A consumption-based measure of the monetary rewards to entrepreneurship

Abstract

Purpose – Recent findings by Hamilton (Journal of Political Economy, 2000) suggest that the self-employed do not receive a monetary premium for the risk and uncertainty associated with business ownership. The purpose of this paper is to show that income underreporting by entrepreneurs can explain the lack of evidence for monetary premia. Using a large national data set (Panel Study of Income Dynamics (PSID)), the author first document evidences of underreporting, and then proceed to make alternative comparisons using measures of consumption. The author finds that the self-employed enjoy large earnings premia that are reflected in their consumption. Design/methodology/approach – Using PSID the author creates and analyzes a household level data set comparing monetary rewards of self-employment to those of wage work. The author employs previous findings about entrepreneurial saving behavior to show, via quintile regression analysis, consumption rewards to entrepreneurship, and compare those rewards to income rewards. Findings – The author finds self-employed enjoying significant consumption premia, over the income premia, throughout the income distribution. Contrary to previous claims (e.g. see Hamilton, 2000) the author finds that self-employment is a financially rewarding undertaking. Due to different income reporting metrics and tax exemption structure entrepreneurs enjoy even larger monetary rewards when compared to wage workers along consumption axis. In light of these findings the paper proposes consumption, rather than income metrics, to be applied when quantifying rewards to self-employment. Research limitations/implications – Household level of analysis is a major drawback in using this approach. This is an outcome of consumption data collected and reported on household rather than individual income. Because of this limitation transitions into and out of self-employment cannot be separated from household changes, i.e., divorces and marriages. However, divorces and marriages are assumed to not have systematic component favoring wage workers or self-employed. Practical implications – Significant resources are allocated toward supporting entrepreneur. Small business administration, congress, state agencies, and community development corporations contentiously outline both risks associated with failure rates and low rewards to self-employment. This paper provides policymakers with better tools for assessment of true monetary rewards. Better assessment of true rewards, especially contrasting corporations vs individual earnings in self-employment should enable the policymakers to provide better support for the entrepreneur. Social implications – Entrepreneur, in social light, is perceived as a much more successful individual. This view differs with recent data. Previously overly naive positive estimate of entrepreneur has been attributed to the bias of survival. This paper provides additional support for social view of entrepreneur by pointing to an overlooked, by the policymakers and most researchers, information segment – consumption data. These additional benefits that have been well understood by the public can now be substantiated for the policymakers. Originality/value – This paper develops unique method for documenting monetary rewards to entrepreneurship. Using information about entrepreneurial saving behavior this paper demonstrates significant monetary premia, over reported income premia enjoyed by entrepreneurs. The premia is documented throughout income distribution and is not an outcome of entrepreneurial superstars or even average entrepreneur.