Modern Theories of Entrepreneuria...
Modern Theories of Entrepreneurial Behavior: A Comparison and Appraisal Anthony M. Endres Christine R. Woods ABSTRACT. This paper compares and appraises three principal, contemporary theories of entrepreneurial deci- sion making ��� neoclassical, Austrian and behavioral. We employ theory appraisal criteria made available in Fritz Machlup���s (1967) celebrated article on alternative theories of the firm. The paper considers theories that treat sequences of behavior by which individual entrepreneurs reach decisions on two levels: the discovery of profit oppor- tunities and their exploitation. We also consider how each theory characterizes the entrepreneur���s decision making process by contrast with the posited behavior of other eco- nomic agents. Austrian theory is suited to explaining novel, adventurous behavior at the discovery stage. The algorithm for opportunity exploitation in both the neoclassical and Austrian approaches is a single-repertoire, optimization rule. Neoclassical theory is situated in frictionless, atomis- tic Walrasian markets and emphasizes mathematical trac- tability. Austrian and behavioral theories conceive entrepreneurial acts taking place in market processes understood as complex institutional phenomena. There are strong theoretical complementarities between Austrian and behavioral approaches both approaches value descriptive accuracy, though the behavioralists place more weight on operational tractability. Austrians and behavioralists share an interest in heuristics they emphasize the role of prior micro-level knowledge at the discovery stage. Therefore more collaborative research in future between Austrians and behavioralists should prove fruitful. KEY WORDS: alertness, entrepreneurial behavior, heuristics, optimization, theory appraisal JEL CLASSIFICATIONS: M13, M21, D21, B41 1. Introduction In a now classic paper lamenting the elusiveness of the entrepreneur in formal economic analysis Baumol (1968, p. 64) was convinced that eco- nomic ������theory . . . fails to provide a rigorous analysis of the behavior of the entrepreneur������. Later Demsetz (1983, p. 277) maintained that the ������analytical treatment������ of the entrepreneur, as opposed to purely descriptive case-study work, must rely on the standard postulate of maximiz- ing behavior, for there was no defensible alterna- tive. Gilad (1986, p. 189) repeated the claim that economic theory ������has not made any progress in the area of entrepreneurial behavior������. In the last quarter of the 20th century, more than Baumol and Demsetz expected and more than Gilad supposed, economists together with researchers on the borders of economic analysis, behavioral science and management science, have come to offer quite different though not necessarily competing conceptualizations of entrepreneurial behavior. To be sure, research on entrepreneurship in the late 20th century has expatiated on the dis- tinctive functions of entrepreneurs in modern, market-based economic systems (e.g. Baumol, 1993a, b). Yet precise delineation and discussion of different branches of literature on entrepreneur- ial behavior ��� including consideration of well- defined sequences of behavior by which decisions Final version accepted on September 29, 2004 Anthony M. Endres Department of Economics University of Auckland 18 Symonds Street Auckland New Zealand Christine R. Woods Department of Management and Employment Relations University of Auckland 18 Symonds Street Auckland New Zealand E-mail: firstname.lastname@example.org Small Business Economics (2006) 26: 189���202 �� Springer 2006 DOI 10.1007/s11187-004-5608-7
are supposedly reached by entrepreneurs ��� together with a review and an assessment of these branches, has not been undertaken. The purpose of this paper is to offer such an assessment. We consider various attempts to characterize individual entrepreneurial acts and decisions in the broad literature of economics in which three schools of thought have commonly been distin- guished: neoclassical, Austrian and behavioral. This is the first occasion in the literature in which both the key explicit and implicit assumptions about entrepreneurial behaviour have been drawn out and compared between these different schools of thought. Theoretical points of separation or points of complementarity as the case may be, between these different schools of thought on entrepreneurial behavior have not been closely examined. There is one partial exception. Shane (2000, pp. 449���451) makes a tripartite division between neoclassical, Austrian and psychological theories this is a highly empirical contribution that is located expressly in the Austrian tradition. Although Sha- ne���s division is an advance on previous work, the distinction between ������psychological������ and ������Aus- trian������ theories in the article is not fully explicated. The outline provided of ������psychological������ theories is deficient since, on the author���s own terms, there is some overlap between Austrian and ������psycholog- ical������ approaches. Moreover, as we shall observe in this article, all theories of entrepreneurial behavior have psychological aspects either stated explicitly in the initial assumptions or embedded by default in the theoretical framework. The theories under review allow for entrepreneurial success or failure and they share a common definition of the entre- preneur as a gain seeking individual making coor- dination decisions under uncertainty. For our purposes, at the most general level the individual entrepreneur ������must be a decision maker������ who constructs and, where possible, exploits opportunities to enter a new market (Blaug, 1998, p. 217). We also concur with Casson (1982, p. 23 1987, p. 151���152) that the ������entrepre- neur specializes in judgmental decision making������ about resource coordination and allocation in markets where the costs of information acquisition are ������different for different people������. Nonetheless, the entrepreneurial decision process under consid- eration has for a long time remained opaque is it, for instance, distinguishable from the process used by other economic agents? Sections 2, 3 and 4 below discuss this issue by surveying neoclassical, Austrian and behavioral conceptualization of entrepreneurial behavior. Section 5 compares, contrasts and appraises these theories utilizing cri- teria made available by Machlup (1967). In Sec- tion 6 we conclude by briefly assessing the prospects for future research in this field. 