Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/262045 
Year of Publication: 
2021
Series/Report no.: 
Staff Report No. 995
Publisher: 
Federal Reserve Bank of New York, New York, NY
Abstract: 
We study the early stages of firm creation under imperfect information. Because startups make error-prone decisions due to rational inattention, the model generates both inefficient entry and labor misallocation. We show that information frictions alter the effects of lump-sum transfers to startups: the total employment gain is amplified due to an unintended increase in inefficient entry, most entrants hire fewer workers, and misallocation goes up. The transfer makes low-size, previously dominated actions profitable, affecting the entire endogenous learning problem and making even productive startups lean toward more conservative hiring. We show that this novel information channel works against well-known mechanisms (for example, financial frictions) and also dampens the effects of alternative policies such as wage subsidies.
Subjects: 
startups
rational inattention
firm subsidy
JEL: 
D82
D83
E60
H25
Document Type: 
Working Paper

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