Self-Employment Dynamics and the Returns to Entrepreneurship

Abstract

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.

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