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The Need for an Entrepreneurial Theory of the Firm

Throughout the next couple of weeks I will be blogging through the book Organizing Entrepreneurial Judgment: A New Approach to the Firm by Nicolai Foss and Peter Klein. I am hard pressed to think of a more fitting time for this book to be read. The book’s aim is to integrate the study of entrepreneurship with the theory of the firm under economic analysis. Nationally and globally we are at a pivotal moment in which people need to understand how businesses function and the entrepreneurial abilities necessary for continued economic progress. Without further ado, I give you Chapter 1 of the book.

Foss and Klein (FK) lament from the start the schism between the firm and the entrepreneur which has been erected in economic science. They argue that for a full understanding of the firm, one must understand the entrepreneurs who make decisions within the firm; while for a full understanding of the entrepreneur, one must understand the environment of the firm in which he acts. Their effort is to make the needed connection where a substantial gap currently exists between the firm and the entrepreneur.

The Theory of the Firm in Economics

FK give evidence to show that “the economic and managerial analysis of the firm is a vibrant area of research and application….” At the same time, “the theory of the firm as a contractual or organizational entity…is…a relatively new development” that emerged in the 1970s. The authors argue that it was Ronald Coase who first propelled the theory of the firm.

Entrepreneurship

FK also note that there has been a considerable push in the study of entrepreneurship within the past decade as economists have seen the entrepreneur more worthy of inspection in order to understand technological progress. FK pose the question “What is entrepreneurship?” Typically economists have either defined entrepreneurship in terms of either 1) an outcome or a phenomenon (self-employment, start-ups) or 2) a way of thinking or acting (creativity, innovation, alertness, etc…).

Why entrepreneurship and the firm belong together

FK contend that “economic theories of the firm are particularly well-equipped to understand not only the ‘exploitation’, but also the discovery and even the evaluation of entrepreneurial activities.” They see a need for a further and fuller explanation for “why entrepreneurs choose certain ways for organizing their activities.” They point out that economic models which treat entrepreneurship as a variable in an equation is not sufficient for such an explanation. They add that management research has oversimplified the issue by defining entrepreneurship exclusively as “the creation of new firms”. FK point out that experience shows that entrepreneurial activity occurs in established, mature firms. These firms act entrepreneurially when seizing new opportunities through acquiring other companies, starting a new product, diversifying their funds, and so on.

FK adopt Frank Knight’s conception of entrepreneurship as judgmental decision-making. When understood this way, entrepreneurship helps explain how a firm actually transforms opportunities into realized profits. For it is the entrepreneurs, making decisions according to their best judgment, within the firm that make this happen. Furthermore, FK suggest that systematic differences in firm-level performance are due to the varying degrees of room entrepreneurs are given to exercise their judgment as well as delegate judgment to employees under them.

An overview of our narrative

FK break away from the economics analysis which has left a legacy of an incomplete understanding of entrepreneurship. Entrepreneurship is not restricted to boldness, imagination or creativity. Neither is entrepreneurship merely alertness to profit opportunities, a belief most attributed to economist Izrael Kirzner. Rather, FK adopt entrepreneurship as “judgmental decision-making under uncertainty”, the view most commonly associated with economists Frank Knight and Ludwig von Mises. In this sense, all humans demonstrate entrepreneurship in action. But FK focus on entrepreneurship within the firm. Entrepreneurs exercise judgment in attempting to employ the firm’s resources in the most profitable way. This is necessary at each step of the firm’s development, not only at its inception. A firm has a limited amount of capital goods it can own. Different capital goods have different attributes and serve different purposes. The entrepreneur must choose which goods to acquire and how to arrange them.

In chapter one, Foss and Klein convincingly argue that the firm and the entrepreneur cannot be treated as islands unto themselves. For a full understanding of the economic reality of our world, one must understand both the firm and the entrepreneur and how they relate; how they are connected. Why do entrepreneurs form certain kinds of firms and not others? How does a firm’s structure encourage or discourage entrepreneurial activity? Foss and Klein aim to address such questions by integrating the firm and entrepreneurship. Chapter two will present the reader with a more detailed explanation of entrepreneurship to strengthen the groundwork for understanding the connection.

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  1. Live Blogging Organizing Entrepreneurial Judgment « Organizations and Markets - August 13, 2012

    […] the Summary version? Hoping for an HBO Special? Not to worry, the good folks at HansEconomics are live-blogging the book, and the first chapter is up today. Thanks to John Dellape for doing […]

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