An Estimated Model of Entrepreneurial Choice under Liquidity Constraints

TLDR

Knight and Schumpeter disagreed on whether capital is distinct from entrepreneurship, framing the debate on the necessity of wealth for starting a business. The study investigates whether capital is separate from entrepreneurial activity or if wealth is required to launch a venture in modern economies. Empirical analysis finds that liquidity constraints bind, making wealth a prerequisite for entrepreneurship, and that wealthier individuals are more likely to start businesses, thereby rejecting the alternative explanation that wealth simply produces better entrepreneurs.

Abstract

Is the capital function distinct from the entrepreneurial function in modern economies? Or does a person have to be wealthy before he or she can start a business? Knight and Schumpeter held different views on the answer to this question. Our empirical findings side with Knight: Liquidity constraints bind, and a would-be entrepreneur must bear most of the risk inherent in his venture. The reasoning is roughly this: The data show that wealthier people are more inclined to become entrepreneurs. In principle, this could be so because the wealthy tend to make better entrepreneurs, but the data reject this explanation. Instead, the data point to liquidity constraints: capital is essential for starting a business, and liquidity constraints tend to exclude those with insufficient funds at their disposal.