Inherited Agglomeration Effects in Hedge Funds

This paper studies inherited agglomeration effects, how human capital that accrues to managers while working at a parent firm in an industry hub can be subsequently transferred to a spinoff. We test for inherited agglomeration effects in the context of the hedge fund industry and find that hedge fund managers who previously worked in New York and London outperform their peers who worked elsewhere previously by 10-14 basis points per month or about 1.5% per year. The results are driven by managers who worked in investment management positions previously, and are at least as large as traditional agglomeration effects that arise from being located in an industry hub contemporaneously. The evidence suggests that inherited agglomeration effects are an important, but as yet overlooked, factor influencing the performance of new firms. INTRODUCTION Entrepreneurial spawning, the founding of new companies by employees of incumbent (“parent”) firms, is a key driver of entrepreneurial activity in the economy (Bhide, 2000), and an important branch of the literature has shed light on the phenomena and its antecedents (Agarwal, Echambadi, Franco and Sarkar 2004; Gompers, Lerner and Scharfstein, 2005). While it is well established that the resources an entrepreneur brings to a spawn at founding impact the performance of the new venture (Stinchcombe 1965; Boeker, 1988, 1989), and that new firms are shaped by the experience entrepreneurs gain through prior employment (e.g., Dencker, Gruber and Shah, 2009; Fern, Cardinal and O’Neil, 2011), there is still much we do not know * We thank Rajshree Agarwal, Raffi Amit, Iwan Barankay, Charles Baden-Fuller, Olivier Chatain, Gary Dushnitsky, Simone Ferriani, David Hsu, Sascha Klamp, Joris Knoben, Ethan Mollick, Chris Rider, Lori Rosenkopf, Harbir Singh, MB Sarkar, and participants at the Atlanta Competitive Advantage Conference, the EGOS conference in Lisbon, the DRUID conference, the Strategic Management Society conference in Rome and the Academy of Management conferences in Montreal and San Antonio for helpful comments and suggestions. Maeve Flynn, Elaine Ho, Bryan Hsu, Nicole Wang and Austin Winger provided outstanding research assistance. We are grateful to the Wharton Entrepreneurship and Family Business Research Centre at CERT, the Kauffman Foundation, and the Rodney L. White Center for Financial Research at The Wharton School for their generous financial support. 2 about how managers’ prior employment experience influences the performance of entrepreneurial spawns. Yet understanding why some new firms thrive while others fail is of great importance for scholars and practitioners alike. Indeed, Helfat and Lieberman (2002) write that “surprisingly little is known about [the birth of capabilities and resources within organizations], despite its centrality to the understanding of firm evolution” (p.725). More recently Chatterji (2009) highlights the need for more research on how parent firm characteristics influence the performance of spawns, writing “it would be interesting to attempt to further differentiate between . . . parent firms . . . (as) there is more work to be done in comparing the performance of spawns based on the characteristics of their parent firm” (p.202), an observation echoed by Fern, Cardinal and O’Neil (2011) who note, “few studies have explored how prefounding experience influences . . . a new venture’s . . . performance.” This paper examines an intuitive, but largely overlooked, channel through which performance effects are transferred from parent firms to new firms: inherited agglomeration effects—the economic benefits that accrue to managers while working at a parent firm in an industry hub that can be subsequently transferred to a spinoff, regardless of where the new venture is located. We use the term “inherited” agglomeration effects to emphasize that the economic benefits of agglomeration are appropriated and transmitted from parent firms in industry hubs via managers who leave to manage spawns and to distinguish between this effect and traditional agglomeration effects. While there is a large and prominent literature examining how a new venture’s location in an industry hub influences its performance (e.g., Audretsch and Feldman, 1996; Stuart and Sorenson, 2003), there is little research on how parent firm 1 We use the terms spawn and spinoff interchangeably throughout. 2 Traditional agglomeration effects are economic benefits firms enjoy concurrently from being physically located in an industry hub. While we also measure traditional agglomeration effects in our empirical application, our main interest is with inherited agglomeration effects.