Private Benefits and Entrepreneur s Choice of Manager*

Transcription

1 Private Benefits and Entrepreneur s Choice of Manager* Elena Kulchina Duke University, Fuqua School of Business 100 Fuqua Drive Durham, NC 27708, USA Elena.Kulchina@Duke.edu April, 2013 Abstract When starting a firm, an entrepreneur is faced with a difficult question of whether to manage it personally or hire a manager. Despite the fact that many entrepreneurs choose to hire managers, the entrepreneurship literature has primarily ignored the complexity of this choice and assumed that entrepreneurs always manage their firms themselves. As a result, we know very little of what motivates an entrepreneur to manage a firm personally or hire an agent. This paper examines the role of non-pecuniary private benefits in the choice of manager. I use a setting of foreign entrepreneurs who, in order to manage their firms abroad, need to relocate to a host country and thus experience non-pecuniary benefits and costs of relocation associated with personally managing the firm. I show that entrepreneurs with presumably higher benefits of relocation are more likely to manage their firms abroad personally and even seem to substitute relocation benefits for some firm profit. These findings are consistent with the idea that entrepreneurs anticipating large non-pecuniary private benefits associated with ownermanagement are more likely to become owner-managers and are willing to substitute nonfinancial benefits for monetary earnings. These results add to the growing literature in strategy and entrepreneurship exploring the role of personal preferences in entrepreneur s strategic decisions, such as self-employment, location choice and equity control. Keywords: owner-manager, choice of manager, firm performance, private benefits, foreign entrepreneurs *Special thanks to Olav Sorenson, Joanne Oxley, Mara Lederman, Tim Simcoe, Ashish Arora, Michael Roach, Francine Lafontaine and Denis Davydov for their helpful suggestions. This work was supported by a grant from the AIC Institute for Corporate Citizenship at the University of Toronto. This paper is based on my dissertation, which is a finalist for the Buckley and Casson AIB Dissertation Award. 1

2 1 Introduction When starting a firm, an entrepreneur must decide whether to operate the business personally or hire a manager. Surprisingly, the entrepreneurship literature has primarily ignored the complexity of this choice and assumed that entrepreneurs always manage their firms themselves (e.g., Berglann et al., 2011; Hamilton, 2000; Nanda and Sorensen, 2010). For example, in their comprehensive review, Van Praag and Versloot (2007) show that empirical entrepreneurship studies typically include only individuals who are self-employed or the ownermanager of an incorporated business (Van Praag and Versloot, 2007, p.354). In reality, however, some entrepreneurs hire outside agents to manage their firms. 1 Yet we know very little about what motivates an entrepreneur to manage a firm personally or hire an agent and particularly about the motivating roles of financial and nonfinancial benefits. 2 The dominant assumption in the economics of entrepreneurship literature has been that entrepreneurs make strategic choices regarding the firm so that to maximize firm profit. Indeed, recent studies demonstrate that the choice between a hired manager and an entrepreneur-manager may have a large impact on firm performance and value (e.g., Kulchina, 2012). Thus, one may expect that an entrepreneur chooses a manager so as to maximize firm profit and the factors motivating this choice are the ones that positively associated with firm performance. Nevertheless, the studies exploring the role of personal preferences in entrepreneurs strategic decisions suggest that some nonfinancial benefits may possibly motivate an entrepreneur to deviate from the profit-optimizing choice. Recent research on self-employment, for example, has demonstrated that individuals put significant emphasis on the non-pecuniary 1 Chen and Thompson (2012) show that 13% of Danish startups switch from owner-managers to hired managers in the first 6 years of firm operation. Kulchina (2012) demonstrates that 37% of foreign entrepreneurial startups in Russia have hired managers. 2 There are very few studies related to the manager choice in entrepreneurial firms. Lin and Hu (2007) have found that family-ceos are more likely to be found in small firms and firms with low R&D intensity and large advertising budgets. Burkart et al. (2003) and Fraja (1996) have developed theoretical models that suggest that owner-managers should prevail during bad times and in an environment with low protection of the minority shareholders. Wasserman (2003) has demonstrated that a founder-ceo is likely to be replaced by an outside executive after completion of product development and a new round of financing or when the founder has low equity and narrow background. 2

3 private benefits of self-employment, such as autonomy, and may even value them more than monetary returns (e.g., Hamilton, 2000; Moskowitz and Vissing-Jorgensen, 2002). Yet, one should be cautious when generalizing these findings to the choice of manager: First, since these studies examine a compound choice of firm-ownership and owner-management, it is unclear if nonfinancial benefits play a role in both decisions or in the ownership choice only. Second, what may seem as the choice determined primarily by private benefits can still be consistent with profit maximizing behavior (e.g., Dahl and Sorenson, 2012). In this paper, I explore the motivating role of non-pecuniary private benefits associated with the managerial position in the entrepreneur s decision to manage the firm personally. I define the non-pecuniary private benefits (henceforth, also private benefits) as the benefits associated with managing a firm other than direct monetary earnings from the firm, such as firm profit. I also examine what implications the presence of these private benefits has for firm performance. I examine these questions in the setting of foreign entrepreneurs in Russia individuals who open their firms outside of their native countries. An owner-manager position may be associated with numerous private benefits, such as independence, sense of control, gaining a prestigious position in a local business community, living in a desirable location and others. Quantifying private benefits is extremely difficult, but for foreign entrepreneurs, it is possible to capture at least some of these private benefits with a proxy variable. To manage a firm personally an entrepreneur typically needs to live nearby. Thus a foreign entrepreneur who manages a firm in Russia would normally need to live in Russia and incur personal benefits and costs of living in Russia relative to staying in a home country. Therefore, a strong non-pecuniary private benefit or cost associated with managing a firm abroad is the benefit or cost of relocating and living in a host country. I proxy for the private benefits of living in Russia for an entrepreneur from a given foreign country with the number of the 3

