Entrepreneurial Risk-Taking, Young Firm Dynamics, and Aggregate Implications

Despite the importance of high-growth young firms for economic growth, determinants of their growth and survival dynamics are not well understood. In this study, I develop a dynamic occupational choice model that identifies a key predictor of the early growth trajectory of young firms: the outside options of the business founders. I show that entrepreneurs with higher outside options as paid workers tend to take larger business risks, and thus exhibit a more up-or-out type of firm dynamics. I find empirical support for the model's predictions using a large founder-firm matched data set built from administrative databases of the U.S. Census Bureau. I find that controlling for past business performance, young firms operated by entrepreneurs with higher outside options exhibit (i) higher firm exit rates, (ii) more growth dispersion, and (iii) faster growth conditioning on survival. With the calibrated model, I find that deterioration in the outside options of entrepreneurs can have a sizable negative impact on aggregate output and productivity via lower risk-taking by young firms and slower growth in their life cycle. These findings indicate that the expected post-failure outcomes of entrepreneurs are an important factor that governs young firm growth as well as aggregate output and productivity.