Abstract
How is firm creation affected by imperfect information? Our model of rational inattention generates inefficient entry and labor misallocation, because startups make error-prone decisions. Learning decisions of prospective entrepreneurs alter the effects of lump-sum transfers to startups: the total employment gain is amplified due to an unintended increase in inefficient entry, most entrants hire fewer workers, and misallocation goes up. The transfer changes the learning incentives and makes even productive startups lean towards more conservative hiring. We show that this novel information channel works against well-known mechanisms, and thus can help reconcile recent empirical evidence on startup policies.
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