4 entrepreneur s nationals working in Russia. 3 To address endogeneity concerns, I use color revolutions arguably exogenous home-country events that are expected to change the benefits of moving to Russia relative to staying in a home country. Specifically, I ask whether the benefits from relocation to a host country affect an entrepreneur s likelihood of managing a firm personally and whether entrepreneurs are willing to substitute relocation benefits for some firm profit. I find that entrepreneurs with more nationals working in Russia are more likely to manage their firms in Russia personally despite the fact that they get lower relative firm-performance benefits to being a manager. For example, an entrepreneur from China would be 25 percentage points more likely to manage a firm in Russia than an owner of an otherwise similar firm from the United States. But the operating return on assets (OROA) premium for being an owner-manager for an entrepreneur from China would be 7 percentage points lower than for an owner of a similar firm from the United States. These findings are consistent with the idea that non-pecuniary private benefits associated with managing a firm may significantly influence an entrepreneur s decision to manage a firm personally and may substitute for some financial benefits in the form of firm profit. My findings make contributions to several areas of the strategy and entrepreneurship literature: First, it is one of the very first attempts to examine the non-performance determinants of the choice between an owner-manager and a hired manager in entrepreneurial startups. My results suggest that non-pecuniary private benefits may play a significant role in the entrepreneur s decision to manage a firm. Second, this paper contributes to the small but rapidly growing literature on the role of nonfinancial benefits in strategic decisions of family firms. So far, this literature has focused on the role of private benefits in the entrepreneur s ownership stake, location choice and self- 3 Russia does not have an open immigration system. The majority of foreigners come to Russia on work visas and thus, the number of foreign nationals working in Russia should well reflect the general attractiveness of Russia to the foreign country citizens. 4

5 employment decision (Dahl and Sorenson, 2012; Ehrhardt and Nowak, 2003; Hamilton, 2000), and my findings broaden the set of choices where private benefits may play an important role. Finally, my findings contribute to the area of international entrepreneurship by examining manager choice of foreign entrepreneurs. Foreign entrepreneurs are a rapidly expending but underexplored phenomenon, which is attracting increasing attention of researchers. The recent studies have been intensively examining the behavior of immigrant-entrepreneurs, international small ventures and quasi-foreign returnee-entrepreneurs. My results suggest that the relative attractiveness of a host country plays an important role in the entrepreneurs choice of manager and sheds light on the observation why some groups of foreign entrepreneurs are much more likely to manage their firms personally even when their relative monetary returns to ownermanagement are low or negative. 2 Theoretical Background Self-employment and top-management positions are typically associated with various non-pecuniary private benefits. Such benefits may include satisfaction from the ability to do an interesting job and being one s own boss, pleasure from running a family firm and having a future opportunity to pass it to the heirs, enjoyment of being a part of the local business elite and having political influence in the community, and happiness from the ability to choose a preferable employment location near family and friends (Dahl and Sorenson, 2012; Ehrhardt and Nowak, 2003; Hamilton, 2000; Moskowitz and Vissing-Jorgensen, 2002). Entrepreneurship studies have consistently reported that non-pecuniary benefits play an important positive role in the individuals decision to become self-employed. Moreover, these studies have documented that individuals are willing to forgo some financial earnings in favor of the non-pecuniary private benefits. Hamilton (2000) and Moskowitz and Vissing-Jorgensen 5

6 (2002), for example, have found that individuals see the autonomy that comes with being selfemployed as one of the major attractive features of self-employment. Hamilton (2000) compared earnings of self-employed individuals and paid employees and found that an average entrepreneur is earning less and is willing to sacrifice substantial monetary earnings in exchange for the private benefits of owning a business. Moskowitz and Vissing-Jorgensen (2002) demonstrate that when adjusted for higher risks, entrepreneurship provides lower financial returns than regular employment. Entrepreneurship studies have also demonstrated that nonfinancial private benefits may be even more preferable than monetary earnings (see Santarelli and Vivarelli (2007) for review). For example, the surveys conducted by Vivarelli provide the evidence that personal motivations rank above profit expectations in the decision to start a business (Santarelli and Vivarelli, 2007). According to Benz and Frey (2008) and Blanchower (1998), self-employed individuals report higher levels of job satisfaction than employed persons, with such private benefits of selfemployment as autonomy and interesting work being ranked above financial returns among their preferred work characteristics. Since non-pecuniary private benefits influence individuals decisions to become selfemployed, and since being an owner-manager is a significant part of self-employment, one may also expect non-pecuniary private benefits to influence a more nuanced entrepreneur s decision to manage a firm personally. Burkart and his colleagues (2003), for example, developed a theoretical model which implies that in the presence of high private benefits of management, entrepreneurs would manage their firms personally. By analogy with the role of private benefits in the self-employment choice, I expect that entrepreneurs not only are more likely to manage their firms personally in the presence of non-pecuniary private benefits associated with managing a firm, but are also more willing to forgo some firm profit when they gain private benefits from owner-management. 6

