Asymmetric Information and Entrepreneurship

Abstract

Why do individuals become entrepreneurs? We argue that information asymmetries and the quest to maximize pecuniary returns produce entrepreneurs. In our model, individuals signal their hidden ability to employers (e.g., via educational qualifications). However, signals are imperfect and individuals with greater ability than their signals convey to employers become entrepreneurs. Empirical analysis of two longitudinal samples of U.S. and U.K. residents supports the model's predictions that (i) entrepreneurs have higher ability than employees with comparable signals, (ii) employees have better signals than equally able entrepreneurs, and (iii) entrepreneurs' earnings are higher and exhibit greater variance than employees' with similar signals.

Keywords: entrepreneurship, employment, occupational choice

JEL Classification: L26, J24