The Entrepreneurial Earnings Puzzle: Mismeasurement or Real?

A review of recent evidence on relative earnings from entrepreneurship versus wage work presents a puzzle: why do individuals become entrepreneurs when entrepreneurs on average apparently earn less than employees? After considering several potential explanations, we empirically analyze one: income underreporting by entrepreneurs. Using a nationwide panel survey representing U.S. households over 15 years, we estimate that entrepreneurs on average/at the median, earn 4 percent less/7 percent more than employees. However, after correcting for income underreporting using a standard model, the mean financial gain to entrepreneurship is positive and large, greater than 42 percent. However, we show that this estimate is built on some unpalatable model assumptions.