7 In other words, we would expect that entrepreneur s utility of being an owner-manager is a function of both firm profit and non-pecuniary private benefits associated with the topmanagement position. Thus, we can write entrepreneur s utility function from being an ownermanager as U OM =f(π OM, PB), where π OM is firm profit when an entrepreneur manages a firm personally and PB is entrepreneur s non-pecuniary private benefits associated with being firm manager relative to hiring a manager. Let s assume that π OM is also an increasing function of the entrepreneur s managerial skills (S): π OM = π (S). 4 If we assume that the terms are linearly additive, entrepreneur s utility from managing a firm can be written as U OM = π OM +PB= π(s)+pb. 5 Entrepreneur s utility from having a hired manager is U HM = π HM, where π HM is firm profit under a hired manager. In Figure 1, I plot entrepreneur s utility depending on the entrepreneur s managerial skills, keeping the quality of the venture fixed. Dashed line is entrepreneur s utility when he hires a manager, which is assumed to be independent of the entrepreneur s managerial skills. 6 Solid lines represent entrepreneur s utility from being an owner-manager. If we assume that an entrepreneur is maximizing his utility when choosing between owner-management and hiring a manager, an entrepreneur is managing a firm personally when U OM U HM. When PB=0, U OM1 =π and we only observe owner-management if entrepreneur s S S* and 0 Δπ=π OM -π HM. When PB>0, U OM line shifts to the left to U OM2. ow, some entrepreneurs with S S S* are also managing the firm. Profit at the equilibrium point shifts from π* to π. So, we will observe some entrepreneurs managing their firms even when it is economically inefficient and π OM <π HM. Assuming that π (S) is a monotonic function, ) < ) Insert Figure 1 about here 4 Normally, it would also be a function of firm, environment and entrepreneur characteristics, but for simplicity, I hold them constant and allow only entrepreneur s skills vary. 5 For summation, PB should be expressed in monetary terms. 6 In reality, U HM may be slightly increasing if entrepreneurs with better managerial skills are also more able to select hired managers with better skills, but the slope of U HM is still expected to be low than that of U OM. 7

8 In the above discussion, I assumed that firms with owner-managers and hired managers are of the same quality. Alternatively, it is possible that firms with owner-managers are of a lower quality than firms with hired managers. Thus, an entrepreneur may open a lower quality firm when he expects to gain private benefits from the owner-management and compensate with them for lower firm performance. However, when an entrepreneur hires a manager, he does not gain private benefits from managing the firm to compensate for lower firm performance. Thus, a nonmanaging entrepreneur would only open a high-quality, high-performance firm. Then even if an entrepreneur is managing a firm only when he is a better manager than a hired agent, the performance of owner-managed firms with private benefits will be lower than the performance of owner-managed firms without such benefits, but the utility will be the same. Figure 2 illustrates this process. Let s suppose that an entrepreneur opens a firm when his U π 1 *. In the presence of private benefits, he will open a lower quality firm, which will shift performance lines of hired managers and owner-managers, U HM =π HM and π OM, down, but the utility of owner-management, U OM, will stay the same. Since we only observe performance, but not utility, ) < ) Insert Figure 2 about here Foreign Entrepreneurs To examine the relationships between private benefits, manager choice and firm performance, one needs to operationalize non-pecuniary private benefits, which are very difficult to observe and reliably quantify (Dyck and Zingales, 2004; Ehrhardt and Nowak, 2003). Prior studies quantified private benefits using either survey questions (e.g., Hamilton, 2000) or some 8

