“Entrepreneurship, Learning and Wealth” (Job Market Paper)
Abstract- It is often argued that borrowing constraints are crucial to understanding entrepreneurial activity in the United States. However, as I show in more detail in a companion paper, data on the portfolios of entrepreneurs raise doubts about the importance of borrowing constraints. Most entrepreneurs are not using the equity in their homes to finance their businesses, and hold positive positions in financial assets such as stocks and bonds. Motivated by this fact, in this paper, I propose a theory that does not rest on borrowing constraints and nevertheless succeeds in replicating a number of key facts that have been previously used as evidence of financial frictions. The core of this theory is a simple learning mechanism. In my model, agents are imperfectly informed about their entrepreneurial ability (their "type") and entrepreneurial ability is positively correlated with income. In each period, agents use their income realization to update their belief about their own type. They then choose their occupation (worker or entrepreneur) on the basis of their belief. In the dynamic stationary general equilibrium of the model, the following patterns emerge: 1) positive correlation between cash flow and investment; 2) higher propensity of starting a business for wealthier agents; 3) higher fraction of entrepreneurs in the upper wealth classes, even holding income levels constant; 4) upward mobility for workers who enter entrepreneurship, and downward mobility for exiting entrepreneurs; and 5) savings rates that are higher for those entering entrepreneurship and lower for those exiting (compared to those who stay as workers or stay as entrepreneurs). While previous work has used these patterns to argue that entrepreneurs face binding borrowing constraints, this paper shows that the same patterns may emerge simply because entrepreneurs are uncertain about their ability and learn slowly about it.
“Portfolios of entrepreneurs: are borrowing constraints really binding?”
Abstract- An implication of the vast literature on borrowing constraints for entrepreneurs is that business owners should be investing the marginal dollar of their wealth in their businesses. I use cross-sectional data from the Survey of Consumer Finances to compare portfolio allocations for workers and entrepreneurs; and panel data from the same sources to study portfolio changes for workers who stay as workers, workers who switch into entrepreneurship, continuing entrepreneurs, and entrepreneurs who exit entrepreneurship. First, I find that most entrepreneurs are far from maxing-out their mortgages and hold non-trivial positive positions in financial assets such as stocks and bonds. Second, I find that entrepreneurs' mortgage rates, total debt, and holdings of stocks and bonds are similar to those of workers. Third, when comparing the portfolios separately by wealth class, I find that poorer entrepreneurs, who arguably could be more cash-strapped, actually use less available mortgage financing than their counterpart workers. Fourth, I find that those that have been entrepreneurs (either continuing entrepreneurs, exiting entrepreneurs, or new entrepreneurs) pay their mortgages faster than non-entrepreneurs. Combined, these findings suggest that the portfolios of entrepreneurs are at odds with theories that propose borrowing constraints as the key ingredient in understanding occupational choice and entrepreneurial activity in the United States.
“What can calibration exercises say about the tightness of borrowing constraints on entrepreneurs?”
Abstract- I find that the standard general equilibrium model of occupational choice developed by Cagetti and De Nardi (2006) results in extremely binding borrowing constraints for entrepreneurs. Their desire to match the wealth distribution mandates very slow decreasing returns to scale on the entrepreneurial technology. An unintended consequence of the slow decreasing returns to scale is that borrowing constraints are considerably tighter in the model than in the data.
Next, I calibrate the model to match measures of firm size and slack in the financial constraint, the later given by the real estate equity available for borrowing on the entrepreneur's primary home. Finally, two policy experiments are analyzed. I show that the recalibration of the model, which yields faster decreasing returns to scale and a lower concentration of wealth, considerably dampens the effects of alternative redistributive policies aimed at favoring either high-ability would-be entrepreneurs or poor agents.