Testing Agency Theory with Entrepreneur Effort and Wealth

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Abstract
We develop a principal‐agent model in an entrepreneurial setting and test the model's predictions using unique data on entrepreneurial effort and wealth in privately held firms. Accounting for unobserved firm heterogeneity using instrumental‐variables techniques, we find that entrepreneurial ownership shares increase with outside wealth and decrease with firm risk; effort increases with ownership; and effort increases firm performance. The magnitude of the effects in the cross‐section of firms suggests that agency costs may help explain why entrepreneurs concentrate large fractions of their wealth in firm equity.