Distinguishing Limited Liability from Moral Hazard in a Model of Entrepreneurship∗
Alexander Karaivanov, Anna Paulson, Robert Townsend
We present and estimate a model where the choice between entrepreneurship and wage work may be influenced by financial market imperfections. The model allows for limited liability, as in Evans and Jovanovic (1989), moral hazard, as in Aghion and Bolton (1996), and a combination of both constraints. The paper uses structural techniques to estimate the model and identify the source of financial market imperfections using data from rural and semi-urban households in Thailand. Structural, non-parametric and reduced form estimates provide independent evidence that the dominant source of credit market imperfections is moral hazard. We reject the hypothesis that limited liability alone can explain the data.
