Entrepreneurial investment dynamics and the wealth distribution

Using restricted firm level data from the Kauffman Firm Survey, I document that (a) the distribution of average returns to capital amongst nascent entrepreneurial firms is left skewed, and (b) has higher persistence in the left tail than the right. I find that a model where the entrepreneur’s capital investment is illiquid can largely rationalize this data. On average, a continuing entrepreneur loses about 43% of the value of her capital stock upon downsizing, and faces an additional loss of 55% when exiting. These frictions on capital reallocation generates sizable distortions A full removal of both frictions under the assumption of a closed economy can lead to average welfare gains of almost 23.1% in consumption equivalent variation, and aggregate TFP gains of 23.3%. Further decomposition of these welfare changes find that 89% of welfare losses are directly attributable to incomplete markets and financial frictions, and 11% to the illiquidity frictions. In addition, I also find that a model directly calibrated to firm level data is unable to replicate the level of wealth inequality observed in the real economy, contrary to prior papers which are calibrated to household survey data. This arises directly from the left-skewed distribution of returns to entrepreneurship observed in the KFS. In contrast, a counterfactual world with no illiquidity frictions is much more successful at replicating the empirical wealth distribution. (JEL D31, E21, E22, L26) ∗Duke University. email: [email protected]. Acknowledgements: I would like to thank my committee members Craig Burnside, Andrea Lanteri, Matthias Kehrig, Cosmin Ilut, Kyle Jurado, as well as the rest of the macroeconomics group at Duke for their helpful comments and advice. I would also the participants at the Fall 2017 Midwest Macro conference and the 2017 SEA conference for helpful discussion and comments. Finally, I would like to thank the Kauffman Foundation for providing sponsorship to access the Kauffamn Firm Survey at the NORC enclave. All errors are my own.