Why Do Entrepreneurs Hold Large Ownership Shares? Testing Agency Theory Using Entrepreneur Effort and Wealth

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Abstract
We augment the standard principal-agent model to accommodate an entrepreneurial setting, where effort, ownership, and firm size are determined endogenously. We test the model's predictions (some novel) using new data on entrepreneurial effort and wealth. Accounting for unobserved firm heterogeneity using instrumental variables, we find entrepreneurial ownership shares increase with outside wealth, decrease with firm risk, and decrease with firm size; effort increases with ownership and size; and both ownership and effort increase firm performance. The magnitutde of the effects in the cross-section of firms suggests that agency theory is important for explaining the large average ownership shares of entrepreneurs.