The Impact of Workers’ Compensation Laws on Entrepreneurial Activity

Abstract

Government policy that aims to stimulate business activity often overlooks its indirect impacts on entrepreneurial entry. In particular, the role of free time, especially in concert with liquidity con-straints, remains an underexplored factor. In this paper, we exploit two exogenous shocks to workers’ free time to furnish plausibly causal effects on entrepreneurial activity: (random) injury and the 2011 amendments to the Illinois workers’ compensation laws. Utilizing a two-way fixed effects estimation, we find that as workers’ compensation becomes less generous, i.e., by limiting both financial resources and an employee’s time away from work, entrepreneurial activity within a specific geographical region is significantly reduced. Thus, we provide evidence of an unin-tended and negative impact on entrepreneurial activity caused by an indirect policy change. Fur-ther, this result unduly affects the recently injured or otherwise disabled. Our results are robust to alternative specifications and data sources, suggesting an important incidence of compensa-tory insurance regulation on entrepreneurial activity and, as a result, important considerations for future policymaking. Workers’ compensation is a state-level program that provides replacement wages to workers in-jured on the job. In 2011, amendments to Illinois’ workers’ compensation laws made this pro-gram less generous in terms of both financial benefits and time out of work. We study the impact of these amendments on entrepreneurial activity. We find that less generous workers’ compensa-tion has a large adverse effect on entrepreneurial activity because it constrains two important factors required for experimentation with entrepreneurship: financial resources and time. Our results hold up to several statistical models and controls, including local innovative and high-tech firms, as well as alternative datasets. Our findings yield important insights for policymakers in other states drafting such regulations and for researchers studying the incidence of such poli-cies.