The Old-Boy Network and the Quality of Entrepreneurs

Authors


  • The authors thank Richard Arnott, Jing-Yuan Chiou, Toker Doganoglu, Firat Inceoglu, Daniel Spulber (the editor), the anonymous coeditor, the two anonymous referees, the participants at the 64th European Meeting of the Econometric Society, 2009 Annual Meeting of ASSET, and Ifo/CESifo & ACES Conference on Banking and Institutions, especially the discussant Katharina Eck, and seminar participants at METU and IMT-Lucca for helpful comments. Inci acknowledges CESifo sponsorship for his conference presentation.

Abstract

We study a model of network formation and start-up financing with endogenous entrepreneurial type distribution. A hub firm admits members to its network based on signals about entrepreneurs' types. Network membership is observable, which allows lenders to offer different interest rates to network and stand-alone entrepreneurs. We show that a network outcome can display a smaller number of high-type entrepreneurs even though the network is neither nepotistic nor informationally disadvantaged. Although a welfare-improving network can emerge as a technically stable or unstable equilibrium, one that decreases welfare is always formed by a technically unstable equilibrium. However, the adverse welfare effects of a network and its corresponding type configuration may persist because ex post high-type entrepreneurs prefer to stay high type whereas those who wish to become high type may need some time to react.

Ancillary