Asymmetric Information and Entrepreneurship

“1. Signaling. When you look for a job you “signal” your ability to employers via a resume with a list of your educational qualifications and work history. Signaling is a fancy academic term to describe how one party (in this case someone who wants a job) credibly conveys information to another party (a potential employer).
2. Capable. People choose to be entrepreneurs when they feel that they are more capable than what employers can tell from their resume or an interview. So, entrepreneurs start ventures because they can’t signal their worth to potential employers.
3. Better Pay. Overall, when people choose entrepreneurship they earn 7% more than they would have in a corporate job. That’s because in companies pay is usually set by observable signals (your education and experience/work history).
4. Less Predictable Pay. But the downside of being an entrepreneur is that as a group their pay is more variable – some make less than if they worked at a company, some much more.
5. Smarter. Entrepreneurs score higher on cognitive ability tests than their educational credentials would predict. And their cognitive ability is higher than those with the same educational and work credentials who choose to work in a company.
6. Immigrants and Funding. Signaling (or the lack of it) may explain why some groups such as immigrants, with less credible signals to existing companies (unknown schools, no license to practice, unverifiable job history, etc.) tend to gravitate toward entrepreneurship. And why funding from families and friends is a dominant source of financing for early-stage ventures (because friends and family know an entrepreneur’s ability better than any resume can convey).
7. Entrepreneurs defer getting more formal education because they correctly expect their productivity will be higher than the market can infer from just their educational qualifications. (There are no signals for entrepreneurial skills.)”