April 2006

IZA DP No. 2071: A Selection-Based Theory of the Transition from Employment to Entrepreneurship: The Role of Employer Size

A simple occupational choice model is used to predict that entrepreneurs who found new firms are more likely to work for small than for large firms prior to start-up. The mechanism underlying the result is heterogeneous risk aversion. The model also predicts a positive association between new firm formation and previous self-employment experience. These predictions accord with previous empirical findings, but notably self-selection rather than productivity effects can explain them.