Skip to main content

Advertisement

Log in

The higher returns to formal education for entrepreneurs versus employees

  • Published:
Small Business Economics Aims and scope Submit manuscript

Abstract

How valuable is formal education for entrepreneurs’ income relative to employees’? And if the income returns to formal education are different for entrepreneurs vis-à-vis employees, what might be a plausible explanation? To explore these questions, we analyze a large representative US panel. We show that entrepreneurs have higher returns to formal education than employees. We refer to this as the entrepreneurship returns puzzle. We run post hoc analyses to explore a number of potential explanations of this puzzle. Indirectly, our analysis indicates that the higher returns to formal education for entrepreneurs might be due to the fewer organizational constraints they face, leading to more personal control over how to use their human capital, compared to employees.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Similar content being viewed by others

Notes

  1. Theory predicts that omitting ability in the wage equation causes OLS estimates to be upward biased (Griliches 1977; Ashenfelter et al. 1999).

  2. The interacted regressor ‘Entrepreneur × Education’ in the income equation varies over time per individual due to variations over time per individual in occupational status. A substantial fraction of the individuals in the sample have been both an entrepreneur and an employee in the observed period, and can thus be used to identify the differential effect of education for spells in entrepreneurship vis-à-vis wage employment for specific individuals.

  3. Our results are not sensitive to increasing this lower boundary of the number of hours.

  4. As will become clear when discussing the regression results, the income premium for entrepreneurs vanishes and turns negative when controlling for individual characteristics such as formal education, abilities, cohort effects, age effects, and macroeconomic circumstances. This is a common finding for the US (Parker 2004).

  5. We note that the number of hours worked may depend, in turn, on income. Thus, the variable is not truly exogenous.

  6. As long as there is no serial correlation in the error terms, the use of these clustered standard errors will generate the same results as the fourth specification (see, for instance, Angrist and Pischke 2008). However, there could be unobserved individual characteristics that vary over time whilst (1) affecting income levels and (2) being serially correlated. This will not affect the estimated coefficients, but only the standard errors.

  7. Blackburn and Neumark (1993) estimate the returns to formal education (for employees) based on the NLSY data. They use a broad set of identifying instruments, including the ones we use, as well as the formal education levels of the respondents’ parents.

  8. The set of identifying instruments is also tested to be valid when capital constraint-related variables, such as residence value, stock value, value of assets, value of inheritances, and total savings, were included in the income equation. This renders additional support for the validity of the identifying instrument ‘number of siblings’ that could perhaps affect income through its effect on capital constraints.

  9. As an additional robustness check, we also included controls that are often added to the income equations of entrepreneurs or employees, but that are omitted here due to their potential endogeneity in these equations. These variables include experience as employee, experience as entrepreneur and a set of industry dummies. Including these variables (which sometimes leads to fewer available observations) leaves the main results qualitatively the same.

  10. This choice behavior is inconsistent with (information about) higher returns to formal education in entrepreneurship than in wage employment in the context of assuming income-maximizing individuals. In general, however, there is remarkably little evidence that income prospects affect the decision to become an entrepreneur (Parker 2009).

  11. Standard arguments for a relationship between locus of control and entrepreneurship are that people with more internal locus of control are more likely to exploit opportunities, and will thus with a higher probability engage in entrepreneurial activities (Shane and Venkataraman 2000; Wijbenga and Van Witteloostuijn 2007), perform better as entrepreneurs (Brockhaus 1980) or be more effective leaders (Boone et al. 1996). Note that our findings (see Table 6 in the Appendix) do not support these expectations.

  12. IV estimation is left out since it does not render credible results upon the inclusion of all these interactions, resulting in four endogenous variables: (1) ‘Education’, (2) ‘Education × Entrepreneurship’, (3) ‘Education × Locus of control’, and (4) ‘Education × Entrepreneur × Locus of control’.

  13. The baseline effect of firm size on income is positive for employees, though. This stylized fact is often referred to as the ‘employer-size wage effect’ (Brown and Medoff 1989).

References

  • Angrist, J., & Krueger, A. (1991). Does compulsory school attendance affect schooling and earnings? Quarterly Journal of Economics, 106(4), 979–1014.

