The Burden of the Nondiversifiable Risk of Entrepreneurship
American Economic Review
vol. 100,
no. 3, June 2010
(pp. 1163-94)
Abstract
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)Citation
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.100.3.1163Additional Materials
JEL Classification
- 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