Destructive Creation at Work: How Financial Distress Spurs Entrepreneurship

Abstract

Using U.S. Census firm-worker data, I document that firms' financial distress has an economically important effect on employee departures to entrepreneurship. The impact is amplified in the high-tech and service sectors, where employees are key assets. In states with enforceable noncompete contracts, the effect is mitigated. Compared to typical entrepreneurs, distress-driven entrepreneurs are high-wage workers who found better firms, as measured by jobs, pay, and survival. Startup jobs compensate for 33% of job losses at the constrained incumbents. Overall, the financial inability of incumbent firms to pursue productive opportunities increases the reallocation of economic activity into new firms.

Keywords: Financial distress, Capital Structure, Entrepreneurship, Start-ups, Human Capital

JEL Classification: D22, D24, G32, G33, L22, L26