9 proxy variables that could simultaneously capture an entrepreneur s nonfinancial and financial benefits (e.g., Dahl and Sorenson, 2012). Survey data have two disadvantages: they are typically collected for a relatively small number of respondents and may be biased by the entrepreneurs post-decision adjustment of prior expectations. So in this study, I use a proxy variable for some private benefits. To do so, I focus on the choice between an owner-manager and a hired manager in foreign entrepreneurial firms. Foreign entrepreneurs are faced with a variety of potential private benefits when managing their firms, such as independence, control, living in a host country, etc., some of which could be captured by a proxy variable. Foreign entrepreneurs are people who establish their firms outside of their native countries. For example, an American who opens an Internet-access company in Tokyo is a foreign entrepreneur: Brad Bartz, a 30-year-old Californian foresaw a Japanese Internet boom and noticed that few companies could connect personal-computer users to the Net. In 1994 he rented office space, persuaded Sun Microsystems Inc. of Mountain View, Calif., to give him about $150,000 of computer equipment in exchange for free advertising work and created Internet Access Center KK. (The Wall Street Journal, 1996) When starting a firm, entrepreneurs must also decide whether to manage the business personally or hire a professional manager. With advanced communication and transportation technologies, opening a firm abroad has become easier (Drori, Honig and Wright, 2009) and no longer necessarily requires an entrepreneur to reside near the operating facilities. Foreign entrepreneurs have the options of living at a distance from their ventures and extending operations to multiple countries (Oviatt and McDougall, 1994). However, being a CEO of the firm and overseeing its everyday operations still requires an entrepreneur to relocate to a host country and live near the firm. Otherwise, coordination and agency costs, which typically increase with distance, may become unreasonably high (Brickley and Dark, 1987; Jensen and Meckling, 1976). 9

10 Since relocation abroad always comes with some benefits and costs, for a foreign entrepreneur a significant private net benefit (or cost) 7 of being an owner-manager of a firm abroad is associated with the need to live in a host country. Private benefits of relocation may include access to a different culture, better education, or higher living standards and are reflected in the foreign entrepreneur s desire to reside in a host country: For foreign entrepreneurs who expect high private benefits from living in a host country, the relocation will be more desirable. Governments of many countries, including the United States, New Zealand, Canada, Australia, the United Kingdom and some others, seem to recognize the existence of such private benefits when they provide capital-investment based immigration visas for potential entrepreneurs: Foreigners who open their firms in a host country with certain amount of capital investment can get long-term residence in this country and thus receive private benefits of relocation that are tied to starting a firm. Since living in a host country is required for managing a firm personally, an entrepreneur who anticipates high private benefits of host country residence will be more willing to manage a firm personally, whereas an entrepreneur who anticipates personal disutility from relocation to a host country will be less willing to become an owner-manager of his firm. For example, a Mexican entrepreneur opening a firm in the U.S. would typically expect high private benefits of living in the U.S., such as high living standards, better education and lower crime rates, and therefore, would be more likely to manage his firm personally. Thus, foreign entrepreneurs desire to live in a host country should reflect the amount of private benefits associated with personally managing a firm there. Ideally, I would want to measure each entrepreneur s desire to relocate before the relocation. However, such a measure is not available to me. Nevertheless, it is possible to observe an average willingness of individuals 7 Henceforth by referring to the benefits of relocation I refer to net benefits (benefits minus costs) relative to staying in a home country. 10

11 from a certain nation to relocate to a host country. Prior research on immigration has demonstrated that an individual s decision to immigrate is based on both individual level reasons, such as reuniting with family members or seeking adventure, and population-level reasons that are common for all country nationals, such as better education, higher living standards, lower crime and better climate, but population-level reasons usually prevail. In Hagelskamp et al. (2010), for example, all surveyed Chinese immigrants reported access to better education as a very important reason for their immigration to the U.S. Thus, I expect that population-level reasons create a baseline desire to relocate, whereas individual-level reasons cause deviations from this baseline. This baseline is reflected in the numbers of nationals who are willing to relocate to a host country. I assume that entrepreneur s desire is proportional to the baseline desire of his nationals to relocate. Thus, based on the propositions above I expect that Hypothesis 1: An entrepreneur whose nationals are more willing to reside in the firm s host country will be more likely to manage his firm in the host country personally. The literature reviewed in the previous section suggests that entrepreneurs may forgo some monetary earnings in exchange for non-pecuniary benefits. Similarly to how non-pecuniary private benefits may substitute for income in self-employment decision, I expect that nonpecuniary private benefits of relocation associated with being a firm manager will substitute for some portion of firm profits, whereas private disutility from being a manager will be compensated by extra firm performance premium. In fact, managers in large corporations often receive higher compensations when sent to an undesirable location relative to comparable positions in their home countries. Thus, I expect that entrepreneurs who gain high private benefits associated with relocation to become an owner-manager in a desirable location could substitute these private benefits for a portion of firm profit: 11

12 Hypothesis 2: When becoming an owner-manager, a foreign entrepreneur will be willing to substitute private benefits of relocation to the host country for some firm profit. 4 Data and Main Variables Setting: I examine the choice between an owner-manager and a hired manager in foreign entrepreneurial firms opened in Russia between 1997 and Russia suits my purposes well for two reasons. First, private benefits of relocation more strongly apply to foreign entrepreneurs who start a firm when living outside of the host country. Individuals living permanently in a host country are less sensitive to the private benefits of relocation in their decisions to become firm managers. For them, the estimates would be primarily based on the disutility of living in a host country. It is difficult, however, to distinguish between these two types of foreign entrepreneurs in historical datasets. Nevertheless, since Russia is a country without an open immigration system, the share of foreign entrepreneurs who had permanent residence at the time of firm registration should be small. Second, in countries allowing a non-managing foreign entrepreneur to immigrate with his firm, it would be harder to capture the effect of relocation benefits: This effect would be less visible for entrepreneurs with positive relocation benefits, and I would again primarily base estimation on the disutility of relocation. In Russia, however, firm ownership does not justify long-term residence visas. Long-term residence permits in the form of work visas are issued only to those foreign entrepreneurs who are employed by their firms, therefore nonmanaging foreign entrepreneurs cannot easily relocate to Russia. Relocation benefits are strongly tied to firm management and become a part of the owner-management benefits. In line with prior immigrant entrepreneurship studies (e.g., Aldrich and Waldinger, 1990; Saxenian et al., 2007), I define foreign entrepreneurial firm as a firm owned solely by one or 12

