Opportunity Costs and Entrepreneurial Activity

Raphael Amit, Eitan Muller, and Iain Cockburn


We provide empirical support for the hypothesis that the lower the pooprtunity costs of individuals, the more they are likely to undertake entrepreneurial activity. This prediction emerged from earlier theoretical work in which we modelled 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 than those who remained employees throughout the entire period sampled. Specifically we establish that the wages of workers who chose chose to remain paid employees were on average 12% higher than those who left to become entrepreneurs. To obtain this resulted will performed a multivariate regression analysis in which we isloatd the employment effect by controlling for gender, age, education, marital status, and region of the country. The estimated employment-status coefficient was 2349 (t=2.644, p=0.008) indicating that new entrepreneurs earned , on average, $2349 less than paid workers, ceteris paribus . Peoplw who were paid employees in 1988 and became entrepreneurs in 1989 earned, at the time they decided to make the switch, significantly less than those who stayed in paid employment.

The causality in our result has not been established. It is possible that would-be entrepreneurs are not doing well in paid employment for reasons that are unrelated to their entrepreneurial attributes or inclination. Given that their wages are relatively low, these individuals may be seriosly considering developing their own business.

Conversely, it is possible that these individuals' entrepreneurial activities and attitudes are such that they do not fit in well to a corporate settting, and these behavioural factors contribute to poor job performance (or evaluations), and it is thus the very fact that they are independent entrepreneurs that causes the compensation differential.

If this latter explanation is incorrect and we are left with the former, then, to the extent that earnings can be used as a rough indication of ability, our results imply that future entrepreneurs are less capable on average than employed individals. This may explain, in part, the high failure rate of new ventures. Future work should be directed at establishing causality more definitely, and such research may contribute to a deeper understanding of the underlying causes of the high failure rate of newly established enterprises.