Information Frictions and Entrepreneurship

Abstract

Why do individuals become entrepreneurs? Why do some succeed? We propose two theories in which information frictions play a central role in answering these questions. Empirical analysis of two national longitudinal samples reveal the following patterns: (i) entrepreneurs have higher ability than employees with comparable education, (ii) employees have better education than equally able entrepreneurs, and (iii) entrepreneurs' earnings are higher and exhibit greater variance than employees with similar education. These, and other empirical tests support our asymmetric information theory of entrepreneurship that when information frictions cause firms to undervalue workers lacking traditional credentials, workers' quest to maximize their private returns drives the most able into successful entrepreneurship.

Keywords: Entrepreneurship; Asymmetric Information; Signaling; Education; Job-matching

JEL Classification: L26, J24