13 several non-russian individuals. By this definition, I do not include domestic entrepreneurs or Russian subsidiaries of multinational corporations. Data: I use foreign entrepreneurial firms that were started and operated in Russia between 1997 and The data come from the Ruslana subsample of the Amadeus database a private database assembled by the Bureau van Dijk (BvD) from government, public and private information sources. The Amadeus database by BvD provides reliable accounting, ownership and top-management information, which has recently been widely used in academic studies (e.g., Belenzon, Berkovitz and Rios, 2013; Javorcik, Saggi, and Spatareanu, 2011; Kosova, 2010; Kulchina, 2013). The database has several unique features essential for my research: First, it covers 90% of firms located in Russia, including both public and private firms. This allows me to study private entrepreneurial startups. Second, it is one of a very few existing databases that allow distinguishing between firms with owner managers and hired managers. Owner-manager is a dummy variable that equals 1 when any of the firm owners with at least 20% equity stake is also a firm CEO. This is a common threshold in the literature (e.g., Villalonga and Amit, 2006), but the findings are robust to the higher thresholds of 51% and 100%. 8 Appendix 1 details the procedure used to construct owner-manager variable. Firm performance: Following prior research (e.g., Anderson and Reeb, 2003), I measure firm performance as the operating return on assets (OROA) calculated as the ratio of operating profit (earnings before interest and taxes) to the book value of assets. 9 Sample: To test hypothesis 1, I use a cross-sectional dataset of firms at the time of entry. To test hypothesis 2, I use a pooled cross-sectional dataset where each firm may be observed for up to 11 years and a cross-section of firms at the age of one year. The final estimation sample 8 Empirically, 20 percent is also the smallest share owned by any firm CEO in the dataset. Unlike large public firms, entrepreneurs rarely grant equity shares to hired managers. 9 All monetary values are in nominal Russian rubles. Inflation effect is captured by the year dummy variables in regression models. I removed outliers: the top and bottom 1% of observations on OROA. For example, for operational return on assets (OROA), this removes observations with OROA approximately above 150 percent and below -300 percent. 13

14 consists of 4,475 firms: 53% of these firms operate in the trade sector (retail and wholesale), 25% in services, 10% in production, 8% in construction and 4% in other industries. The most common home countries are China (28% of firms), Belarus (12%), Turkey (10%), India (5%) and Ukraine (4%). Owner-managers operate 64% of the foreign entrepreneurial firms. The remaining 36% are operated by hired managers. The complete distribution of firms by country and management status is shown in Appendix 2. Desire to live and work in Russia: To capture the desire of people from a foreign country to live and work in Russia, I use the number of country citizens working in Russia in year t, Ln(foreign workers). 10 The data for this variable came from Russian Statistical Labor Yearbooks. Note that the number of foreign workers is different from the number of immigrants: Immigrants would come to live in Russia permanently, whereas foreign workers come on temporary work visas. I use the number of foreign workers rather than the number of immigrants for several reasons: First of all, Russia does not provide a reliable data on the number of immigrants in the studied period. Second, Russia does not have an open immigration system and the number of people coming to Russia as immigrants is limited and would not reflect the desire of foreign nationals to live in Russia. Work visas are issued in much greater numbers than permanent residence permits, can be obtained from outside of Russia and require much shorter processing time. Foreign workers are also more flexible than permanent residents and can easily leave Russia if it is no longer an attractive location. Finally, since foreign owner-managers come to work in Russia, foreign workers are the most relevant group in their relocation goals, whereas immigrants may include refugees and the elderly, who may have different criteria for relocation. 10 While the number of foreign workers also includes foreign owner-managers, the number of foreign ownermanagers is so small relative to the total number of foreign workers that it does not significantly affect the fluctuations of the independent variable. 14

