The existence of capital market imperfections causes business investment decisions to be strongly dependent on households' private wealth allocation. I claim that if a linkage exists between private wealth and business decisions, it should be stronger in countries characterized by less developed capital markets. Here, I provide a cross-country comparison assessing the relationship between households' initial net wealth and the probability to switch to entrepreneurship in Italy and United States, using household-level data from the Survey of Household Income and Wealth (SHIW) and the Panel Survey of Income Dynamics (PSID). Although they are both developed countries, Italy and US are characterized by striking differences with respect to transaction costs, downpayment requirements and participation in the financial markets. I formulated several theoretical predictions, which are then confronted with the data at hand. First of all, I argue that initial wealth should matter more for Italian potential entrepreneurs, who might encounter more difficulties than US ones in obtaining enough funds to start a business from a bank or a financial institution. In this perspective, "informal markets" (i.e. help from friends or parents) should play a more significant role for Italian potential entrepreneurs, especially for those ones who are more likely to be constrained. Secondly, I claim that a well developed financial market, reducing household exposure to financial risk, would positively affect transition into entrepreneurship. Therefore, I fill a gap in the literature introducing an index of portfolio diversification, calculated as the inverse of the Herfindhal index, in order to control for the level of financial sophistication. Last but not least, I simultaneously estimate the probability to switch to entrepreneurship and changes in net wealth. Using a sample selection model with endogenous switching allows me to deal with endogeneity problems, related to the fact that households might actually pile up assets in advance in order to start a business.
Financial development and selection into entrepreneurship: evidence from Italy and US
DEIDDA, MANUELA
2014-01-01
Abstract
The existence of capital market imperfections causes business investment decisions to be strongly dependent on households' private wealth allocation. I claim that if a linkage exists between private wealth and business decisions, it should be stronger in countries characterized by less developed capital markets. Here, I provide a cross-country comparison assessing the relationship between households' initial net wealth and the probability to switch to entrepreneurship in Italy and United States, using household-level data from the Survey of Household Income and Wealth (SHIW) and the Panel Survey of Income Dynamics (PSID). Although they are both developed countries, Italy and US are characterized by striking differences with respect to transaction costs, downpayment requirements and participation in the financial markets. I formulated several theoretical predictions, which are then confronted with the data at hand. First of all, I argue that initial wealth should matter more for Italian potential entrepreneurs, who might encounter more difficulties than US ones in obtaining enough funds to start a business from a bank or a financial institution. In this perspective, "informal markets" (i.e. help from friends or parents) should play a more significant role for Italian potential entrepreneurs, especially for those ones who are more likely to be constrained. Secondly, I claim that a well developed financial market, reducing household exposure to financial risk, would positively affect transition into entrepreneurship. Therefore, I fill a gap in the literature introducing an index of portfolio diversification, calculated as the inverse of the Herfindhal index, in order to control for the level of financial sophistication. Last but not least, I simultaneously estimate the probability to switch to entrepreneurship and changes in net wealth. Using a sample selection model with endogenous switching allows me to deal with endogeneity problems, related to the fact that households might actually pile up assets in advance in order to start a business.
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