Harvard University Department of Economics

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1 Harvard University Department of Economics Entrepreneurship and Venture Capital Economics 970 Eliot House, E-14 Spring 2006 Tuesday, Thursday Quantitative level: 2 2:30-4pm Instructor: Wan Wong wan@hbs.edu Office: Morgan Hall 362-C, HBS Telephone: (617) I. COURSE DESCRIPTION Entrepreneurship is a powerful economic force. In the US alone, more than half a million new businesses are started each year. Many fail, but a few achieve spectacular success and become household names such as Microsoft, HP, Dell, and Google. The rapid development of the US economy over the past decades has been accompanied by large doses of creativity, risk taking, innovation and passion. Indeed, new dynamic theories of the economy suggest that entrepreneurial activities provide a constant flow of new ideas and experimentation vital to the health of the economy as a whole. But transforming creative ideas into commercially viable businesses is a major challenge for entrepreneurs and investors alike. Financial intermediaries such as venture capitalists facilitate this process. Emerging in its modern form in the US around the late 1960s, venture capital has grown into a sizeable industry whose importance is reflected in the fact that one third of all initial public offerings today are backed by venture capital. This tutorial will explore these fascinating areas of economic activity. What is entrepreneurship? What makes a good entrepreneur? Does success require special traits and skills or just luck? What roles do venture capital and other forms of private equity play? Can large companies follow the examples of successful individual entrepreneurs in pursuing innovation? We will apply modern theories of business and economics to shed some light on these questions and others. II. COURSE OBJECTIVES To build on the foundations laid in earlier courses by applying frameworks of economic analysis to specific subject areas To help students develop an effective style for writing analytical economics papers To practice the art of analysis, communication, argument, and listening To practice applying statistical methods to the analysis of data III. COURSE REQUIREMENTS Class participation (25%) Attendance is mandatory. Class discussions are an essential component of the sophomore tutorial. Your preparation time should be allocated both to reading and understanding the assigned materials, and to reflecting upon and challenging their assumptions, results, and relevance. You will be evaluated on punctuality, the quality of your participation as well as your ability to discuss and challenge the ideas of your classmates. 1

2 Response papers (15%) Students will prepare 10 (out of a possible 19) commentaries on class sessions (classes 2 to 21 inclusive, but excluding class 13). These short commentaries (up to one page in length, single spaced) are due by 9am on the day of the relevant class, and are intended to evoke some thoughtful consideration of the material read, for example, exploring an issue or concept in greater depth, raising some theoretical or empirical questions, comparing and contrasting approaches or findings across the readings, etc. These are not meant to be a big burden on students time, and bullet point formats are not only acceptable, but encouraged. Note that these are meant to be reaction pieces and not summaries (i.e. write about what you liked and disliked, what else the readings made you think of, whether you thought the authors arguments were persuasive, etc.). Short essays (15%) Two short essays totaling approximately 4-6 pages of writing will be assigned. In these essays, your ability to support assertions with evidence and economic logic will be evaluated. Empirical paper (15%) We will design a study to conduct an empirical investigation. You will be required to construct an econometric model, analyze the results, and report your findings and conclusions (2-3 pages). Term paper (including prospectus) (30%) You will be required to submit a term paper of pages related to one of the topics addressed in the course. In preparation for the term paper, you will need to submit a prospectus in which you propose a thesis or question, and outline how you will address the issue and your proposed approach. The prospectus will be due on April 20, 2006, and the final term paper itself will be due by noon on Friday May 12, Assignment schedule Due date Response papers By 9am on relevant day Short essay #1 February 28, 2006 Short essay #2 March 21, 2006 Empirical paper April 11, 2006 Prospectus for term paper April 20, 2006 Term paper By noon on May 12, 2006 Grading summary Final grades will be determined as follows: Class participation 25% Response papers 15% Short essays 20% Empirical paper 10% Term paper (including prospectus) 30% IV. COURSE POLICIES Attendance Attendance is mandatory at all regular class meetings. Exceptions will be granted only on a case-bycase basis. If you do not have enough time to sufficiently prepare for a class, you should still attend, but you must let me know before the start of class that you are not as prepared as you would like to be. We all have other things going on in our lives and will occasionally face severe time constraints. This is not a problem as long as it does not happen often and we set the right expectations upfront. Deadlines No assignment will be accepted beyond the announced deadline. As with attendance, exceptions will only be considered on a case-by-case basis. 2

