The Small Firm Effect and the Entrepreneurial Spawning of Scientists and Engineers

Scientists and engineers in small firms are far more likely than their large firm counterparts to enter entrepreneurship, a phenomenon we label the small firm effect. We explore the origins of this small firm effect, identify four classes of explanations—preference sorting, ability sorting, opportunity cost, and the possibility that workers in small firms develop entrepreneurial human capital—and exploring these empirically, by examining the determinants of entrepreneurial entry and performance. We find that preference sorting plays a role in generating the small firm effect: small firms attract those with prior preferences for autonomy, who are similarly drawn into entrepreneurship. Similarly, ability sorting plays a role: those who ultimately become entrepreneurs may be drawn to small firms because the offer tighter pay-for-performance links and are drawn to entrepreneurship for the same reason, or because the skills required for success in small firms are also valuable in entrepreneurship. Evidence suggests that, while those with the very least to lose enter entrepreneurship with greater frequency, opportunity cost has at best a small role to play in explaining the small firm effect. Finally, we interpret evidence that prior experience in small firms predicts positive performance outcomes in the early stages of entrepreneurship as suggesting that employment in a small firm also appears to make these workers better entrepreneurs. This effect may be largest among those of high ability.