American Economic Review: Vol. 100 No. 3 (June 2010)


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The Burden of the Nondiversifiable Risk of Entrepreneurship

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Hall, Robert E., and Susan E. Woodward. 2010. "The Burden of the Nondiversifiable Risk of Entrepreneurship." American Economic Review, 100(3): 1163-94.

DOI: 10.1257/aer.100.3.1163


Entrepreneurship is risky. We study the risk facing a well-documented and important class of entrepreneurs, those backed by venture capital. Using a dynamic program, we calculate the certainty-equivalent of the difference between the cash rewards that entrepreneurs actually received over the past 20 years and the cash that entrepreneurs would have received from a risk-free salaried job. The payoff to a venture-backed entrepreneur comprises a below-market salary and a share of the equity value of the company when it goes public or is acquired. We find that the typical venture-backed entrepreneur received an average of $5.8 million in exit cash. Almost three-quarters of entrepreneurs receive nothing at exit and a few receive over a billion dollars. Because of the extreme dispersion of payoffs, an entrepreneur with a coefficient of relative risk aversion of two places a certainty equivalent value only slightly greater than zero on the distribution of outcomes she faces at the time of her company's launch. (JEL G24, G32, L26, M13)

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Hall, Robert E. (Stanford U)
Woodward, Susan E. (Sand Hill Econometrics, Palo Alto, CA)

JEL Classifications

G24: Investment Banking; Venture Capital; Brokerage; Ratings and Ratings Agencies
G32: Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure
L26: Entrepreneurship
M13: New Firms; Startups

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