    Article  Google Scholar 

  • Angrist, J., & Pischke, J. (2008). Mostly harmless econometrics. Princeton NJ: Princeton University Press.

    Google Scholar 

  • Ashenfelter, O., Harmon, C., & Oosterbeek, H. (1999). A review of estimates of the schooling/earnings relationship, with tests for publication bias. Labour Economics, 6(4), 453–470.

    Article  Google Scholar 

  • Ashenfelter, O., & Krueger, A. (1994). Estimates of the returns to schooling from a new sample of twins. American Economic Review, 84(5), 1157–1173.

    Google Scholar 

  • Becker, G. (1964). Human capital: A theoretical and empirical analysis with special reference to education, 1993 (3rd ed.). Chicago: University of Chicago Press.

    Google Scholar 

  • Benz, M., & Frey, B. (2008). Being independent is a great thing: Subjective evaluations of self-employment and hierarchy. Economica, 75(298), 362–383.

    Article  Google Scholar 

  • Black, S., Devereux, P., & Salvanes, K. (2005). The more the merrier? The effect of family composition on children’s education. Quarterly Journal of Economics, 120(2), 669–700.

    Google Scholar 

  • Blackburn, M., & Neumark, D. (1993). Omitted-ability bias and the increase in the return to schooling. Journal of Labor Economics, 11(3), 521–544.

    Article  Google Scholar 

  • Blais, R. A., & Toulouse, J. M. (1990). National, regional or world patters of entrepreneurial motivation? Journal of Small Business and Entrepreneurship, 7(2), 3–20.

    Google Scholar 

  • Blanchflower, D., & Oswald, A. (1998). What makes an entrepreneur? Journal of Labor Economics, 16, 26–60.

    Article  Google Scholar 

  • Bonjour, D., Cherkas, L., Haskel, J., Hawkes, D., & Spector, T. (2003). Returns to education: Evidence from U.K. twins. American Economic Review, 93(5), 1799–1812.

    Article  Google Scholar 

  • Boone, C., & De Brabander, B. (1993). Generalized versus specific locus of control expectancies of chief executive officers. Strategic Manangement Journal, 14, 619–626.

    Article  Google Scholar 

  • Boone, C., De Brabander, B., & van Witteloostuijn, A. (1996). CEO locus of control and small firm performance: An integrative framework and empirical test. Journal of Management Studies, 33(5), 667–699.

    Article  Google Scholar 

  • Boone, C., Van Olffen, W., & Van Witteloostuijn, A. (2005). Team locus-of-control composition, leadership structure, information acquisition, and financial performance: A business simulation study. Academy of Management Journal, 48, 889–909.

    Article  Google Scholar 

  • Brockhaus, R. (1980). The effect of job dissatisfaction on the decision to start a business. Journal of Small Business Management, 18(1), 37–43.

    Google Scholar 

  • Brown, C., & Medoff, J. (1989). The employer size-wage effect. Journal of Political Economy, 97(5), 1027–1059.

    Article  Google Scholar 

  • Card, D. (1999). The causal effect of education on earnings, In O. Ashenfelter (Ed), Handbook of labor economics (Vol. 3A, pp. 1801–1863). Amsterdam: Elsevier.

  • Carter, N. M., Gartner, W. B., Shaver, K. G., & Gatewood, E. J. (2003). The career reasons of nascent entrepreneurs. Journal of Business Venturing, 18(1), 13–39.

    Article  Google Scholar 

  • Cobb-Clark, D., & Schurer, S. (2011). Two economists’ musing on the stability of locus of control, IZA DP Working Paper 5630. Bonn: Institute for the Study of Labor.

    Google Scholar 

  • De Haan, M. (2009), Birth order family size and educational attainment. Economics of Education Review (forthcoming).

  • Deaton, A. (2000). The analysis of household surveys. Washington, DC: Johns Hopkins University Press.

    Google Scholar 

  • Dobrev, S. D., & Barnett, W. P. (2005). Organizational roles and transition to entrepreneurship. Academy of Management Journal, 48, 433–449.

    Article  Google Scholar 

  • Fairlie, R. (2005a). Entrepreneurship and earnings among young adults from disadvantaged families. Small Business Economics, 25(3), 223–236.

