularly acute for startups involved in the production of clean energy. One of key bottlenecks threatening innovation in energy production is the inability of VCs to exit their investments at the appropriate time. This hurdle did exist in industries such as biotechnology and communications networking that faced a similar problem when they first emerged, but was ultimately overcome by changes in the innovation ecosystem. However, incumbents in the oil and power sector are different in two respects. First, they are producing a commodity and hence face little end-user pressure to adopt new technologies. Second, they do not tend to feel as threatened by potential competition from clean energy startups, given the market structure and regulatory environment in the energy sector. We highlight that the problem is unlikely to get solved without the active involvement of the government. Even if it does, historical experience suggests it may take several years.

House Money and Entrepreneurship

We examine the relationship between house prices and entrepreneurship using micro data from the US Census Bureau. Increases in house prices are often thought to drive entrepreneurship through unlocking the collateral channel for bank loans, but this interpretation is challenged by worries regarding omitted variable biases (e.g., rising local demand) or wealth effects (i.e., that people with more valuable homes are more likely to enter entrepreneurship for reasons other than access to collateral). We construct an empirical environment that utilizes very localized price changes, exploits variations in initial home values across residents in the same zip code, and embeds multiple comparisons (e.g., owners vs. renters, homestead exemption laws by state). For the United States during the 2000-2004 period, the link of home prices to the rate of entrepreneurship through home equity channels is modest in economic magnitude. This is despite a focus on a time period that experienced the largest concentration of US home price growth over the last two decades. Even when we do connect home equity to entrepreneurship, part of the effect is linked to an increased demand for entrepreneurship. While housing collateral plays a role in the entry that we observe, it does not seem to be a major barrier to entrepreneurship in our context.

Financing Entrepreneurial Experimentation

The fundamental uncertainty of new technologies at their earliest stages implies that it is virtually impossible to know the true potential of a venture without learning about its viability through a sequence of investments over time. We show how this process of experimentation can be particularly valuable in the context of entrepreneurship because most new ventures fail completely, and only a few become extremely successful. We also shed light on important costs to this process of experimentation and demonstrate how these can fundamentally alter both the rate and direction of start-up innovation across industries, regions, and periods of time.

Financial Development and Technology Diffusion

We examine the extent to which financial market development impacts the diffusion of 16 major technologies, looking across 17 countries, from 1870 to 2000. We find that greater depth in financial markets leads to faster technology diffusion for more capital-intensive technologies, but only in periods closer to the invention of the technology. In fact, we find no differential effect of financial depth on the diffusion of capital-intensive technologies in the late stages of diffusion or in late adopters. Our results are consistent with a view that local financial markets play a critical role in facilitating the process of experimentation that is required for the initial commercialization and diffusion of technologies.

Cost of Experimentation and the Evolution of Venture Capital

We study how technological shocks to the cost of starting new businesses have led the venture capital model to adapt in fundamental ways over the prior decade. We both document and provide a framework to understand the changes in the investment strategy of venture capitalists (VCs) in recent years — an increased prevalence of a “spray and pray” investment approach — where investors provide a little funding and limited governance to an increased number of startups that they are more likely to abandon, but where initial experiments significantly inform beliefs about the future potential of the venture. This adaptation and related entry by new financial intermediaries has led to a disproportionate rise in innovations where information on future prospects is revealed quickly and cheaply, and reduced the relative share of innovation in complex technologies where initial experiments cost more and reveal less.