The Rewards to Entrepreneurship

Abstract

The study examines differences in the incomes of entrepreneurs and paid employees and considers alternative explanations for such differences. We do so with the help of National Science Foundation surveys of recipients of BA/BS or higher degrees in science and engineering for the years 1995, 1997 and 1999. In contrast to the results of earlier studies, we find that entrepreneurs earned more on average than paid employees. However, they earned less at the low end of the income distribution. The difference in results for average income is explained by whom the various studies sampled.

We offer a model of asymmetric information, with a partial incorporation of risks in the context of a minimum wage. The differences in income dispersion reflect variations in the marginal products of entrepreneurial effort, which are, in part, a consequence of asymmetric information. Asymmetric information is also held to explain differences in the age profiles of income between entrepreneurs and paid employees with convergence in information and incomes at later ages.

Our empirical results show the effects of many observed variables such as age, experience in a specific job, MA and Ph.D. degrees, undergraduate grade point averages, marital status, gender, race, the education of parents and still other variables. We then examine the pattern of residuals from the regressions of income on the observed variables. An attempt is made to decompose the effects of the principal unobserved variables, namely talent and luck, with the help of an instrument for talent in the context of two-stage least square regressions. In general, the conclusion is that talent plays a much greater role in explaining the incomes of entrepreneurs than of paid employees.

Keywords: Entrepreneurial income, asymmetric information, human capital

JEL Classification: D20, J23