    Article  Google Scholar 

  • Fairlie, R. (2005b). Self-employment, entrepreneurship, and the NLSY79. Monthly Labor Review, 128(2), 40–47.

    Google Scholar 

  • Feldman, N., & Slemrod, J. (2007). Estimating tax non-compliance with evidence from unaudited tax returns. Economic Journal, 117(518), 327–352.

    Article  Google Scholar 

  • Griliches, Z. (1977). Estimating the returns to schooling: Some econometric problems. Econometrica, 45(1), 1–22.

    Article  Google Scholar 

  • Hansen, K., Heckman, J., & Muller, K. (2004). The effect of schooling and ability on achievement test scores. Journal of Econometrics, 121, 39–98.

    Article  Google Scholar 

  • Harmon, C., Oosterbeek, H., & Walker, I. (2003). The returns to education: Microeconomics. Journal of Economic Surveys, 17, 115–156.

    Article  Google Scholar 

  • Hartog, J., & Oosterbeek, H. (2007). What should you know about private returns to education? In J. Hartog & H. Maassen van den Brink (Eds.), Human capital: Moving the frontier. Cambridge: Cambridge University Press.

    Chapter  Google Scholar 

  • Hartog, J., van Praag, M., & van der Sluis, J. (2010). If you are so smart, why aren’t you an entrepreneur? Returns to cognitive and social ability: Entrepreneurs versus employees. Journal of Economics and Management Strategy, 19(4), 947–989.

    Article  Google Scholar 

  • Heckman, J., Stixrud, J., & Urzua, S. (2006). The effects of cognitive and noncognitive abilities on labor market outcomes and social behavior. Journal of Labor Economics, 24(3), 411–481.

    Article  Google Scholar 

  • Hundley, G. (2001). Why and when are the self-employed more satisfied with their work? Industrial Relations, 40(2), 293–317.

    Google Scholar 

  • Huselid, M. A. (1995). The impact of human resource management practices on turnover, productivity, and corporate financial performance. Academy of Management Journal, 38(3), 635–672.

    Article  Google Scholar 

  • Hvide, H. (2009). The quality of entrepreneurs. Economic Journal, 119, 1010–1035.

    Article  Google Scholar 

  • Hyytinen, A., Ilmakunnas, P., & Toivanen, O. (2008). The return to entrepreneurship puzzle, Working paper, Helsinki School of Economics.

  • Iversen, J., Malchow-Møller, N., & Sørensen, A. (2011). The returns to education in entrepreneurship: Heterogeneity and non-linearities. Entrepreneurship Research Journal, 1, 1–36.

    Google Scholar 

  • Kawagushi, D. (2006). Compensating wage differentials among self-employed workers: Evidence from job satisfaction scores, Working Paper. Tokyo: Hitotsubashi University.

    Google Scholar 

  • Levitt, S., & Dubner, S. (2005). Freakonomics: The rogue economist explores the hidden side of everything. New York: HarperCollins.

    Google Scholar 

  • Lyssiotou, P., Pashardes, P., & Stengos, T. (2004). Estimates of the black economy based on consumer demand approaches. Economic Journal, 114(497), 622–640.

    Article  Google Scholar 

  • McNally, J., Martin, B., & Kay, M. (2011). Examining the formation of human capital in entrepreneurship: A meta‐analysis of entrepreneurship education outcomes. Journal of Business Venturing (forthcoming).

  • Mincer, J. (1958). Investment in human capital and personal income distribution. Journal of Political Economy, 66(4), 281–302.

    Article  Google Scholar 

  • Mincer, J. (1974). Schooling, experience, and earnings. Cambridge, MA: National Bureau for Economic Research.

    Google Scholar 

  • Oosterbeek, H., van Praag, M., & IJsselstein, A. (2010). The impact of entrepreneurship education on entrepreneurship skills and motivation. European Economic Review, 54(3), 442–454.

    Article  Google Scholar 

  • Oreopoulos, P. (2006). Estimating average and local average treatment effects of education when compulsory schooling laws really matter. American Economic Review, 96(1), 152–175.

    Article  Google Scholar 

  • Özcan, S., & Reichstein, T. (2009). Transition to entrepreneurship from the public sector: Predispositional and contextual effects. Management Science, 55, 604–618.

