Failure Is an Option: Institutional Change, Entrepreneurial Risk, and New Firm Growth

Abstract

Does an institutional change that lowers failure barriers improve new firm growth? We take advantage of a quasi-natural experiment in Japan that drastically reduced the stringency of bankruptcy regulations to examine this question. Using longitudinal data over a 10-year period, we find that bankruptcy reform increases the rates of bankruptcy and founding—and, more importantly, the likelihood of high-growth ventures—by disproportionately encouraging elite individuals (i.e., those with superior human and social capital) to start firms. In turn, these firms are more likely than others to achieve high growth. Broadly put, we contribute to research at the nexus of institutional theory and entrepreneurship by emphasizing the connectedness of barriers to failure, venture growth, and elite entrepreneurs. We also highlight how institutional change that eases bankruptcy change can foster a regenerative cycle of failure, founding, and growth by attracting more capable entrepreneurs. Overall, we conclude that lowering barriers to failure via lenient bankruptcy laws encourages more capable—and not just more—entrepreneurs to start firms. The online appendix is available at https://doi.org/10.1287/orsc.2017.1110 .

Institutions and Entrepreneurial Activity: The Interactive Influence of Misaligned Formal and Informal Institutions

“…In Japan, informal institutions are thought to heavily influence individuals away from risk because of the stigma of failure present as a social norm. Yet, in 2003, Japanese policymakers passed a reform of the country's formal bankruptcy laws to allow for limited liability and a quicker resolution of bankruptcy for entrepreneurs (Eberhart et al 2017). The effects of this reform were to encourage risk taking, especially by more "elite" individuals.…”

The (Un) intended consequences of institutions lowering barriers to entrepreneurship: The impact on female workers

“…In this respect, we document that minority workers, such as women, will create and capture relatively less value within the firm, following the unintended effects of reducing entry barriers to venture formation and the subsequent attrition of female peers. Second, we extend research on institutions and entrepreneurship (e.g., Eberhart et al, ; Eesley, ), by documenting not only the intended but also the unintended consequences of such regulations, and examining how such effects might vary with employee gender. Finally, our study contributes to the discussions in strategic human capital, focused on the critical role of human capital in creating and sustaining a firm's competitive advantage (e.g.,Harris and Helfat, ; Mawdsley and Somaya, ; Starr, Ganco, and Campbell, ).…”

“…The concept of barriers to venture formation is central to both entrepreneurship and strategy research, which has increasingly recognized the key role the institutional environment plays in facilitating or hindering the founding of a startup. Entrepreneurship scholars have long linked regulatory changes, which ease the access to capital and other resources when forming and nurturing a new venture, to higher rates of new foundings and greater quality of new ventures, conditional on entry (e.g., Armour and Cumming, ; Chatterji and Seamans, ; Eberhart, Eesley, and Eisenhardt, ; Eesley, ). At the same time, strategy scholars have recognized the threat that such changes impose on incumbent firms, whose competitive advantage might be eroded because market competition intensifies (Porter, ), and valuable employees move to startups (e.g., Agarwal et al, , Ganco, Ziedonis, and Agarwal, 2015; Hall, ; Lippman and Rumelt, ).…”

“…However, past studies have only focused on individuals who leave for entrepreneurship (e.g., Eberhart et al, ; Eesley, ), contributing to the relevant loss of human capital for incumbent firms (e.g., Ganco, Ziedonis, and Agarwal, 2015). Yet not all employees will become founders when entry barriers to forming new ventures fall; indeed, many will stay behind at incumbent firms.…”

Innovation and Entrepreneurship in the European Union—A Reform Agenda

“…Psychological costs often accompany bankruptcies, and in many countries, the public exhibits negative attitudes towards business failures (OECD 1998;Eberhart et al 2017), which are stigmas that may unnecessarily discourage people from entrepreneurial activities. Some countries, such as the United States, look more favorably upon failed business projects (Audretsch et al 2002), and it is important that the business culture gives failed entrepreneurs a "second chance" and allows them to start anew.…”