Principal Topic

In this paper we set up a theoretical model of the entrepreneurship decision where opportunity cost is one of the driving forces. Prior work has established the importance of opportunity costs in the decision to start a new venture (Amit, Mueller & Cockburn, 1995). However, work on this construct has not developed because of the challenge of measuring the opportunity costs of entrepreneurship. We overcome this challenge by using simulation techniques to test the theory.

Method

The model posits that the entrepreneurship decision is based on opportunity cost. Individual choices then lead to the creation of a pool of new ventures. We track the enterprise over the hurdles of obtaining angel and venture capital financing and finally to success through a corporate sale or a stock market listing. A given pool of entrepreneurs is cut down at each hurdle so that the final successful group is a small fraction of the original number. The system is recursive so that successful entrepreneurs can seed new generations of entrepreneurs by becoming angels or venture capitalists. Some of the new ventures that they fund may be their own, so that so-called ‘serial entrepreneurs’ are included as a special case. We simulate the model and carry out sensitivity analysis related to a number of parameters, including the heights of various hurdles (affected by institutional factors) and the nature of returns (related to market efficiency).

Results and Implications

Preliminary results suggest that the initial population of entrepreneurs is inversely related to institutional factors supporting employment security. We also find that a nonlinear pattern of returns supports a stochastically higher success rate than a linear pattern, so that instruments in entrepreneurial finance that have option-like characteristics (e.g., venture funding) are superior to those with guaranteed returns (e.g., bank loan financing). The results should have interesting implications for understanding the variation in rates of entrepreneurship among regions, as well as important policy implications for regions interested in increasing the rates of entrepreneurship.

CONTACT: Ram Mudambi, Department of General & Strategic Management, Fox School of Business, Temple University, Philadelphia PA 19122; (T) 215-204-2099; (F) 215-204-8029; rmudambi@sbm.temple.edu