2. On the neoclassical theory of entrepreneurial behavior Since the mid-20th century neoclassical formula- tions of entrepreneurial behavior have been embodied in more comprehensive theories of pro- duction, of the firm in perfectly competitive mar- ket structures, or of firm formation in a competitive equilibrium context. It was sheer hyperbole for Baumol (1968, pp. 66���67) to claim that in the ������neoclassical model������ the ������theoretical firm is entrepreneurless ��� the Prince of Denmark has been expunged from the discussion of Ham- let������. Baumol���s position was motivated by the neo- classical conception of the entrepreneur as a functionary and as another factor of production separate from the standard triumvirate: land, labor and capital. The traditional production function describes an engineering relationship between inputs and outputs rather than a behav- ioral phenomenon. Entrepreneurship, like other inputs, is a deployable scarce resource. Some writ- ers in the neoclassical tradition refer to specific entrepreneurial inputs as a type of human capital viz. ������entrepreneurial ability������ or ������business acu- men������(Evans and Jovanovic, 1989, p. 810). How- ever as Blaug (1996, pp. 440���441) argued, ������the strange disappearance of the entrepreneur from the center stage of economic theory������ may be attributed to intractable analytical di���culties with the marginal product of the entrepreneurial input given its indivisibility and its nonstandardized, heterogeneous character. Since Walras���s contribu- tion in the late 19th century an overarching con- ception of end-state equilibrium has circumscribed the notion of the neoclassical entrepreneur as a decision maker within the ���firm as production function��� approach. In a world of uncertainty (understood as calculable risk), and given the entrepreneur���s decisions take place with optimally 190 Anthony M. Endres and Christine R. Woods
imperfect information (following Stigler 1961), a theory of profit has been appended to the neoclas- sical model of the firm as a production function that sustains a minimalist entrepreneurial role. Entrepreneurs are only distinguished from other factor inputs by assuming they act as residual profit claimants given their special risk-bearing appetite (Blaug, 1996, p. 444). Risk adverse agents remaining in the firm are designated as administra- tors, employees or laborers. In sophisticated models in the neoclassical tra- dition, such as the Khilstrom and Laffont (1979, p. 720) general equilibrium model of firm forma- tion, entrepreneurs contribute managerial and organizational skills (������entrepreneurial ability������). Unlike risk averse laborers, entrepreneurs bear the risks associated with production. We now list concisely those features of this neoclassical approach that have implications for the behavior of entrepreneurs.1 1. Entrepreneurs have equal access to the same risky ideas or technology and receive all the profits of risk-taking. 2. All entrepreneurs are risk neutral, so that a unit of entrepreneurial labor is homogeneous in respect of risk attitude. 3. While entrepreneurial labor inputs are deploy- able they are not deployable in infinitesimal amounts. 4. Entrepreneurs are the firm���s principal decision makers and enjoy free entry to the industry concerned. 5. Since risk attitude is potentially affected by firm size, the model���s range of applicability is to entrepreneurial behavior in ������small busi- nesses and farms������(Khilstrom and Laffont, 1979, p. 749) in short it is restricted to an atomistically competitive economy. 6. Entrepreneurs are always and everywhere max- imizers (or optimizers in that they may act as cost minimizers as well). In elaborating on the dynamics of firm entry and exit the neoclassical approach identifies an equilib- rium outcome. When an ine���cient equilibrium outcome is investigated ������it takes three forms: risks are maldistributed, firms are operated at the wrong levels and there is an inappropriate number of firms������(ibid: 721). Institutional impediments such as a dearth of risk-sharing opportunities can lead to an ine���cient allocation of risks. Stock market institutions and venture capital financing arrangements are not incorporated in these mod- els. Crucially, the referents used for theory con- struction and evaluation is the existence, stability and e���ciency of competitive equilibrium. It is against these outcomes that the neoclassical theory of entrepreneurial decision making must be judged. Khilstrom and Laffont (1979, p. 720) explicitly address entrepreneurs��� decision styles, a matter taken for granted in most other work in the neo- classical tradition where individual behavior is set in the form of ������expected utility maximizing������. By this postulate, it is proposed that the entrepreneur will maximize the subjective expected utility of profits derived from risk bearing. Moreover, neo- classical entrepreneurs obey the standard von Neuman���Morgenstern axioms of decision-making under uncertainty (preference completeness, consistency, independence). They are idealized, representative entrepreneurs rather than real entrepreneurs, just as the firms in which they behave are hypothetical and representative. And entrepreneurs have a systematic response to uncer- tainty, use probabilistic calculating procedures, can easily be turned into good Bayesian learners and act comfortably in strategic decision making contexts by calculating their actions according to their competitors��� possibilities (Laville, 2000b, p. 421). Whatever nuance may have been appended to the model in the later 20th century there is no escaping Baumol���s (1968, p.68) original observa- tion that neoclassical entrepreneurs are ������automa- ton maximizers������ and automaton maximizers they have remained.2 Some specific (often tacit) neoclassical behav- ioral assumptions in respect of entrepreneurial behavior have not hitherto been widely appreci- ated in the literature. An entrepreneur: 7. lists all alternative opportunities for allocating resources in an equilibrating manner in exist- ing markets 8. finds opportunities evenly (randomly) distrib- uted in the market and these have the same value for all who search for them 9. determines all the possible consequences of acting upon an opportunity 191 Modern Theories of Entrepreneurial Behavior