Entrepreneurship in Equilibrium: A Signaling Approach

Abstract

Firms launch formal programs to identify promising employee ideas and to provide support for their commercialization. This paper examines an alternative role of the firm's internal screening process in employee turnover. I argue that because the firm has better information vis-a-vis the market about the quality of a project proposed by a current employee, its decision to implement the project serves as a signal of quality. Thus, the firm has an incentive to distort the implementation decision in order to conceal information from the market. The analysis presents the conditions under which the incumbent firm uses its informational advantage to distort the implementation decision and retains the employee either with or without implementing her project. The analysis reveals that the presence of distortion depends mainly upon the opportunity cost of the employee not working in the incumbent firm's core business and the informational rents associated with distorting the implementation decision.