15 I use a stock variable rather than an annual inflow 11 and log it since the number of foreign workers is highly skewed. The data on foreign workers are provided for 19 countries between 1998 and 2008, which means that the data are available for 2,372 firms from my sample. Countries with missing data have larger GDP, lower population and provide firms that are a little larger and less likely to operate in construction and extraction industries. The complete comparison is reported in Appendix 3. The distribution of the 2,372 firms from the final sample by country, manager type and the average number of nationals working in Russia is shown in Appendix 4. The number of foreign workers reflects the demand for relocation, but it may also reflect the size of the foreign country. At least, the size of the foreign country has a bounding effect to migration. So I need to account for the population size, which I do by using a natural logarithm of the foreign country population as a control variable. 12 Table 1 reports variable definitions and key statistics, and Table 2 provides a matrix of correlation coefficients Insert Table 1 about here Insert Table 2 about here An annual inflow of foreign workers by country is unavailable. However, since foreign workers can always leave Russia if it becomes unattractive, the stock variable well reflects the desire of people of certain nation to work and live in Russia. 12 An alternative way to normalize by the population size is to use the number of foreign workers per capita. I use it as a dependent variable in the robustness check and find similar results. I refrain from using it in the main specification for several reasons: First, the total population has a bounding effect, but it is not clear how it affects emigration in the numbers below the boundary. When X people are leaving a large country, it does not necessarily mean that they reflect lower desire to emigrate than when X people leave a small country. Second, the effect of population is likely to be non-linear. Finally, the effect of the number of workers is also likely to be non-constant, but decreasing, so the log-transformation is appropriate. 15

16 5 Analysis: Choice of Manager Table 3 compares entrepreneurial startups from countries with high and low work migration to Russia and presumably with high and low private benefits of relocation. 13 As expected, entrepreneurs from countries with high migration to Russia seem to be more likely to be owner-managers. Also as expected, an average performance of firms with owner-managers from countries with high migration is lower than that of owner-managers from countries with low migration. The difference in performance between firms with owner-managers and hired managers for firms from countries with high migration is lower than that for countries with low migration. Of course, this comparison is done in the raw data and we do not know if firms in different cells are comparable, thus while these results are suggestive, they are not definitive. 5.1 Empirical Strategy Insert Table 3 about here Hypothesis 1 predicts a positive relationship between the number of foreign workers from the firm s home country in Russia and the probability that the firm will have an owner-manager. To estimate this relationship, I start with a simple probit model: P n n OM Ln( foreign workers ) i Z ki G pj D i i 1, (1) 0 1 j k k 1 p 1 where i is the firm, j is the firm s country of origin, OM i is the owner-manager dummy p variable, Z ki are firm-level control variables, G pj are country-level control variables, D i are dummy variables indicating the year when the firm was opened in Russia (the year of entry to Russia dummy variables) and i is an error term. In line with prior studies (Lin and Hu, 2007; Wasserman, 2003), control variables comprise firm characteristics that may influence manager 13 Work migration is defined as high when an average migration from country j to Russia across the observation period is above the mean migration for all countries for which migration is observed. 16

17 choice: the number of shareholders and the natural logarithms of assets and long debt. I also control for Gross Domestic Product (GDP) in nominal U.S. dollars and population of the entrepreneur s home country. Finally, I control whether the firm comes from a non-cis country, where CIS stands for the Commonwealth of Independent States and Tajikistan, which includes the majority of the former Soviet Union republics. First, CIS entrepreneurs have a smaller liability of foreignness, which increases their likelihood to look for employment in Russia and to be better skilled at managing firms there. Second, in 2003 Russia implemented a work visa quota system that applied to non-cis countries. 14 All time-variant variables are measured in the year of the firm s entry. 15 I do not use country fixed effects because for the majority of countries, there is little variation in the main dependent variable within the home countries. Results with country fixed effects are presented in Appendix 7. Even after the inclusion of control variables, causal interpretation of the observed relationship may be problematic due to several endogeneity concerns. First, some changes in Russia may simultaneously affect the number of foreign workers and the probability that a foreign entrepreneur will become an owner-manager. If such changes do not uniformly apply to all home countries, they will not be captured by the year of entry dummy variables and may bias my coefficients. For example, Russia may limit the number of foreign workers from some countries by issuing fewer work visas, but this would also limit the ability of foreign entrepreneurs to manage their firms in Russia personally by limiting their ability to get work visas. Alternatively, as the number of the entrepreneur s nationals willing to work in Russia increases, fewer work visas remain available for potential owner-managers, which would negatively bias my findings. 14 I have also tried to control for the interaction of non-cis dummy and the quota time period, This, however, had no impact on my findings in both the choice of manager and performance models. 15 If information on firm-level control variables is not available for the year of entry, because some firms start reporting in the first year after entry, I use firm-level data from the first year after entry. Standard errors are robust. Clustering on country produces very similar results in this and following models. 17

18 Thus, my first step is to address endogeneity problems on the side of Russia, by instrumenting the number of foreign workers in Russia with some variable that is related to the desire to emigrate from a home country, but is unrelated to Russia. As such an instrument, I use the number of immigrants from country j to 12 Organization for Economic Co-operation and Development (OECD) countries, Australia, Austria, Canada, Denmark, Finland, France, Germany, Luxembourg, Norway, Spain, Turkey and the United States. These are countries that reported their migration statistics for all years between 1998 and These countries provide variation in culture, climate and economic situation. Some of them also have an open migration system. Preferably, I would want to use foreign workers from country j in the OECD countries, but since these numbers are frequently unavailable, I use the number of immigrants instead. 16 The two-stage model with an instrument is presented below: foreign workers j Ln oecd j n Z k ki k 1 p 1 n Z Ln( ) ( ), (2) P 0 1 n n OM Ln( foreign workers ) i Z ki Z pj D i i 1, (3) 0 1 j k k 1 p 1 where Ln(oecd) is the number of immigrants from the firm s country of origin to 12 OECD countries in the year of the firm s entry to Russia. Standard errors are clustered on country. The second endogeneity problem lies on the side of the entrepreneur s home country. Some characteristics of the home country may simultaneously affect emigration and make it more profitable for an entrepreneur to manage his firm personally. For example, citizens of countries with better education may be in higher demand abroad and be more likely to emigrate, as well as simultaneously be better managers for their firms than hired locals. To address this endogeneity problem, I need a shock to the entrepreneur s home country that would increase the number of country emigrants but would not affect entrepreneurs skills and resources. As such a p p pj Di i 16 Using immigrants for OECD countries creates a smaller bias than in using them for Russia, since OECD countries vary in their immigration rules with many having a relatively open migration system thus their immigration numbers better reflect the demand for relocation. 18

