Destructive Creation at Work: How Financial Distress Spurs Entrepreneurship

Using US Census employer-employee matched data, I show that employer financial distress accelerates the exit of employees to found start-ups. This effect is particularly evident when distressed firms are less able to enforce contracts restricting employee mobility into competing firms. Entrepreneurs exiting financially distressed employers earn higher wages prior to the exit and after founding start-ups, compared to entrepreneurs exiting non-distressed firms. Consistent with distressed firms losing higher-quality workers, their start-ups have higher average employment and payroll growth. The results suggest that the social costs of distress might be lower than the private costs to financially distressed firms.