Self-Employment Dynamics and the Returns to Entrepreneurship

Small business owners and others in self-employment have the option to transition to paid work. If there is initial uncertainty about entrepreneurial earnings, this option increases the expected lifetime value of self-employment relative to pay in a single year. This paper first documents that moves between paid work and self-employment are common and consistent with experimentation to learn about earnings. This pattern motivates estimating the expected returns to entrepreneurship within a dynamic lifecycle model that allows for non-random selection and gradual learning about the entrepreneurial earnings process. The model accurately fits entry patterns into self-employment by age. The option value of returning to paid work is found to constitute a substantial portion of the monetary value of entrepreneurship. The model is then used to evaluate policies that change incentives for entry into self-employment.