Reputation capital, financial capital, and entrepreneurship

Abstract

About 90% of entrepreneurs in the high-tech and professional service industries were previously employed in the same sector. In this paper, we provide a theory for how aspiring entrepreneurs choose an employer. We contrast ‘transparent’ employers (or firms) promoting personal accountability and employee empowerment with ‘opaque’ employers emphasizing team work and down-playing individual accomplishment. Markets use transparent firms' output to a larger extent to update employees' reputation since this output is more informative about individual talent. This has three effects. First, it harms employees who could become entrepreneurs if their reputation was maintained, but benefits the others. Second, it fosters effort, which raises wages, and thus the financial capital available to start a venture. Third, the perspective of entrepreneurship can induce employees to exert excessive effort, an effect that transparency exacerbates. We show that intermediate-reputation employees choose opaque firms, whereas higher- and lower-reputation employees choose transparent firms. Empirical implications follow.

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