One surprising result in the literature on entrepreneurship is that median entrepreneurs fare worse than wage-workers. In fact, the median entrepreneur is “poor” relative to his counterparts in the labor force. Hamilton (2000), for example, focuses on entrepreneurs and workers who have between 10 and 35 years of labor market experience. Using the 1984 Survey of and Program Participation he shows that for all those individuals, the predicted median wage worker’s hourly wage is higher than that of the median entrepreneur. Other studies have looked at a subset of entrepreneurs and have reached similar conclusions: the payoff to becoming an entrepreneur is low relative to wage work.
The disparity in earnings is such a puzzle that so far models trying to explain it have relied mainly on heterogeneity between entrepreneurs and workers, for example in their preferences, rationality or beliefs. While some of these explanations have been considered sensible, a re-examination of the data calls them into question.
In this paper, I start by revisiting the empirical evidence and show that the median earnings differential between entrepreneurs and wage workers is in fact U-shaped as a function of time over their tenures within a firm or business. Entrepreneurs earn more than workers both early and late in their tenures. Previous empirical evidence focused mainly on the middle period of individuals’ lives, leading to the incorrect finding that entrepreneurs earn less than wage workers. Thus, the puzzle needs to be redefined: the puzzle is not that entrepreneurs earn less than wage workers, but rather that the earnings differential is U-shaped. As in Hamilton (2000), the empirical evidence is on wages and does not take into account returns on equity invested in the company (in the form of dividends for example).
For entrepreneurs, this can be a source of income. What I show in this paper, is that even without taking such payments into account, entrepreneurs do not necessarily fare less well than wage workers. Indeed, one direct implication of the U-shape differential in earnings is that the evidence is not necessarily in favor of workers: since future earnings are discounted, the fact that entrepreneurs earn less than wage workers in the middle of their lives can be compensated by higher earnings earlier on.
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Entrepreneurship Does Pay
