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It's the Opportunity Cost, Stupid! How Self-Employment Responds to Financial Incentives of Return, Risk and Skew

Author

Listed:
  • Berkhout, Peter

    (RIGO Research Institute)

  • Hartog, Joop

    (University of Amsterdam)

  • van Praag, Mirjam C.

    (Copenhagen Business School)

Abstract

There is no robust empirical support for the effect of financial incentives on the decision to work in self-employment rather than as a wage earner. In the literature, this is seen as a puzzle. We offer a focus on the opportunity cost, i.e. the wages given up as an employee. Information on income from self-employment is of inferior quality and this is not just a problem for the outside researcher, it is an imminent problem of the individual considering self-employment. We also argue that it is not only the location of an income distribution that matters and that dispersion and (a)symmetry should not be ignored. We predict that higher mean, lower variance and higher skew in the wage distribution in a particular employment segment reduce the inclination to prefer self-employment above employee status. Using a sample of 56,000 recent graduates from a Dutch college or university, grouped in approximately 120 labor market segments, we find significant support for these propositions. The results survive various robustness checks on specifications and assumptions.

Suggested Citation

  • Berkhout, Peter & Hartog, Joop & van Praag, Mirjam C., 2011. "It's the Opportunity Cost, Stupid! How Self-Employment Responds to Financial Incentives of Return, Risk and Skew," IZA Discussion Papers 6166, Institute of Labor Economics (IZA).
    • Handle: RePEc:iza:izadps:dp6166
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    References listed on IDEAS

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    1. 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.
    2. Joop Hartog & Ada Ferrer‐i‐Carbonell & Nicole Jonker, 2002. "Linking Measured Risk Aversion to Individual Characteristics," Kyklos, Wiley Blackwell, vol. 55(1), pages 3-26.
    3. Joseph Golec & Maurry Tamarkin, 1998. "Bettors Love Skewness, Not Risk, at the Horse Track," Journal of Political Economy, University of Chicago Press, vol. 106(1), pages 205-225, February.
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    Cited by:

    1. Arvid Raknerud & Mirjam van Praag, 2014. "The entrepreneurial earnings puzzle. Evidence from matched person-firm data," Discussion Papers 789, Statistics Norway, Research Department.

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    More about this item

    Keywords

    entrepreneurship; self-employment; wage-employment; income distribution; income risk; income skew; income variance; occupational choice; labor market entry; labor market segments; opportunity cost;
    All these keywords.

    JEL classification:

    • J24 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Human Capital; Skills; Occupational Choice; Labor Productivity
    • L26 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Entrepreneurship

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