Integrated Communities Benefit More from Venture Capital
The less segregated a community is, the more likely people of diverse backgrounds will mix and generate ideas. A new study co-authored by Yale SOM professor Olav Sorenson suggests that this mixing is a boon to venture capital, leading to more innovation and more economic growth.
Aerial photos of, from left, Boston, Chicago, and San Francisco
Diversity has long been a goal of businesses, universities, and communities. In addition to providing basic fairness to those who might otherwise be shut out, a diversity of experiences and points of view is believed to be beneficial to organizational performance. A new study co-authored by Professor Olav Sorenson extends this idea by showing that ethnically integrated communities get greater benefit from venture capital investment than more segregated ones.
The benefit to more integrated communities was economically meaningful. The study found that “a city one standard deviation more racially integrated than the average enjoyed at least 30% larger effects of venture capital in terms of promoting innovation and entrepreneurship and creating jobs and wealth.”
“The story is about how more integrated communities bring people together who would never come in contact in those that are more segregated,” said Sorenson, the Frederick Frank ’54 and Mary C. Tanner Professor of Management. “You see not just more startups, but ones that create more value, create more jobs, and create more economic growth.”
Sorenson and his co-author, Sampsa Samila, assistant professor at IESE Business School, began their research by trying to determine whether or not social structure within a community was important for economic growth. Previous studies suggested that social interaction across a community enhances economic vitality. Sorenson and Samila set out to look at multiple communities to observe whether social relationships do, in fact, influence growth. They chose to focus on venture capital because of its role in funding high-growth businesses and the importance of relationships to venture capitalists.
The researchers used the level of integration in an area as a proxy for how likely people in that community were to have relationships that crossed ethnic lines. “People tend to lead local lives,” said Sorenson. “They interact with people in the same block or neighborhood. In more integrated communities, you get more diverse and connected networks, allowing people access to a much larger set of information and resources than in those that are more segregated.”
These relationships have significant implications for venture capital. Venture capitalists tend to invest in startups near them, relying on friends and professional acquaintances for leads, as well as the kind of information they couldn’t get with a Google search or a cold call.
In their research, Sorenson and Samila studied Metropolitan Statistical Areas, comparing venture capital investments to the number of patents, new businesses, employment, and aggregate income. When ethnic integration is factored in, the data shows that the less segregated an MSA is, the better venture capital performs. In the short term, for example, a metro area one standard deviation above the mean in residential integration enjoys at least a 30% larger stimulus from an increase in venture capital. Over the long term, for a city one standard deviation more integrated than the average, this translates to six more patents, 2,100 more jobs, and $180 million in added payroll with a doubling in venture capital. “Over time,” Sorenson said, “these differences can account for a significant share of the differences in growth among communities.”
For one exercise, the pair calculated how far a dollar in venture capital would grow when applied to various cities. Using Boston as a benchmark, they found a significant swing, with the Bay Area creating roughly 15% more value than Boston, and Chicago getting about 16% less value than a dollar invested in Boston.
The researchers also speculate that a similar benefit from integration may operate at the national level. They point to the difference between the “melting pot” model of immigration in the United States and the “salad bowl” approach in some other countries. “This is just speculative,” Sorenson said, “but I think one of the reasons the U.S. has gotten more out of innovation could be a result of how much better immigrants integrate. When different people live close to each other, there are more opportunities for serendipitous interaction. It becomes easier to make connections, and you end up with more and better ideas.”