Why entrepreneurs start companies rather than join them
If we were asked why we will want to startup our company rather than work with a large company, we will have a countless reasons at some point in time like:
- I want to be my own boss.
- I love risk.
- I want flexible work hours.
- I want to work on tough problems that matter.
- I have a vision and want to see it through.
- I saw a better opportunity and grabbed it.
It never crossed our mind that we started our own company because we thought more of our abilities than the value a large company would put on them. At least not consciously. But that’s the conclusion of a provocative research paper, Asymmetric Information and Entrepreneurship, that explains a new theory of why some people choose to be entrepreneurs. The authors’ conclusion: Entrepreneurs think they are better than their resumes show and realize they can be more successful by going it alone. And in most cases, they are right.
We will summarize the paper’s conclusions, then share a few thoughts about what they might mean – for companies, entrepreneurs and entrepreneurial education. (By the way, as you read the conclusions keep in mind the authors are not talking just about high-tech entrepreneurs. They are talking about everyone who chooses to be self-employed – from a corner food vendor without a high school diploma to a high-tech founder with a PhD in Computer Science from Stanford.)
The authors’ research came from following 12,686 people over 30+ years. They found:
- Getting a job involves 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).
- Entrepreneurs believe their signal falls short. 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.
- Entrepreneurs have higher average 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).
- But the pay is less predictable. 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.
- 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.
- Immigrants also have trouble signaling. 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).
- 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.)