19 shock I use color revolutions primarily non-violent movements against government regimes that resulted in government change and similar civil movements that were aimed at overthrowing government leaders but did not succeed. The examples of color revolutions are Serbia's Bulldozer Revolution in 2000, Georgia's Rose Revolution in 2003, Ukraine's Orange Revolution in 2004 and Lebanon s Cedar Revolution in The examples of the protest civil movements similar to color revolutions but not followed by the change of government leaders are movements in Belarus and Azerbaijan in See complete list in Appendix 5. These revolutions and civil movements (henceforth, I refer to both types under the term color revolutions ) created relatively large groups of people who were dissatisfied with the outcome of the movement, even if they did not actively participate in it. Such people were more willing to emigrate. For example, I have found a significant increase in the numbers of immigrants from the countries with color revolutions to the 12 OECD countries in the three years after the event (see Appendix 6 for details). I expect that for the citizens of the affected countries, color revolutions increased the relative benefits associated with relocation to manage a firm in Russia (relocation became more attractive relative to staying at home). As a result, foreign entrepreneurs from countries that experienced color revolutions were more likely to manage their firms in Russia for private reasons. I investigate the effect of color revolutions and similar movements that affected 10 countries at different points of time between 2000 and It is important that color revolutions did not lead to the redistribution of wealth or immediate change of any country characteristics that could affect entrepreneurship, such as entrepreneurs skills, experience or resources. 17 Since establishing a firm abroad may take from up to several years, I investigate the effect of color revolutions on the likelihood that a firm has an owner-manager in 17 A major concern would be the change in the exchange rates, which may significantly devaluate savings, but I did not observe dramatic national currency exchange rate changes following color revolutions. 19

20 the year when the movement took place and in the following two years. Difference-in- Differences model is presented below: P n n OM color revolution j i Z ki Z pj D i C j i 1, (4) 0 1 k k 1 p 1 where color revolution is a dummy variable that equals 1 for the country where the revolution took place for three consecutive years starting with the year of the revolution. The effects of Post dummy variable and country fixed effects are captured by the year of entry D i and the country of origin C j dummy variables. The model is estimated by Probit. 18 p 5.2 Results Table 4 demonstrates a positive relationship between the desire to relocate to Russia and entrepreneur s choice to be an owner-manager: foreign entrepreneurs from the countries whose citizens are more willing to relocate to Russia are more likely to manage their firms in Russia personally. A probit model in Column 1 shows a positive correlation between the number of immigrants from a foreign country and the probability that a firm from that country will have an owner-manager Insert Table 4 about here To demonstrate the size of the effect, Figure 3 pictures predicted probabilities that a firm has an owner-manager depending on the number of entrepreneur s nationals working in Russia. For example, for a firm with average characteristics, the probability of having an owner-manager is 71% if the owner has 229 thousand nationals working in Russia (as for China) and 46% if he has 5 thousand nationals working in Russia (as for the U.S.). Coefficients for the control 18 OLS estimation of Diff-in-Diffs also produces positive and significant coefficient for color revolution,

21 variables suggest that smaller firms with lower debt and fewer shareholders, who come from countries with low GDP and large populations are also more likely to have owner-managers Insert Figure 3 about here Columns 2 and 3 report 2SLS model with an instrument that allows addressing endogeneity on the side of Russia. The first stage results demonstrate that there is indeed a high correlation between the number of immigrants to the OECD countries and the number of foreign workers in Russia. The second stage coefficient suggests that a 10% increase in the number of foreign workers from the home country increases the probability that the firm will have an owner-manager by approximately 1 percentage point. The ivprobit model in Column 4 confirms a positive relationship between the number of foreign workers from the country of the firm s origin and the probability that the firm will have an owner-manager, and points to a negative host country endogeneity bias. According to the Difference-in-Differences model in Column 5, after the color revolution, entrepreneurs from the affected countries were significantly more likely to manage their firms in Russia personally. An increase in the probability of having an ownermanager for a firm that entered after the color revolution is 15 percentage points, compared to a similar firm that entered before. 6 Analysis: Performance Implications 6.1 Empirical Strategy Hypothesis 2 predicts that when owner-managers come from the country whose citizens more frequently work in Russia, they will be more willing to accept low firm profit than ownermanagers of similar firms with fewer nationals in Russia, because the former are compensated 21

