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Do Startups Pay Less?

Today, many young people are forgoing careers at established firms to join startups. Yale SOM’s Olav Sorenson investigated whether they are making the right financial choice.

  • Olav Sorenson
    Frederick Frank '54 and Mary C. Tanner Professor of Management

By Jyoti Madhusoodanan

In recent years, more MBA students have chosen to forgo careers at large, established firms and chosen to join startups. Professor Olav Sorenson, whose research interests include entrepreneurship and venture capital, has increasingly found himself facing a question from job-seeking students: if I want to be financially successful, should I join a startup or an established company?

Sorenson wanted to offer a response that was based on more than just personal experience or individual anecdotes. But existing research failed to yield an answer. Previous studies had examined entrepreneurship rates or how founders of startups fared in the long run, yet little was known about whether a small company might offer an employee more or less income compared to larger businesses.

The answer might have implications for government policy as well as personal decision making; in many places, national and local governments encourage startups as a means of creating jobs and stimulating economic growth. “Given how much interest there is from a policy perspective, it’s important to know whether startups provide good jobs in terms of wages, benefits, and job satisfaction,” Sorenson says. “What we wanted to know is this: for the same individual, which is a better option?”

Sorenson and his colleagues turned to national registry data from Denmark to understand how a company’s age and size influenced the wages employees received. At first glance, it appeared that small firms paid less, and a firm’s age had no impact on wages. But, Sorenson points out, this observation is complicated by differences between employees themselves. Those at smaller firms are often younger, may have less formal education, and are more likely to have had a spell of unemployment in their career. When the team factored these variations into their data, they found that both a company’s age and size influenced how much a particular employee might earn. Their results are scheduled for publication in Industrial and Labor Relations Review.

Larger firms paid more than smaller ones did, and younger companies appeared to pay less than older firms. That’s not surprising, according to Sorenson. Since these companies can afford more equipment and capital, “even the same worker is going to be more productive in a firm with more facilities,” Sorenson says. “It’s mostly about economies of scale.”

But when the researchers compared similarly-sized firms by age, in various industries, they found that—contrary to popular belief—startups offered higher wages than older companies. The effect of a company’s age on a worker’s income was unexpected. Although one might expect that older firms would learn to function more efficiently and effectively—thus growing more profitable and paying their employees more—the data suggest this is not the case with businesses that remain small.

“We fully went into this study thinking that younger firms would pay less,” Sorenson says. “And they generally do—but the reason for it is that the startup is small.”

Another possible factor is that joining a startup is a riskier venture. Employees at young firms face involuntary unemployment if the venture fails, and startups may be compensating for this possibility by paying more wages. “If you think about that perspective, the difference in wages is perhaps smaller than it should be,” Sorenson says.

Sorenson cautions that all of the data for this study was from Denmark; the same trend might also be seen in other economies, but confirming that will require further studies. Unlike in the U.S. or UK, employment-related benefits such as retirement plans or health insurance in Danish companies are centrally provided by the state, and are largely similar across businesses. So the difference in an employee’s income at a large company versus a smaller one stems primarily from a difference in wages. “To extend these results to the U.S., we’d need to consider the other benefits employers offer,” Sorenson says.

Whether higher salaries at startups actually compensate for the higher risk of unemployment associated with working there isn’t clear yet. And if other benefits such as retirement or healthcare were to be factored in, the difference between pay at startups and older firms might be even less significant.

Understanding the quality of jobs provided by startups is important for several reasons. Although job creation is typically viewed as a boon to the economy, it’s important to ensure that this is really the case, Sorenson explains. “If the alternative to startups is unemployment, then the jobs are a good thing,” he says. “But if these jobs are displacing ones at larger firms, then instead of creating more good jobs we might just be replacing better jobs with not-so-good ones.”

Nonetheless, a job is about more than just money. “One thing that matters to people and isn’t captured here is how satisfying a job is,” Sorenson says. “And we can’t say startups are creating bad jobs in terms of that aspect.”

Department: Research