Opportunity costs and entrepreneurial activity

Raphael Amit, Eitan Muller, Iain Cockburn

Research output: Contribution to journalArticlepeer-review

Abstract

We provide empirical support for the hypothesis that the lower the opportunity costs of individuals, the more likely they are to undertake entrepreneurial activity. This prediction emerged from earlier theoretical work in which we modeled the decision of individuals to develop new ventures on their own, seek the backing of a venture capitalist, or remain as paid employees. We use a large sample, drawn from the 1992 Canadian Labor Market Activity Survey. We find that paid employees who choose to leave their employment to become entrepreneurs earned, prior to leaving, substantially less on average then those whose employment status did not change and who remained paid employees throughout the survey period. Specifically, we establish that the wages of those workers who chose to remain paid employees throughout the survey period were, on average, 12% higher than the wages of those who left their employment to become entrepreneurs. To obtain this result, we performed a multivariate regression analysis in which we isolated the effect of employment status by controlling for gender, age, education, marital status, and region of the country. The employment-status coefficient was 2349 (t = 2.644; p = .008), indicating that new entrepreneurs earned in 1988, on average, $2349 less than paid workers, ceteris paribus. In other words, 1988 paid employees who chose to become entrepreneurs in 1989 and/or 1990 earned, at the time they made the decision to switch, significantly less than those whose employment status did not change and who remained paid employees throughout the survey period. The causality in our result has not been established. It is possible that would-be entrepreneurs are not doing well in their current jobs for reasons that are unrelated to their entrepreneurial attributes or inclination. Their performance may be adversely affected by some coincidental factors. Given that their wages are relatively low, some of these individuals may be seriously considering the development of their own business. Conversely, it is possible that their entrepreneurial abilities and attitudes are such that they do not fit into a corporate setting. These behavioral dimensions may have contributed to poor job performance, relative to their peers. Thus, it is the very fact that they are independent entrepreneurs that causes the compensation differential. If the latter explanation is incorrect and we are left with the former, then it is likely that inasmuch as earnings can be used as a rough indication of the competence or ability of different individuals, our findings could imply that, on average, those employees who choose to become entrepreneurs are less capable than other employed individuals. This could in part explain the high failure rate of new ventures. Future work should be directed at establishing causality more definitely. Such research would contribute to a deeper understanding of some of the reasons for the high failure rate of newly established enterprises.

Original languageEnglish
Pages (from-to)95-106
Number of pages12
JournalJournal of Business Venturing
Volume10
Issue number2
DOIs
StatePublished - Mar 1995

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