Inferring the Unobserved Human Capital of Entrepreneurs

The goal of this paper is to study the role of unobserved human capital in entrepreneurial choice and its impact on the survival of newly created firms. Our starting point is that, when starting a new business, an entrepreneur’s labor market situation (e.g. employed or not) reflects how his human capital may be valuated through salaried labor. This in turn affects the entrepreneurial decision so that, an entrepreneur’s human capital should be correlated with the state at which he decided to start a new firm. We illustrate this point with descriptive statistics computed from a survey of French startups. These statistics show that the impact of education on the new firm’s survival is most pronounced for firms created by individuals salaried in their preferred branch of activity while it is rather limited if the entrepreneur was in the wrong branch or newly unemployed. In this paper we argue, both theoretically and empirically, that these results may be explained by some unobserved heterogeneity in the entrepreneur’s human capital that is correlated both with the initial labor market situation and with some observable measures of human capital such as education or experience. We first present a simple model of entrepreneurial choice that provides predictions about an entrepreneur’s actual human capital as a function of human capital observed by the econometrician as well as the individual’s state in the labor market when the firm was created. The model allows for some information asymmetry on the labor market as well as other sources of inefficiencies such as incentive problems due to moral hazard. It also allows in a simple way for some dynamic considerations on the part of the entrepreneur regarding potential depreciation of his human capital. We argue that the data may be best explained by a model where employer’s information on employee’s human capital is sufficiently poor and where there is a strong concern about human capital depreciation for those with a high le(This abstract was borrowed from another version of this item.)