DP6021 Risk-bearing and Entrepreneurship

Author(s): Andrew Newman

Publication Date: January 2007

Keyword(s): moral hazard , occupational choice , principal-agent model

JEL(s): D2 , D8 , L2 , O16

Programme Areas: Development Economics , Industrial Organization

Link to this Page: www.cepr.org/pubs/dps/DP6021.asp.asp

In the 'Knightian' theory of entrepreneurship, entrepreneurs provide insurance to workers by paying fixed wages and bear all the risk of production. This paper endogenizes entrepreneurial risk by allowing for optimal insurance contracts as well as the occupational self-selection. Moral hazard prevents full insurance; increases in an agent’s wealth then entail increases in risk borne. Thus, even under decreasing risk aversion, there are robust instances in which workers are wealthier than entrepreneurs. This empirically implausible result suggests that risk-based explanations for entrepreneurship are inadequate.