A sizeable fraction of the self-employed keep on running their businesses despite insufficient monetary compensation compared to their potential employee earnings. This fact is often argued to stem from non-pecuniary benefits of being one’s boss as pointed by Hamilton, (2000). In this paper I build a life-cycle model of occupational choice subject to information friction which offers an alternative explanation and entails markedly different policy implications. In my model agents receive imperfect signals on their employee and managerial skills and business ideas but inference about them can only be done via observing the output. Payoffs from self-employment depend, contrary to payroll jobs, on both types of skills jointly and the quality of the business idea which leads to a confounding signal problem. Because of lack of identification the decision about switching occupations consistently depends on initial information about managerial ability and business idea. In this environment the existence of low-earnings self-employment is a frictional outcome. In a quantitative version of my model I investigate the welfare implications of age-based self-employment support policies.

Discussant: Florian Sniekers (University of Amsterdam/VU University Amsterdam)