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: Industrial Organization, Development Economics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=6021

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.