Firm Formation with Complementarities: The Role of the Entrepreneur

We model entrepreneurship and the emergence of firms as a result of simultaneous bidding for labor services among heterogeneous agents. Unique to our approach is that occupational choices, job matching and organizational forms are determined simultaneously, so that the opportunity costs of entrepreneurs are accounted for. We find that (1) individuals who are relatively unmanageable become entrepreneurs; (2) entrepreneurs compete against each other and create value by building effi cient organizations and offering potentially very well paid jobs for others; and (3) entry of an additional entrepreneur typically reduces some individual wages, but always raises the average wage and depresses the average incomes of incumbent entrepreneurs strictly so if the new firm partially imitates existing organizations. Our results shed a new light on the role of entrepreneurs in the economy and may be applied to explain low returns to self-employment. JEL: L26, J24, J31, D20, L23 How talent is allocated to jobs in the labor market greatly affects the productivity of firms and economies. One aspect of this is the basic "occupational choice" the decision whether to run ones own firm or to seek employment elsewhere. Intuitively, this choice requires that an individual compares the prospects as an entrepreneur and the income that be could earned in ∗Department of Economics, Brown University. E-mail: [email protected]. †Erasmus School of Economics, Erasmus University Rotterdam, The Netherlands and Tinbergen Institute, Rotterdam, The Netherlands. E-mail: [email protected].