Entrepreneurship, Bequests, and the Distribution of Wealth

Abstract

Entrepreneurs hold a significant fraction of the total wealth in the economy; they are approximately 8% of the population but hold 39% of total net worth. In this paper, we construct and solve numerically a life cycle optimization model with intergenerational transmission of bequests to study the choice of starting an entrepreneurial activity, and its effect on the wealth accumulation of entrepreneurs and on the distribution of wealth in the population. We examine two forces that determine self selection into an entrepreneurial activity: initial wealth and attitudes to risk. Starting a business requires initial funds, and entrepreneurs may have to invest part of their own wealth into the business activity. Some of this initial funds may come from parental transfers and bequests. Entrepreneurial income has higher return, but is riskier than labor income: more risk averse households may decide not to become entrepreneurs, despite the expected gains from such activity. We calibrate our model to the US economy. We find that the possibility of an entrepreneurial activity increases by 50% the fraction of wealth held by the top 1%. We also show that increasing the coefficient of risk aversion significantly decreases the percentage of entrepreneurs, and even in the absence of initial funding requirements, we cannot match the percentage of 8.6% of entrepreneurs. We also study the effects of changes in the initial funding requirements and in the degree of intergenerational altruism.