Why do individuals become entrepreneurs? – New York University Research #Entrepreneurship

Why do individuals become entrepreneurs?

This is a research paper review.

This research paper was published by the New York University professors Deepak Hegde and Justin Tumlinson. In this paper they posit that there are 2 theories, both of which are based on information asymmetries.

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

Information Frictions and Entrepreneurship

The researchers have built a mathematical model to view data on a) who becomes an entrepreneur vs working at a firm, b) what their earnings over time are and c) why do entrepreneurs choose to start a company.

Empirical analysis of longitudinal samples from the U.S. and the U.K. reveal the following patterns:

(i) entrepreneurs have higher cognitive 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.

What this means it that employers value people’s degree, credentials, etc. Most entrepreneurs believe they are as good (or better) than their peers who might have graduated with a degree from a better institution.

For example, potential employers commonly accept educational attainment and work history as signals of unobservable ability. However, the signals are imperfect if a worker believes his ability exceeds what potential employers can infer from his observable characteristics, then he chooses entrepreneurship and becomes residual claimant of his productivity, rather than join a firm in which he would be paid according to his observable signals.