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Why Are Entrepreneurs Liquidity-Constrained?

Author

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  • Weiying Zhang

    (Guanghua School of Management, Peking University)

Abstract

Why are entrepreneurs liquidity-constrained? The existing literature has almost exclusively focused on incentive problems associated with choices of work efforts and of project qualities. This paper shifts attention to the effect of liquidity-constraints on the quality of the entrepreneurial pool. Assuming that entrepreneurial ability is private information while personal wealth is public information, the paper shows that entrepreneurs are liquidity-constrained because the critical ability for one to choose being an entrepreneur rather than a wage worker increases with his personal wealth and therefore markets read low wealth of a would-be entrepreneur as a signal of low entrepreneurial ability and high probability of default. A normative implication is that liquidity constraints may be socially desirable since they work as a mechanism to guarantee that only high-ability people will be selected for entrepreneurship.

Suggested Citation

  • Weiying Zhang, 2000. "Why Are Entrepreneurs Liquidity-Constrained?," Annals of Economics and Finance, Society for AEF, vol. 1(1), pages 165-188, May.
    • Handle: RePEc:cuf:journl:y:2000:v:1:i:1:p:165-188
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    More about this item

    Keywords

    Entrepreneurial ability; Asymmetric information; Liquidity constraints;
    All these keywords.

    JEL classification:

    • P16 - Political Economy and Comparative Economic Systems - - Capitalist Economies - - - Capitalist Institutions; Welfare State

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