The Indirect Effect of Entrepreneurship on Pay Dispersion: Entry Cost Reduction, Mobility Threat, and Wage Redistribution Within Incumbent Firms

Abstract

Past research has examined the link between initiatives promoting entrepreneurship and compensation, but scholars have predominantly focused on earnings of individuals directly engaged in the founding process, such as founders, cofounders, and start-up employees. Shifting our focus to incumbent workers, we instead propose that a decline in the cost of entrepreneurship increases the variance in pay among incumbent workers who are not involved in entrepreneurial activities. We posit that, as entrepreneurship becomes a more attractive career option, due to institutional changes, the outside option value of entrepreneurship increases. The resulting increase in mobility threat will disproportionately benefit high earners or those employees who are more difficult to replace: As their bargaining power increases, incumbents will disproportionately reward these workers, especially when they are systematically more inclined to leave for entrepreneurship. We explore these arguments using a difference-in-differences methodology, based on the enactment of an entry reform that reduced the cost of entry in Portugal between 1995 and 2009. We find that an exogenous decrease in the administrative costs of establishing a new venture led to high earners capturing disproportionate rewards relative to low earners. We further show that this relationship was especially pronounced among high earners who (a) exhibited a higher ex ante propensity to transition into entrepreneurship; (b) had fewer credible outside options in paid employment; and (c) operated in industries with decentralized wage bargaining arrangements. By documenting the impact of institutional changes that promote entrepreneurship on incumbent workers’ pay, our study contributes to recent debates about the impact of entrepreneurship on individual earnings. Funding: This work was supported by the CY Initiative, the FCT—Portuguese Foundation of Science and Technology, and the Knowledge, Technology and Organization Research Center at Skema. Supplemental Material: The online appendix is available at https://doi.org/10.1287/orsc.2022.16201 .