Working Paper Series in Economics and Institutions of Innovation,
Royal Institute of Technology, CESIS - Centre of Excellence for Science and Innovation Studies

Abstract: The paper analyzes a modified version of Lazear’s (2004, 2005) model for occupational choice that includes a utility adjustment factor reflecting non-pecuniary net benefits associated with entrepreneurship. The model is used to derive analytical expressions for the relative income returns to entrepreneurship defined in two ways: in relation to the incomes of observationally similar wage employed and in relation to the counterfactual incomes of entrepreneurs as wage employed. The analysis shows that the upper bound on the income returns defined in counterfactual terms increases with the market value of entrepreneurial talent and that the lower bound decreases with increasing non-pecuniary benefits. If the entrepreneurial incomes are instead related to the incomes of observationally similar wage employed, and if the skill profiles in the population are assumed to follow a Fréchet distribution, then the upper bound on the relative expected returns will decrease with increasing non-pecuniary benefits. We also show that entrepreneurs on average will earn less than observationally similar wage employed even if there are no net benefits and that the associated self-selection bias will increase the higher the fraction of entrepreneurs. Individual-based data from the Swedish employment register is used to calibrate the parameters of the modified Lazear model and to compute the income returns to entrepreneurship. The model-based income distributions for entrepreneurs and wage employed are consistent with the observed distributions.

Keywords: entrepreneurship; occupational choice; self-employment; self-selection bias; skill distribution; Fréchet distribution; entrepreneurship puzzle; returns to entrepreneurship

JEL-codes: J24; J30; L26; M13

29 pages, March 13, 2019

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