Possible explanations for earnings differentials in self‐employment and paid employment are investigated. The empirical results suggest that the nonpecuniary benefits of self‐employment are substantial: Most entrepreneurs enter and persist in business despite the fact that they have both lower initial earnings and lower earnings growth than in paid employment, implying a median earnings differential of 35 percent for individuals in business for 10 years. The differential cannot be explained by the selection of low‐ability employees into self‐employment and is similar for three alternative measures of self‐employment earnings and across industries. Furthermore, the estimated earnings differentials may understate the differences in compensation across sectors since fringe benefits are not included in the measure of employee compensation.
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