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The Unobserved Returns to Entrepreneurship

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  • Sarada, FNO

Abstract

This paper seeks to understand the returns to self-employment. The analysis is motivated by the empirical puzzle that most entrepreneurs enter and persist in self-employment, despite lower initial earnings and earnings growth (Hamilton, 2000). I propose a new hypothesis to make sense of this observation. In particular, reported income is unlikely to be a good measure of the return to self-employment given the underreporting incentive, and opportunities available to business owners. Moreover, business owners also have access to multiple avenues for compensating themselves and their employees. As such, any survey of business owners will face great difficulties in capturing the many ways in which business income can be received. As evidence for the potential importance of such understating, Slemrod (2007) reports that the evasion rate amongst non-farm proprietorships varies between 18 and 57 percent depending on industry. In this paper, I make use of the PSID to test my hypothesis. The estimation strategy relies on the presumption that reported consumption by the self-employed will not be systematically misreported, even though income can easily be. The results indicate that individuals report earning 27 percent less but appear to consume 5 percent more in self-employment. This implies a 32 percent differential between reported wage and consumption for the selfemployed, indicating that the former measure is not a good barometer of the financial returns to self-employment. Furthermore, this increased consumption does not seem to be offset by higher uncertainty as evidenced by my finding, that the variance in consumption while selfemployed is not significantly different than that in wage employment. Other results include that the self-employed work longer hours and that consumption is the same as that prior to self-employment for those who return to wage employment.

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Bibliographic Info

Paper provided by Department of Economics, UC San Diego in its series University of California at San Diego, Economics Working Paper Series with number qt04b3p1p0.

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Date of creation: 05 Nov 2010
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Handle: RePEc:cdl:ucsdec:qt04b3p1p0

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Related research

Keywords: Entrepreneurship; wage and consumption; Social and Behavioral Sciences;

References

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  1. Hall, Robert E, 1978. "Stochastic Implications of the Life Cycle-Permanent Income Hypothesis: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 86(6), pages 971-87, December.
  2. Blanchflower, David G. & Oswald, Andrew & Stutzer, Alois, 2001. "Latent entrepreneurship across nations," European Economic Review, Elsevier, vol. 45(4-6), pages 680-691, May.
  3. Evans, David S & Leighton, Linda S, 1989. "Some Empirical Aspects of Entrepreneurship," American Economic Review, American Economic Association, vol. 79(3), pages 519-35, June.
  4. Per Engstrom & Bertil Holmlund, 2009. "Tax evasion and self-employment in a high-tax country: evidence from Sweden," Applied Economics, Taylor & Francis Journals, vol. 41(19), pages 2419-2430.
  5. Dan Lovallo & Colin Camerer, 1999. "Overconfidence and Excess Entry: An Experimental Approach," American Economic Review, American Economic Association, vol. 89(1), pages 306-318, March.
  6. Tobias J. Moskowitz & Annette Vissing-Jørgensen, 2002. "The Returns to Entrepreneurial Investment: A Private Equity Premium Puzzle?," American Economic Review, American Economic Association, vol. 92(4), pages 745-778, September.
  7. Cooper, Arnold C. & Woo, Carolyn Y. & Dunkelberg, William C., 1988. "Entrepreneurs' perceived chances for success," Journal of Business Venturing, Elsevier, vol. 3(2), pages 97-108.
  8. Guo, Sheng, 2010. "The superior measure of PSID consumption: An update," Economics Letters, Elsevier, vol. 108(3), pages 253-256, September.
  9. Kihlstrom, Richard E & Laffont, Jean-Jacques, 1979. "A General Equilibrium Entrepreneurial Theory of Firm Formation Based on Risk Aversion," Journal of Political Economy, University of Chicago Press, vol. 87(4), pages 719-48, August.
  10. Barton H. Hamilton, 2000. "Does Entrepreneurship Pay? An Empirical Analysis of the Returns to Self-Employment," Journal of Political Economy, University of Chicago Press, vol. 108(3), pages 604-631, June.
  11. Tobias J. Moskowitz & Annette Vissing-Jorgensen, 2002. "The Returns to Entrepreneurial Investment: A Private Equity Premium Puzzle?," NBER Working Papers 8876, National Bureau of Economic Research, Inc.
  12. Skinner, Jonathan, 1987. "A superior measure of consumption from the panel study of income dynamics," Economics Letters, Elsevier, vol. 23(2), pages 213-216.
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Cited by:
  1. Andersen, Steffen & Nielsen, Kasper Meisner, 2012. "Ability or Finances as Constraints on Entrepreneurship? Evidence from Survival Rates in a Natural Experiment," Working Papers 03-2012, Copenhagen Business School, Department of Economics.
  2. Lechmann, Daniel S. J., 2013. "Can working conditions explain the return-to-entrepreneurship puzzle?," Discussion Papers 86, Friedrich-Alexander-University Erlangen-Nuremberg, Chair of Labour and Regional Economics.

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