The Effect of Regime Change on Entrepreneurship: A Real Options Approach with Evidence from U.S. Governor Elections

Entrepreneurship Illustrations

Author Information
David S. Lucas
Department of Entrepreneurship & Emerging Enterprises
Research Fellow, Institute for an Entrepreneurial Society
Whitman School of Management
Syracuse University

Journal (Year)
Journal of Business Venturing (forthcoming)

Summary of Your Paper
The paper finds that growth-oriented entrepreneurial activity is reduced and delayed when the political party of a governor changes hands, demonstrating how prospective entrepreneurs grapple with political uncertainty.

Research Questions
1. What is the effect of regime change (the change of partisan political power) on early-stage entrepreneurial activity?
2. How does this effect differ for growth-oriented vs. non-growth entrepreneurial activity?


What We Know
The political environment is certainly not the only determinant of entrepreneurial activity, but it is an important one. To that end, the electoral turnover of political power, a form of “regime change,” is widely considered a bedrock feature of modern democracy. But it is not clear from existing research how regime change would affect entrepreneurial activity. For instance, scholars have argued that policy uncertainty hinders entrepreneurship, but there is relatively little causal evidence on this. And on the other hand, regime change could plausibly help entrepreneurs—e.g., if it breaks up “rent-seeking” activity often generated by connections between incumbent politicians and incumbent firms. So, while we know that elections are a source of uncertainty, we have little evidence about how electoral turnover of political power affects early-stage entrepreneurial activity.


Novel Findings
The paper uses "real options theory" to develop a novel theory with three main arguments, each of which is supported in the findings. First, I argue that early-stage entrepreneurial activity will be reduced when an election yields a regime change, because uncertainty about future policy makes the value of the prospective ventures more volatile. I focus on changes in early-stage activity right after vs. right before the election, using monthly data to closely align with the spike in uncertainty. Second, I suggest that prospective growth-oriented ventures—those looking to hire employees—will be most susceptible to this disruption and hence most negatively affected right after the election. Third, and most novel, I suggest that some of this reduction in activity right after the election is not purely a "decline," but rather a "delay" of activity to a later period. Hence, some of the prospective entrepreneurs that "would have" moved forward after the election instead should appear as a positive boost in entrepreneurial activity in a later period—specifically for those growth-oriented ventures that were most deterred initially. I test all these using monthly data on new business applications, and I find results consistent with the theory as above.


Novel Methodology 
This paper is one of the first in entrepreneurship journals to use a method for causal analysis called the "regression discontinuity design." The intuition is that you can compare entrepreneurial activity in states that experience very close elections—those where an incumbent party's candidate barely wins to those where the challenging party's candidate barely wins—to identify a "causal" effect. The paper also presents a novel approach to affirming the "sensitivity" of these results, showing that the findings are quite consistent across hundreds of thousands of plausible versions of the regression discontinuity design.

Implications for Policy
From a policy standpoint, my work offers evidence in support of the premise that political stability facilitates entrepreneurship. The regime changes that I study inject uncertainty that deters entrepreneurship. Of course, such uncertainty must always be understood in its proper context. It seems clear that a level of uncertainty associated with free and fair elections does not undermine their value. Overall, then, the policy takeaway is that predictability should be considered as an important element of a policy environment conducive to an entrepreneurial society.

Full Citation
Lucas, David S. “The Effect of Regime Change on Entrepreneurship: A Real Options Approach with Evidence from U.S. Governor Elections." Journal of Business Venturing, forthcoming.

Although political turnover is said to be a healthy component of the business environment, the literature is equivocal about the effects of regime change on early-stage entrepreneurial activity. I present incumbent displacement—the electoral defeat of an incumbent political party’s candidate—as a source of regime change, and I analyze how this affects business formation through the lens of real options theory. I test my theory using US gubernatorial elections from 2004–2022, leveraging a regression discontinuity design to compare changes in business formation trends following elections where a challenger party candidate wins or loses by a close margin. I find that regime change reduces venture creation activity for growth-oriented ventures specifically. I also find evidence of a partial rebound in subsequent months—suggestive that some entrepreneurs delay entry while others permanently abandon their ventures.

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