Destructive Creation at Work: How Financial Distress Spurs Entrepreneurship

Abstract

Zarutskie, as well as finance faculty and PhD students at the University of North Carolina-Chapel Hill. I am thankful to Danielle Sandler for her assistance with the data clearance requests. Any opinions and conclusions expressed herein are those of the author and do not necessarily represent the views of the U.S. Census Bureau. All results have been reviewed to ensure that no confidential information is disclosed.

Customer Capital, Financial Constraints, and Stock Returns

“…Babina (2017) provides several pieces of evidence consistent with our model's implications. First, employees' exit rates are higher in distressed firms.…”

“…Intuitively, the firm is more likely to replace key talents when it is financially constrained, because the required compensation becomes very costly when the marginal value of the firm's internal funds is high. The mechanism has been documented and tested extensively in the literature (see, e.g., Brown and Matsa, 2016;Babina, 2017;Baghai et al, 2017). Such endogenous separations due to heightened financial constraints risk play a crucial role in generating sizable impacts on firm value and the cross-sectional asset pricing patterns across firms with different ICC.…”

“…Although retaining talent-dependent customer capital on average brings positive net cash flows, the associated operating leverage increases firms' exposure to financial constraints risk. When firms face heightened financial constraints risk, key talents may find it optimal to escape from a sinking ship or jump to a safer boat (see, e.g., Brown and Matsa, 2016;Babina, 2017;Baghai et al, 2017). 3 Alternatively, firms may find it optimal to conduct operating deleveraging by replacing incumbent talents with less-cash-compensated new talents (see, e.g., Gilson and Vetsuypens, 1993).…”

Entrepreneurial Spillovers from Corporate R&D

“…The positive effect of R&D on entrepreneurship that we document is one mechanism for why high-growth startup founders are often former employees of large incumbent firms (Gompers, Lerner & Scharfstein 2005, Klepper 2009. We offer corporate R&D as a new source for where ideas for high-growth startups come from, a topic of considerable recent interest (Aghion & Jaravel 2015, Babina 2017).…”

“…This captures founders and early employees. Similar variables are used in , Babina 2017, andAzoulay, Jones, Kim &. permit a rigorous robustness test of our main results.…”