3 Submission of assignments All assignments should be submitted by before expiry of the deadline. Office hours There will be no official regular office hours, but I am available to meet with students at mutually convenient times. Please me to schedule meetings. My office is in Morgan Hall on the Allston side of the Harvard campus. V. READINGS The readings for this class are listed in the accompanying list (pages 4 to 6). Not all of them will be required to be read in their entirety. I will specify beforehand which sections of the readings to focus upon. Most of the required readings are available on e-journals at Harvard s libraries. I will distribute electronic copies whenever possible. There will also be a small number of HBS cases that students will need to purchase. VI. WRITING Writing is a form of communication. Developing good writing skills will serve you well in your future careers. You should approach your writing for this class as you would approach any effort to effectively communicate your ideas. In particular, effective communication should: have a clear thesis what is your point? include support for your thesis what are you basing your views on? be interesting to read and write do not excessively focus upon the formal structure of your writing. It is important to structure your writing such that a reader can follow your line of thought. Do not be messy in terms of style. Pick a style (e.g. for citing references) and stick to it. But most importantly, don t let anything get in the way of making your communication interesting. Maintaining the interest of your audience is one of the most important and often most forgotten aspects of communication! be stylistically and grammatically correct, and free of spelling errors in this age of the word processor and built-in spell-checkers, typographical errors reveal negligence on the part of the writer. not be one-sided you are not writing as a lawyer, you are writing as a scientist. You should therefore acknowledge the limits of your analysis and be willing to consider alternative theories. Students are encouraged to take advantage of the services of the Harvard Writing Center, on the Garden Level of the Barker Center, at 12 Quincy Street ( VII. ACADEMIC HONESTY You are welcome to bring ideas from any source into this course. However, you must always clearly state where your ideas came from, give proper credit where credit is due, and provide adequate references so that an interested reader can easily go back to the source. You should familiarize yourself with the university s policies on plagiarism and read Writing with Sources: A Guide for Harvard Students (available online at 3

4 Entrepreneurship Class 1: Entrepreneurs in Economic Theory Ec 970 Entrepreneurship and Venture Capital Schedule of Readings (Spring 2006) Thursday, February 09, 2006 Casson, Mark, "Entrepreneurship", The Concise Encyclopedia of Economics. Liberty Fund, Inc. Ed. David R. Henderson. Library of Economics and Liberty. < Formaini, Robert L., The engine of capitalist process: entrepreneurs in economic theory. Economic and Financial Review, Federal Reserve Bank of Dallas, Fourth Quarter Smith, Robert, The Fabrication of Entrepreneurial Fable: A Biographical Analysis. Journal of Private Equity, Fall Class 2: Class 3: Class 4: Class 5: Entrepreneurship and Geography Said, Carolyn, Silicon Valley Humming Again. San Francisco Chronicle, October 30, The S-Curve and Disruptive Technologies Sources of entrepreneurs Khanna, Tarun, Rajiv Lal, and Merlina Manocaran, February Mahindra & Mahindra: Creating Scorpio. HBS Case Universities and Start-Ups Tuesday, February 14, 2006 "How It Really Works" and other articles, Special Report - Silicon Valley, BusinessWeek, August 25, Thursday, February 16, 2006 Christensen, Clayton M. and Joe. L Bower, Customer Power, Strategic Investment, and the Failure of Leading Firms, Strategic Management Journal 17, Foster, Richard N., Innovation: The Attacker s Advantage. Summit Books (a division of Simon & Schuster, Inc.), 1986, pp (Chapter 4: The S-Curve: A New Forecasting Tool. ) Tuesday, February 21, 2006 Anton, James J. and Dennis A. Yao, 1995, Start-ups, spin-offs, and internal projects, Journal of Law, Economics and Organization 11, Thursday, February 23, 2006 Di Gregorio, Diane and Scott Shane, Why do some universities generate more start-ups than others?, Research Policy, February 2003, p Shaywitz, David A., Entrepreneurs - missing link in training medical scientists. San Francisco Chronicle, October 27, "The Startup Bug Strikes Earlier" and other articles, Special Report - Young Entrepreneurs, BusinessWeek, October 31, "Dropping Back In", Inc Magazine, June Belluck, Pam, At Harvard, an Unseemly Display of Wealth or Merely a Clean Room?, The New York Times, March 22, Evolution of Venture Capital and Private Equity Class 6: The New Kings of Capitalism Short Essay #1 due. Tuesday, February 28, 2006 Bishop, Matthew, Capitalism s New Kings: How Private Equity is Changing the Business World. The Economist survey, 27 November The Double Helix: Entrepreneurship and Private Equity. Future Trends in Private Equity Investment Worldwide. Apax Partners, Class 7: Economics of the Private Equity Market Thursday, March 02, 2006 Fenn, George, Nellie Liang and Stephen Prowse, The Economics of the Private Equity Market. Staff Studies series, Federal Reserve System. 4