22 with private benefits of relocation. I begin with a simple descriptive test: I expect that the performance of firms with owner-managers from countries with a high number of citizens working in Russia should be lower than the performance of other similar owner-managed firms and the coefficient for the interaction term, ( foreign workers, in equation 5 should be OM Ln ) i negative. OROA it 0 OM 1 i 2 Ln( foreign workers ) j OM 3 i Ln( foreign workers j ) controls where Controls include firm-level and country-level control variables as in the equations above and the year of entry and the year of observation dummy variables. I use a pooled cross-sectional dataset of firms. Standard errors are clustered on firm. 19 In the next step, I examine what would happen to firm performance if entrepreneurs based their decision to become owner-managers on their desire to relocate. I expect that when entrepreneur-managers base their decisions to become owner-managers solely on the relocation benefits, their firms will perform worse than they would perform under hired managers. I use a two-stage model: In the first stage, the owner-manager choice is predicted based on the entrepreneur s desire to leave his country, proxied by the number of immigrants to 12 OECD countries. In the second stage, I estimate the effect of the predicted owner-manager choice on firm performance. If entrepreneurs based their manager choice solely on their desire to relocate, foreign owner-managers would negatively affect firm performance relative to hired managers. Thus, the coefficient for Owner-manager variable in the second stage of the 2SLS model below should be negative. n n ( j k p pj D i Y t, (6) it k 1 p 1 OM i Ln oecd ) Z kit G OROA it OM 1 i n Z k kit k 1 p 1 n G p pj Di Y t it, (7) j it,(5) 19 Clustering on country does not change the results as well as using a cross-section of firms 1 year after entry. 22

23 For the estimation, I once again use pooled cross-sectional dataset 20 and cluster standard errors on firm. 21 I use immigration to OECD countries as a less endogenous predictor than the number of foreign workers in Russia. 22 Standard errors are clustered on firm. Finally, I examine how color revolutions affect performance of firms with ownermanagers. I expect that for the owner-managers who entered after the color revolutions, private benefits of relocation are higher than for those owner-managers who entered before. Thus if we compare firms in a Difference-in-Differences model, firms with owner-managers from the affected countries that entered after the color revolutions (in the three consecutive years starting with the year of the revolution) should demonstrate a lower OROA than owner-managed firms that entered before. In contrast, firms with hired managers should not experience any decrease in OROA. The Difference-in-Differences model is reported in equation 8, where I compare performance of firms at the age of 1 year. 23 Standard errors are clustered on country. OROA i 0 1 color revolution j n Z k ki k 1 p 1 n Z p pj Di C j i, (8) 6.2 Results Table 5 demonstrates support for Hypothesis 2: Column 1 shows that while firms with owner-managers perform better than firms with hired managers, this effect is lower for ownermanagers from countries with high work migration to Russia. The coefficient for the interaction term implies that for the 10% increase of the number of foreign workers in Russia from country j, the performance of firms with owner-managers from country j will decrease by But the results also hold if I limit sample to firms at the age of 1 year. 21 Home-country level variables are taken in the year of entry; firm-level variables are taken in the year of observation. Owner-manager dummy is constant within a firm and taken in the year of entry. Control variables no longer include non-cis dummy variable, because it is unlikely to simultaneously affect both owner-manager choice in Russia and immigration to OECD countries. 22 The number of foreign workers produced similar results. 23 One year was chosen as the year when all entering firms are represented. In later years, some unsuccessful firms may cease operations and only relatively successful firms will be left, which may bias the results of the Differencein-Differences model. I do not use multiple years per firm in order not to inflate the Diff-in-Diffs results. 23

24 percentage points. This effect would account for a -7 percentage point difference between an owner-managed firm from China (229 thousand workers in Russia) and an otherwise similar owner-managed firm from the U.S. (5 thousand workers in Russia). This effect can also be observed in Figure 4, where I plot a predicted effect of an owner-manager on OROA relative to a hired manager Insert Table 5 about here Insert Figure 4 about here The results of the 2SLS model, in Columns 2 and 3, suggest that when the ownermanager choice is based on the desire to relocate, an owner-manager negatively affects firm OROA relative to a hired manager. Difference-in-Differences models with color revolutions, in Columns 4 and 5, show that firms with owner-managers from the affected countries that entered after the color revolutions have a 9 percentage point lower OROA, whereas firms with hired managers do not demonstrate any significant difference in performance. Note that firms from the countries with the color revolutions that entered before the revolutions also exhibit no performance change after the revolutions. As mentioned in the theory section, the lower performance lower performance of the owner-managed firms with higher private benefits of owner-management relative to other owner-managed firms can be explained by two potential mechanisms. First, some entrepreneurs with private benefits may manage their firms personally even when it would be economically justified to use a hired manager. Second, entrepreneurs with private benefits may open and manage lower-quality firms compared to other entrepreneurs. While the data do not allow me to clearly separate these two mechanisms, it is still useful to get some insights on them. 24