Information frictions and entrepreneurship

• Published in: Strategic management journal 2021-03, Vol.42 (3), p.491-528
• Main Authors: Hegde, Deepak, Tumlinson, Justin
• Format: Article
• Language: English
• Subjects: Analysis; Asymmetric information; Businesspeople; Cognitive ability; Credentials; Earnings; Education; Employees; Employers; Entrepreneurs; Entrepreneurship; Immigrants; Information theory; job‐matching; Productivity; Secondary schools; signaling; Workers
• ISSN: 0143-2095; 1097-0266
• DOI: 10.1002/smj.3242

Research Summary Why do individuals become entrepreneurs? Why do some succeed? We propose two theories in which information frictions play a central role in answering these questions. Empirical analysis of longitudinal samples from the United States and the United Kingdom reveals the following patterns: (a) entrepreneurs have higher cognitive ability than employees with comparable education, (b) employees have better education than equally able entrepreneurs, and (c) entrepreneurs' earnings are higher and exhibit greater variance than employees with similar education. These and other empirical tests support our asymmetric information theory of entrepreneurship that when information frictions cause firms to undervalue workers lacking traditional credentials, workers' quest to maximize their private returns drives the most able into successful entrepreneurship. Managerial Summary Steve Jobs, Bill Gates, Mark Zuckerberg, Rachael Ray, and Oprah Winfrey are all entrepreneurs whose educational qualifications belie their extraordinary success. Are they outliers or do their examples reveal a link between education and success in entrepreneurship? We argue that employers assess potential workers based on their educational qualifications, especially early in their careers when there is little direct information on work accomplishments and productivity. This leads those who correctly believe that they are better than their résumés show to become successful entrepreneurs. Evidence from two nationally representative samples of workers (from the United States and the United Kingdom) supports our theory, which applies to equally to the immigrant food vendor lacking a high school diploma as well as the PhD founder of a science‐based startup.