Authors: Davide Melcangi and Javier Turen
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Staff Reports
Subsidizing Startups under Imperfect Information
Number 995
December 2021
December 2021
JEL classification: D82, D83, E60, H25
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.
Author Disclosure Statement(s)
Davide Melcangi
The author declares that he has no relevant or material financial interests that relate to the research described in this paper. Prior to circulation, this paper was reviewed in accordance with the Federal Reserve Bank of New York review policy, available at https://www.newyorkfed.org/research/staff_reports/index.html.
Javier Turen
The author declares that he has no relevant or material financial interests that relate to the research described in this paper.
The author declares that he has no relevant or material financial interests that relate to the research described in this paper. Prior to circulation, this paper was reviewed in accordance with the Federal Reserve Bank of New York review policy, available at https://www.newyorkfed.org/research/staff_reports/index.html.
Javier Turen
The author declares that he has no relevant or material financial interests that relate to the research described in this paper.
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