Entrepreneurial Decisions and Liquidity Constraints

Abstract

This paper analyzes the role of liquidity constraints in the formation of new entrepreneurial enterprises. The basic empirical strategy is to determine whether an individual's wealth affects the probability of becoming an entrepreneur, and the conditional amounts of depreciable assets and interest deductions, ceteris paribus. If so, liquidity constraints are likely to be present. To be successful, such a research strategy requires a measure of asset variation that is both precisely measured and exogenous to the entrepreneurial decision. Our data are uniquely well-suited for this purpose. The sample consists of the 1981 and l985 federal tax returns of a group of people who received inheritances in 1982 and l983, along with information on the size of those inheritances from a matched set of estate tax returns. Hence, we can examine how the exogenous receipt of capital affects the decision to become an entrepreneur and important financial characteristics. of new enterprises. Our results suggest that the size of the inheritance has little effect on the probability of becoming an entrepreneur, but that conditional on becoming an entrepreneur, the size of the inheritance has a statistically significant and quantitatively important effect on the amount of capital employed. The conditional elasticity is 0.45. Thus, liquidity constraints matter, but not in the fashion suggested in some earlier investigations.