Abstract
One of the primary objectives of this book is to explore how the theory of the entrepreneur can be integrated with the theory of the firm. The fundamental influence behind the authors’ approach is the theory of the entrepreneur developed by Frank Knight, who emphasized judgment as the key component of entrepreneurship. This theory views entrepreneurship as a particular type of action, specifically, the exercise of judgment regarding the use of resources, under conditions of uncertainty.
More specifically, ‘Judgment … is residual, controlling decision-making about resources deployed to achieve some objectives; it is manifest in the actions of individual entrepreneurs; and it cannot be bought and sold on the market, such that its exercise requires the entrepreneur to own and control a firm’ (p. 78). As the authors argue, this theory is thus a natural starting point for resource-based theories of the firm, because it ties entrepreneurship and firm formation directly to resource use (pp. 41-42). Foss and Klein also point out, however, that from a managerial perspective, the more formal notion of the economic function of the entrepreneur as uncertainty-bearer does not by itself greatly advance our understanding. Research must carefully explore the ‘black box’ of judgment in order to shed light on the links between entrepreneurship and the theory of the firm (p. 81).
To this end, the authors seek to develop the simple concept of judgment. Knight’s work, although important in its own right, was also part of a broader tradition in entrepreneurial thinking which includes writers such as Richard Cantillon, Frank Fetter, and Ludwig von Mises, whose insights are also woven into Knight’s core exposition. Readers will be quick to notice the importance of the ‘Austrian’ school in this book. Indeed, more than a few pages are devoted to discussing the relevance of the Austrian tradition for contemporary theories of entrepreneurship and the firm. To take the most important example, Chapter 5 delves into some aspects of capital theory, particularly the notion of heterogeneous capital assets and its relevance for how and why entrepreneurs organize firms. The concept of the heterogeneity of economic resources is one of the fundamental ideas the book attempts to apply to entrepreneurship and management theory.
Scholars in the entrepreneurship and management literatures might be puzzled by some of the references to the Austrian tradition: typically, references to Austrian themes appear in entrepreneurship and management research in connection with the work of Israel Kirzner, whose research focuses on entrepreneurs’ alertness to and discovery of profit opportunities. This approach does not, therefore, involve asset ownership or resource allocation, and is thus rather different from the judgment view adopted by Foss and Klein (and others in the contemporary Austrian literature). Scope thus exists for confusion between these different approaches. The authors hasten to point out, however, that the judgment theory is also a heritage of the Austrian tradition, and has for some time existed parallel to (in fact, predated) the alertness view. Foss and Klein do devote considerable space to discussing Kirzner’s work, although they argue – along with Kirzner himself – that much of his writing has been misunderstood in contemporary entrepreneurship research. In particular, they point out that Kirzner’s work in entrepreneurship focuses on very different questions (pertaining to the ability of market processes to equilibrate) than most research in present-day entrepreneurship, management, and firm studies. The conclusion they reach is that there are definite difficulties with the alertness approach, and that the judgment view proves more useful when considering problems in current research.
True to its subtitle, the book is mostly concerned with how entrepreneurs and firms can avoid passing each other like ships in the night, and thus the later chapters of the book are devoted to integrating the judgment approach to entrepreneurship into contemporary theories of the firm. The authors propose an ‘entrepreneurial theory of the firm’ (as opposed to a ‘theory of the entrepreneurial firm’) which incorporates the economic function of the entrepreneur into a contractual theory of the firm. They argue (Chapters 7 and 8) that despite the fact that the transaction-cost literature inspired by Coase tends toward mathematical formalism – and away from the issues of Knightian uncertainty, the open-endedness of economic decision-making and entrepreneurship, heterogeneity of entrepreneurs’ mental models, etc. – that contractual views of the firm are fertile ground for entrepreneurial insights (pp. 160–2).
Foss and Klein argue that a particular type of transaction cost can be used to explain the existence of the firm. To begin, contractual relationships of some kind must be taken into account to explain firm boundaries. However, the existence of heterogeneous assets (with qualities which are costly to measure and predict) means that complete contracts are impossible in entrepreneurial endeavours. The entrepreneur’s residual decision-making power – which includes dynamic judgment, and is more significant than that of a residual claimant – implies that he constantly engages in a sort of experimental process of arranging capital assets within the framework of a set of incomplete contracts. The set of contracts in this case constitutes the firm (pp. 164–75).
What of the boundaries of the firm? Starting with a Williamson-style transaction-cost approach, the authors point out that hold-up problems can imply the increased efficiency of vertical integration. But who integrates which assets, and how? The answer suggested in the book is that property rights and ownership (ultimate control over resources) bestow the relevant incentives on producers, incentives which influence the bargaining power of different resource owners. Ownership also confers the ability to reap entrepreneurial rents, and thus to pursue entrepreneurial judgment. The ex post bargaining position therefore influences the ex ante incentive to engage in entrepreneurial judgment. Judgment and ownership are therefore highly complementary and intertwined.
The problems of the internal organization of the firm, and ideas surrounding ‘intrapreneurship’, are also discussed. Although entrepreneurs in this view are the owners of the firm (whether an individual or a board), complex entrepreneurial relations still exist at all levels of the organization. The central idea is that entrepreneurs exercise ‘original judgment’. Other individuals lower in the organizational hierarchy (such as managers and labourers), however, are delegated their decision-making power by the entrepreneur: this is called ‘derived judgment’. As long as the individuals making derived judgments retain some degree of liability for their decisions, they too become entrepreneurs. But the overarching point is that even if entrepreneurs exercising original judgment do not actively participate in the firm’s practical operation, or even its plan formation, they still retain the entrepreneurial function, because they are still the ultimate decision-makers.
The final pages of the book (pp. 240–8) are devoted to considerations of economic policy – particularly in regard to recent financial crises – in light of the book’s overarching theme of the heterogeneity of resources. The authors convincingly point out that policies which ignore the specific character and arrangement of capital assets within firms, as well as firms’ specific entrepreneurial talents, are more likely to stymie economic recovery than stimulate it. Discussing economic policy only in terms of industry-wide indicators necessarily ignores fundamental microeconomic problems which are concealed in aggregate measures of economic performance. To take one example, it is argued that in the years leading up to the crisis, assuming homogeneity among borrowers resulted in lending to individuals and firms who were not credit-worthy. Emphasizing ‘Total lending, total liquidity, average equity prices, and the like obscure the key questions about how resources are being allocated across sectors, firms, and individuals’ (p. 243). What is more, policies which ignore the specific, heterogeneous characteristics of individual entrepreneurs and firms are likely to create perverse incentives, such as the oft-noticed problem of moral hazard resulting from bail-outs.
To sum up, the ideas presented in this book represent a novel contribution to both the entrepreneurship and management literatures. Overall it is a highly readable and fascinating attempt to integrate two very important themes in economic and management thinking: entrepreneurship, and the theory of the firm. It also provides an excellent overview of much contemporary and historical writing on both topics, as well as summaries of how each is currently perceived by the management and economics disciplines. The authors furthermore use their discussions to highlight research opportunities for scholars using the judgment theory, which they thus demonstrate is a viable and fruitful approach. In short, readers will find a large quantity of both new and old ideas in this book, and a healthy appreciation and integration of many diverse pieces of scholarship.