Why do Entrepreneurs start companies rather than join them?

Research conducted by ‘Asymmetric Information and Entrepreneurship’ has concluded that the main reason why some people choose to be entrepreneurs is because the individual believes that they are ‘better than their resumes show and they realise that they can make more money by going it alone’. The research paper goes on to explain that in most cases, the entrepreneur is in fact correct. Many more reasons as to why a person may become an entrepreneur were also found, the full research list of reasons can be found below.

  1. Signaling. When you look for a job you “signal” your ability to employers via a resume with a list of your educational qualifications and work history. Signaling is a fancy academic term to describe how one party (in this case someone who wants a job) credibly conveys information to another party (a potential employer).
  2. Capable. People choose to be entrepreneurs when they feel that they are more capable than what employers can tell from their resume or an interview. So, entrepreneurs start ventures because they can’t signal their worth to potential employers.
  3. Better Pay. Overall, when people choose entrepreneurship they earn 7% more than they would have in a corporate job. That’s because in companies pay is usually set by observable signals (your education and experience/work history).
  4. Less Predictable Pay. But the downside of being an entrepreneur is that as a group their pay is more variable – some make less than if they worked at a company, some much more.
  5. Smarter. Entrepreneurs score higher on cognitive ability tests than their educational credentials would predict. And their cognitive ability is higher than those with the same educational and work credentials who choose to work in a company.
  6. Immigrants and Funding. Signaling (or the lack of it) may explain why some groups such as immigrants, with less credible signals to existing companies (unknown schools, no license to practice, unverifiable job history, etc.) tend to gravitate toward entrepreneurship. And why funding from families and friends is a dominant source of financing for early-stage ventures (because friends and family know an entrepreneur’s ability better than any resume can convey).
  7. Education. Entrepreneurs defer getting more formal education because they correctly expect their productivity will be higher than the market can infer from just their educational qualifications. (There are no signals for entrepreneurial skills.)
  8. Lemons Versus Cherries. The most provocative conclusion in the paper is that asymmetric information about ability leads existing companies to employ only “lemons,” relatively unproductive workers. The talented and more productive choose entrepreneurship. (Asymmetric Information is when one party has more or better information than the other.) In this case the entrepreneurs know something potential employers don’t – that nowhere on their resume does it show resiliency, curiosity, agility, resourcefulness, pattern recognition, tenacity and having a passion for products.

This implication, that entrepreneurs are, in fact, “cherries” contrasts with a large body of literature in social science, which says that the entrepreneurs are the “lemons”—those who cannot find, cannot hold, or cannot stand “real jobs.”


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