The role of innovation in the postentry performance of new small firms: evidence from Italy.

• Author: Arrighetti, Alessandro

1. Introduction

   The aim of this paper is to relate the start-up decision to the postentry performance of new small firms. Hence, this paper is part of economic research in industrial organization, more specifically of the study of industrial dynamics.

   In the literature focusing on industry dynamics, there are at least two different strands relevant to the object of this study. On the one hand, there is the literature devoted to entry and to the start-up decision; this line of the economic thought has typically examined the characteristics external to the firm, such as profit expectations in a given sector, entry barriers, and financial constraints. In this field, the basic research questions concern the "pull factors" that can stimulate the entry flow into a given industry. On the other hand, other studies have tried to link the decision to start a new enterprise to characteristics specific to the individual founder and his/her personal background, personal motivation, and sociological environment. In this field, the basic research issues regard the "push factors" that can stimulate entry into a given industry. A common thread running through both strands is that the decision-making horizon is essentially bounded by the point of entry. In other words, the object of the story is simply the entry into a given market.

   More recently, a growing literature focusing on the postentry performance of firms has developed. Within this third strand of literature, research topics include the measurement and determinants of survival rates, early exit, and the firm's growth. Although the literature on entry does not pay attention to issues like early exit and chances of survival, papers on postentry performance generally take entry as an exogenous occurrence, in some way preliminary to the analysis. How and why the new firm entered the market is generally considered to be beyond the scope of such studies.

   Nevertheless, one can suppose that the initial population of new entrants (entrepreneurs) is not likely to be homogeneous in terms of personal characteristics, motivation, and previous experiences, and it is plausible to suppose a possible link between these preentry features and the firm's subsequent postentry performance. In other words, this paper will address questions such as: does an innovative entrepreneur have the same chances of postentry profitability as a conservative one? Does a former blue collar worker have the same chances as a former manager? Does a defensive motivation for the start-up of a new firm - such as the avoidance of unemployment - tend to be related to an inferior postentry performance? Thus, the purpose of this paper is to provide some insight into the relationship between the decision to start a new firm and the subsequent postentry performance. In particular, we relate those factors that are decisive in leading an economic agent to leave a mother company to start a new firm to the postentry performance of the new-born enterprise. This enables us to distinguish between the types of motivation leading to the better or poorer postentry performance. Although policy conclusions will not be explicitly drawn in this particular study, the results presented in the following sections may be of some help in designing national and local industrial policies.

   In the second section of this paper a survey of previous studies on entry and postentry performance will be presented. The dataset, which consists of a sample of 147 Italian spin-offs, is described in the third section. In the fourth section the hypothesis that different factors inducing new-firm start-ups have a disparate effect on the postentry performance is tested. Finally, the main findings of this study are briefly summarized.

2. Start-Up of Small Firms and Their Subsequent Early Performance: A Review of the Literature

   Entry has an important role in the model of perfect competition since an excess level of profitability induces entry into the industry; that is, if excess profits occur - caused by the opening of a market niche, a cost-saving innovation, or product differentiation - additional agents are attracted into the market. In this view, a queue of well-informed potential entrepreneurs is supposed to be waiting outside the market, and the expected level of profit is the "pull factor" determining entry (Khemani and Shapiro 1986; Acs and Audretsch 1989a; Geroski 1991; Geroski and Schwalbach 1991).

   In most of the conventional entry models, the maximization of expected profits is discounted by taking into account barriers to entry. In these models, entry is still driven by expected profits, but it is also hindered by factors such as initial sunk costs, minimum efficient size, industry-specific features such as innovation, and advertising expenditure (Mansfield 1962; Orr 1974; Baldwin and Gorecki 1987). More recently, "strategic barriers to entry" have attracted the attention of many scholars: in these models entry barriers play a preemptive role in a game between incumbents and potential entrants (Tirole 1989, ch. 8). The main shortcoming of this traditional approach to industrial organization is that by treating the industry market as the essential unit of observation, it is virtually impossible to take into account individual characteristics of the potential founder (push factors). In fact, while the diversification of an existing firm into a new market can be fully explained through the consideration of expected profits and (strategic) entry barriers, the study of the foundation of a new small firm by a single entrepreneur requires a wider perspective. Indeed, if the unit of observation is the level of the market, this obscures the decision-making process at the level of the individual (Winter 1991) and underestimates the factors shaping the entrepreneur's motivation in starting a new business (McClelland 1961).

   As a complement to the simplified view of entry discussed so far, a different tradition can be singled out in the history of economic thought: Schumpeter (1911), Knight (1921) and Oxenfeldt (1943) drew attention to the subjective characteristics of the actual founder of a new firm. Their well-known definitions of entrepreneurship opened the way to a more general framework where pull factors are studied together with some push factors concerning the environment and the particular situation of the potential founder (for a discussion of push factors contrasted with pull factors, see Kilby 1971).

   This literature is mainly empirical in nature and gives interesting insights into the actual process of entry. For instance, according to the results of the surveys carried out by Storey (1982) and Johnson (1986), the founder of a new firm is heavily influenced by his/her own background, with particular reference to his/her previous job experience (it has to be taken into account that the vast majority of new firms originate through spin-off from a mother company: 60% in Storey [1982] and 68% in Vivarelli [1991]). In other words, his/her entrepreneurial project is dependent on technical and managerial competence acquired in the previous job: technical savoir faire, organizational skills, knowledge of the market, and so on (Bates 1990). Thus, spin-off results can be affected by the previous hierarchical job position of an ex-employee (for instance, successful entrepreneurs are more likely to have been managers involved in supervisory functions). As regards the personal characteristics of the founder, family background is also singled out as a key factor by econometric estimates explaining new firm formation as an act of self-employment (Evans and Leighton 1989; De Wit and Van Winden 1989). However, other empirical studies tend to play down the relative importance of this factor in shaping the start-up decision (Vivarelli 1991).

   An interesting way to model entry decision to encompass both pull and push factors is the so-called "income choice" approach (Creedy and Johnson 1983; Storey and Jones 1987; Blanchflower and Oswald 1990; Evans and Leighton 1990; Blanchflower and Meyer 1994). In this theory, a potential founder compares his present income and prospects as an employee with the expected income from the independent activity; if this difference is more than a given threshold, whose level depends on the individual's risk aversion and on particular psychological aptitudes such as a strong desire to be independent, the new firm will be founded. While this approach encompasses the traditional view whereby entry is pulled by...