Why Startups Pay More: Compensation Premiums Beyond Risk Factors

We propose a rationale for the existence of compensation premiums in startups that extends beyond traditional risk-based explanations. The mechanism hinges on the elasticity of substitution between inputs. When workers’ efforts are substitutes, the entrepreneur resolves the group dilemma within teams by offering a compensation scheme that yields utility levels above workers’ reservation utilities. In contrast, when efforts are complements, the compensation premium enables coordination on more efficient outcomes in a game with multiple symmetric equilibria.