Entrepreneurship and the stigma of failure

Entrepreneurial activity varies substantially across regions and sectors and appears to be related to the stigma of failure. To understand this phenomenon, I present a multiple-equilibrium model based on endogenous stigma of failure. Using private information, entrepreneurs choose whether to continue a project or to abandon it and raise funds to undertake a new project. Project outcomes depend on luck and ability, and the cost of capital for failed entrepreneurs is determined by the market’s expectations about their ability. In the conserva-tive equilibrium failed entrepreneurs face a high cost of capital and thus good entrepreneurs are reluctant to terminate a project. The resulting low quality of the pool of failed entrepreneurs justifies in turn the high cost of capital. The reverse is true in the experimental equilibrium where good entrepreneurs are more willing to start again and the cost of capital for failed entrepreneurs is low. The equilibria differ in the level and nature of entrepreneurial activ-ity, with riskier projects undertaken in the experimental equilibrium. I discuss the relative efficiency of the two equilibria and study from this perspective the role of institutions such as bankruptcy rules and fresh start policy. I show that policies aimed at increasing the survival of start-ups can have important counterproductive effects