    Article  Google Scholar 

  • Parker, S. (2009). The economics of entrepreneurship. Cambridge, UK: Cambridge University Press.

    Book  Google Scholar 

  • Parker, S., & van Praag, M. (2006). Schooling, capital constraints and entrepreneurial performance: The endogenous triangle. Journal of Business and Economic Statistics, 24(4), 416–431.

    Article  Google Scholar 

  • Parker, S., & van Praag, M. (2011). The entrepreneur’s mode of entry: Business takeover or new venture start? Journal of Business Venturing (forthcoming).

  • Rotter, J. (1966). Generalized expectancies for internal versus external control of reinforcement. Psychological Monographs, 80(1), 1–28.

    Article  Google Scholar 

  • Shane, S. (2006). Introduction to the focused issue on entrepreneurship. Management Science, 52, 155–159.

    Article  Google Scholar 

  • Shane, S., & Venkataraman, S. (2000). The promise of entrepreneurship as a field of research. Academy of Management Review, 25, 217–226.

    Google Scholar 

  • Smith, A. (1904). In Edwin C. (Ed.) An inquiry into the nature and causes of the wealth of nations. London: Methuen (first published in 1776).

  • Sørensen, J. (2007). Bureaucracy and entrepreneurship: Workplace effects on entrepreneurial entry. Administrative Science Quarterly, 52, 387–412.

    Google Scholar 

  • Spence, A. (1973). Job market signaling. Quarterly Journal of Economics, 87(3), 355–374.

    Article  Google Scholar 

  • Taylor, M. (1996). Earnings, independence or unemployment: Why become self-employed? Oxford Bulletin of Economics and Statistics, 58, 253–266.

    Article  Google Scholar 

  • Unger, J., Rauch, A., Frese, M., & Rosenbusch, N. (2011). Human capital and entrepreneurial success: A meta-analytical review. Journal of Business Venturing, 26(3), 341–358.

    Article  Google Scholar 

  • Van Der Sluis, J., & van Praag, M. (2004). Economic returns to education for entrepreneurs: The development of a neglected child in the economics of education. Swedish Economic Policy Review, 11(2), 183–225.

    Google Scholar 

  • Van Der Sluis, J., van Praag, M., & Vijverberg, W. (2008). Education and entrepreneurship selection and performance: A review of the empirical literature. Journal of Economic Surveys, 22(5), 795–841.

    Article  Google Scholar 

  • Van Praag, M., & van Stel, A. (2012). The more business owners, the merrier? The role of tertiary education. Small Business Economics,. doi:10.1007/s11187-012-9436-x.

    Google Scholar 

  • Wijbenga, F., & van Witteloostuijn, A. (2007). Entrepreneurial locus of control and competitive strategies: The moderating effect of environmental dynamism. Journal of Economic Psychology, 28(5), 566–589.

    Article  Google Scholar 

  • Zellweger, T., Sieger, P., & Halter, F. (2011). Should i stay or should i go? Career choice intentions of students with family business background. Journal of Business Venturing (forthcoming).

Download references

Acknowledgments

We are grateful to Robert Fairlie and Rob Alessie for their excellent comments as well as seminar and conference participants at The Academy of Management, Montreal, DIW Berlin, Germany; Copenhagen Business School Denmark; IFN Stockholm, Sweden,; IZA Bonn, Germany; the Academy of Management 2010, Montreal, Canada; The Utrecht Center for Entrepreneurship, the Netherlands. Arjen van Witteloostuijn acknowledges the financial support from the Flemish Science Foundation (FWO) through the Odysseus program. The usual disclaimer applies.

Author information

Authors and Affiliations

Authors

Corresponding author

Correspondence to Mirjam Van Praag.

Appendix

Appendix

See Appendix Table 6.

Table 6 The effect of formal education on occupational choice

Rights and permissions

Reprints and permissions

About this article

Cite this article

Van Praag, M., van Witteloostuijn, A. & van der Sluis, J. The higher returns to formal education for entrepreneurs versus employees. Small Bus Econ 40, 375–396 (2013). https://doi.org/10.1007/s11187-012-9443-y

Download citation

  • Accepted:

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s11187-012-9443-y

Keywords

JEL Classifications

Navigation