An Estimated Model of Entrepreneurial Choice under Liquidity Constraints

Abstract

Is the capitalist function distinct from the entrepreneurial function in modern economies? Or does a person have to be wealthy before he or she can start a business? Frank H. Knight and Joseph A. Schumpeter held different views on the answer to this question. The authors' empirical findings side with Knight: liquidity constraints bind, and a would-be entrepreneur must bear most of the risk inherent in his venture. The reasoning is roughly this: the data show that wealthier people are more inclined to become entrepreneurs. In principle, this could be so because the wealthy tend to make better entrepreneurs, but the data reject this explanation. Instead, the data point to liquidity constraints: capital is essential for starting a business, and liquidity constraints tend to exclude those with insufficient funds at their disposal. Copyright 1989 by University of Chicago Press.