Entrepreneurship and the Stigma of Failure

37 Pages Posted: 21 Nov 2005

Date Written: November 2005

Abstract

Entrepreneurial activity varies substantially across regions and sectors and appears to be related to the stigma of failure. To understand this phenomenon, I present a multiple-equilibrium model based on endogenous stigma of failure. Using private information, entrepreneurs choose whether to continue a project or to abandon it and raise funds to undertake a new project. Project outcomes depend on luck and ability, and the cost of capital for failed entrepreneurs is determined by the market's expectations about their ability. In the conservative equilibrium failed entrepreneurs face a high cost of capital and thus good entrepreneurs are reluctant to terminate a project. The resulting low quality of the pool of failed entrepreneurs justifies in turn the high cost of capital. The reverse is true in the experimental equilibrium where good entrepreneurs are more willing to start again and the cost of capital for failed entrepreneurs is low. The experimental equilibrium is not always efficient: The conservative equilibrium dominates in low-risk and capital intensive sectors. I study in this context the efficiency of institutions such as bankruptcy rules and fresh start policy. I show that policies aimed at increasing the survival of start-ups can have important counterproductive effects.

Keywords: entrepreneurship, innovation

JEL Classification: M13, 030, 031

Suggested Citation

Landier, Augustin, Entrepreneurship and the Stigma of Failure (November 2005). Available at SSRN: https://ssrn.com/abstract=850446 or http://dx.doi.org/10.2139/ssrn.850446

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