5 Class 8: Class 9: Venture Capital Gompers, Paul, The Rise of Venture Capital, Business and Economic History 23, Valuation Student case presentation #1. Tuesday, March 07, 2006 Gorman, Michael and William Sahlman, What Do Venture Capitalists Do?, Journal of Business Venturing 4, Gompers, Paul and Josh Lerner. The Money of Invention How Venture Capital Creates New Wealth, Boston: Harvard Business School Press, (Chapter 2: The Problem: Financing Entrepreneurial Firms and Chapter 3: The Financing Solution: Venture Capit Thursday, March 09, 2006 Lerner, Josh and John Willinge, A note on valuation in private equity settings, Harvard Business School Case Lerner, Josh and Felda Hardymon, A note on private equity securities, Harvard Business School Case Hardymon, Felda, Josh Lerner, and Ann Leamon, AIT Group Plc, HBS Case Class 10: How do LBO specialists make money? Student case presentation #2. Ahmad, Faisal, Leveraged Buyout Specialists: Sources of Value. Hardymon, Felda, Josh Lerner, and Ann Leamon, Brazos Partners: the CoMark LBO, Harvard Business School Case Class 11: Hedge Funds and Private Equity Class 12: Private Equity Investors Short Essay #2 due. "Making private equity work. Private Equity International article, November Keefe, John, Industry Elite. Institutional Investor Magazine, November 10, Tuesday, March 14, 2006 Thursday, March 16, 2006 The Differences Between Mutual Funds and Hedge Funds, Investment Company Institute. Implications of the Growth of Hedge Funds, Staff Report to the United States Securities and Exchange Commission, September Raman, Ananth, Vishal Gaur and Saravanan Kesavan, "David Berman," Harvard Business School Case Why endowments do it better. Private Equity Online article, November Tuesday, March 21, 2006 Lerner, Josh, Antoinette Schoar, and Wan Wong, Smart Institutions, Foolish Choices? The Limited Partner Performance Puzzle, Journal of Finance, forthcoming. Lerner, Josh. Yale University Investments Office: June 2003, Harvard Business School Case Class 13: Event Studies - lecture and demo Slides on event studies Thursday, March 23, 2006 From Innovation to Growth: IPO exits Class 14: The dot-com Crash of 2000 Healy, Paul M. and Krishna G. Palepu, How the Quest for Efficiency Corroded the Market, Harvard Business Review, Boston: Jul Vol. 81, Iss. 7, p Tuesday, April 04, 2006 Palepu, Krishna G. and Gillian Elcock, The Role of Capital Market Intermediaries in the Dot-Com Crash of 2000, Harvard Business School case

6 Class 15: Initial Public Offerings Loughran, Tim and Jay R. Ritter, The New Issues Puzzle, Journal of Finance, Vol. 50, No. 1. (Mar 1995), Brav, Alon and Paul Gompers, Myth or Reality? The Long-Run Underperformance of Initial Public Offerings: Evidence From Venture and Nonventure-Backed Companies, Journal of Finance. Class 16: Venture Capital and IPOs (1) Empirical paper due. Thursday, April 06, 2006 Tuesday, April 11, 2006 Cossin, Didier, and Dinos Constantinou, Preparing for the Google IPO: A revolution in the making?, IMD Case IMD185. Class 17: Venture Capital and IPOs (2) "Commentary: Refco: The Reckoning," BusinessWeek, November 7, Wong, Wan, Good VCs, Bad VCs, working paper, Harvard University. Thursday, April 13, 2006 Beyond IPOs Class 18: Life cycle of firms Greiner, Larry E. Evolution and Revolution as Organizations Grow. Harvard Business Review, May-June Bulan, Laarni T., Subramanian, Narayanan and Tanlu, Lloyd D., September On the Timing of Dividend Initiations, working paper, Brandeis University and Harvard University. Class 19: The Impact of Venture Capital Class 20: Globalization Prospectus for term paper due. Venture Capital Benefits to the US Economy. Global Insight Report, June Anderson, Howard, Good-bye to Venture Capital. MIT Technology Review, June Class 21: Frontiers of private equity Tuesday, April 18, 2006 Thursday, April 20, 2006 Kortum, Samuel and Josh Lerner, Assessing the Impact of Venture Capital on Innovation, Rand Journal of Economics 31, Tuesday, April 25, 2006 Lerner, Josh, and Gonzalo Pacanins, A note on private equity in developing countries, Harvard Business School Case Creating a Technology Hotbed In China: Lessons Learned from Silicon Valley and Israel. Ernst & Young Report, September Mann, Catherine, The Globalization of Venture Finance, in "Understanding Entrepreneurship, A Research and Policy Report 2005", Kauffman Foundation. Thursday, April 27, 2006 Lerner, Josh, Felda Hardymon, Ann Leamon, and Kevin Book, In-Q-Tel. Harvard Business School Case Class 22: Student presentations (1) Class 23: Student presentations (2) Tuesday, May 02, 2006 Thursday, May 04, 2006 Final papers are due by noon on Friday, May 12,