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How self-employment responds to financial
incentives of return, risk and skew
Peter Berkhout
Rigo Research
Joop Hartog
UvA/TI
Seminar January 26th
Research and Innovation
Policy Conference
Oslo, Norway
Mirjam van Praag
ACE/UvA/TI
Motivation and contribution
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Occupational choice and income
A puzzle
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Empirical support for the role of income incentives in the
occupational choice between wage employment and
entrepreneurship has so far been mostly weak and certainly
mixed, (Parker, 2009, p. 109-11)
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These weak and mixed results ‘pose something of a puzzle,
since they suggest that entrepreneurs do not respond robustly
to pecuniary incentives.... However, there is so much economic
evidence that individuals adjust their behavior in response to
changes in relative prices that it would be puzzling if the same
calculus ceased to apply entirely in the realm of
entrepreneurship as an occupational choice.’ (Parker, p. 110).
Motivation and contribution
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Explanations for apparent irrelevance of financial incentives
1. The possible large role of non-pecuniary and cognitive factors
(e.g., autonomy or optimism)
2. Researchers have difficulties to obtain good, reliable data on
self-employment income
Parker concludes ‘that more careful research is needed
to shed further light on entrepreneurs’ responsiveness to
pecuniary incentives’ (2009, p. 110).
Motivation and contribution
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Our contribution (so we think)
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We argue that the lack of good entrepreneur income data is
not just a problem for the outside researcher, but also for the
subject of research
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We do not only consider the opportunity cost in terms of mean
incomes:
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utility differences between the two options will also result from
entirely different probability distributions of incomes
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We derive three propositions from a simple model on the role
of financial incentives based on opportunity costs
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In particular, under reasonable and testable assumptions, our
theoretical propositions pertain to the effect of the 1st, 2nd
and 3rd moments of the wage income distribution .
Motivation and contribution
5 / 21
Preview of results
Our empirical findings support the validity of our propositions.
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The 1st, 2nd and 3rd moments of the distribution of the
‘opportunity costs’ of choosing for self-employment all have
the expected effect on the occupational choice considered.
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A lower mean wage income in one’s labor market segment
increases the probability of an individual choosing for
entrepreneurship.
A higher variance and lower skew in the distribution of wage
incomes in a labor market segment have the same effect on
occupational choice.
Our findings, thereby, support the idea that the choice for
self-employment is guided by financial incentives.
Simple model: assumptions and propositions
6 / 21
Simple model
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Utility linearly separable in utility from income and
non-pecuniary returns
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P(SE ) = P[ε < E (U(p)) − E (U(w ))] where ε is a latent
individual-specific variable observing differences in the
valuation of non-pecuniary aspects of self-employment and
wage employment. We use Taylor expansions to derive our
propositions
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We express the first, second and third moments of the income
distribution as:
moment
1
2
3
2
self-empl
µp σp κ3p
wage-empl µw σw2 κ3w
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Simple model: assumptions and propositions
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Assumptions
1. Fields of study with well defined curriculums are valid labor
market segments (k = 118)
2. Individuals consider the wage income distribution in their k but
only one common entrepreneurial income distribution (fewer
e’s, incomes less known, higher variation). Or, we assume the
two income distributions are independent
3. No confounding factors underly the choice for a particular field
of study that affect both its wage distribution and the
likelihood of self-employment (for example risk)
4. The (starting) wage distribution we observe is also the
applicable distribution for prospective self-employed
Simple model: assumptions and propositions
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Propositions
With U increasing in the first moment, the second derivative of
utility negative (from risk aversion) and the third derivative positive
(from skew affection/concave utility function), we propose that
1. the probability of self-employment among graduates from a
field of education will decrease in the mean of the wage
distribution in that field,
2. increase in the variance of wages and
3. decrease in the skew of wages for the graduate’s field of
education.
Data
The sample
SEO/Elsevier annual monitor of higher education
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56,138 recent graduates from higher education
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In the years 1999-2008
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Vocational and general 50/50
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Active part of the labor force
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Income data 1.5 years after graduation
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21-30 years old
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118 degree fields(80% of student population)
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3.6 percent self-employed
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few observations on self-employed incomes
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Data
Descriptive statistics (I)
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Data
Descriptive statistics (II)
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Data
Descriptive statistics (III)
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Data
Descriptive statistics (IV)
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Results: testing of propositions, assumptions and robustness
Testing propositions (I)
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Results: testing of propositions, assumptions and robustness
Testing propositions (II)
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Results: testing of propositions, assumptions and robustness
Testing assumptions (I)
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Definition of labor market segments okay
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The role and independence of the distribution of p:
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Fewer observations
Adding p-moments makes no difference, as far as possible
-p-moments are insignificant
Distributions are hardly correlated
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Results: testing of propositions, assumptions and robustness
Testing assumptions (II)
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Results: testing of propositions, assumptions and robustness
Testing assumptions (III)
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Results: testing of propositions, assumptions and robustness
Testing assumptions (IV)
Confounding factors: risk
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Results: testing of propositions, assumptions and robustness
Testing assumptions (V)
Confounding factors: ability
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Discussion and conclusion
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Discussion and conclusion
Income incentives do matter for the choice to become self-employed
instead of wage employed
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So far there has been hardly any evidence for this
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The wage distribution characterized by the three central
moments per labor market segment affects choices.
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The effects are as expected by theory: a higher expected value,
a lower variance and a higher skew in wage employment make
people less likely to become self-employed
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Our approach was possible because we have a sample of young
and equally highly educated individuals who are divided into
118 labor market segments