Asymmetric Information and Entrepreneurship

Abstract

Why do individuals become entrepreneurs? We develop a model in which individuals signal their unobservable ability to employers (e.g., via educational qualifications). However, signals are imperfect and individuals whose ability is greater than their signals convey to employers choose entrepreneurship. Our empirical analysis of two separate nationally representative longitudinal samples of individuals residing in the U.S. and the U.K. 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 those of employees with similar signals.

Keywords: entrepreneurship, employment, occupational choice

JEL Classification: L26, J24