Self-Employment Dynamics and the Returns to Entrepreneurship
Small business owners and others in self-employment have the option to transition to paid work. If there is initial uncertainty about entrepreneurial earnings, this option increases the expected lifetime value of self-employment relative to pay in a single year. This paper first documents that moves between paid work and self-employment are common and consistent with experimentation to learn about earnings. This pattern motivates estimating the expected returns to entrepreneurship within a dynamic lifecycle model that allows for non-random selection and gradual learning about the entrepreneurial earnings process. The model accurately fits entry patterns into self-employment by age. The option value of returning to paid work is found to constitute a substantial portion of the monetary value of entrepreneurship. The model is then used to evaluate policies that change incentives for entry into self-employment.
We thank Kelly Bishop, Luis Garicano, Erik Hurst, Bill Kerr, Edward Lazear, David de Meza, Robert Miller, Ramana Nanda, Paul Oyer, Luis Rayo, Yona Rubinstein, Nathan Seegert, Jeff Smith, Chris Taber, Galina Vereschagina, Matthew Wiswall, and seminar and conference participants at Arizona State University, IZA, the London School of Economics, the NBER Summer Institute, the Utah Winter Business Economics Conference, Wisconsin, and Wharton for helpful comments. All errors are our own. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.