AbstractThe paper formulates a self‐employment/paid‐employment choice problem that draws upon Knight's notion that the individual responds to the risk‐adjusted relative earnings opportunities in each sector. Based on a development of such choice‐theoretic considerations, an econometric model is developed with the purpose of empirically examining the determinants of self‐employment. The model features simultaneous determination of employment status and earnings, which allows for self‐selectivity. The model is estimated using a sample of 4762 individuals from the General Household Survey for 1978. The estimation of the earnings equation enables a calculation of the self‐employment/paid‐employment earnings differential and the estimated probit equation for self‐employment/paid‐employment status facilitates the prediction of the probability of self‐employment. The paper finds that there is positive selection bias in the observed earnings of employees, that the probability of self‐employment depends positively on the earnings difference between the two sectors and that education and age are significant determin