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Home | Blog | A Theory of Entrepreneurship and Institutional Uncertainty

A Theory of Entrepreneurship and Institutional Uncertainty

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Tags Calculation and KnowledgeEntrepreneurship

[Editor's Note: Bylud and McCaffrey have a new article in the Journal of Business Venturing. The executive summary is below and the full article is available online for a limited time.

Highlights

  • We investigate the relationship between entrepreneurs and uncertainty.
  • We clarify the structure of entrepreneurial action with respect to institutions.
  • We analyze entrepreneurs' inability to deal with regime uncertainty.
  • We explicate how entrepreneurs deal with institutional uncertainty.
  • We identify an entrepreneurial rationale for political influence-seeking.

We integrate insights from new institutional economics with theories of entrepreneurship and uncertainty in order to outline a theory of institutional uncertainty. Specifically, we use Oliver Williamson's hierarchical model of institutional systems as a framework for viewing entrepreneurial action. Williamson's model consists of four conceptual levels, each of which constitutes a different level of economizing: the top level L1 contains the norms and culture of society; the second level L2 is made up of political regulations and policies; L3 consists of governance, organizations, and long-term contracting; L4 includes the everyday bidding for resources in the market. Institutions are related horizontally and vertically: in particular, higher-level institutions constrain lower levels by formulating “rules” through which lower-level institutions are ordered.

Different theories of entrepreneurship are relevant at each level. For example, Kirzner's alert entrepreneur, who responds to price discrepancies and thereby corrects entrepreneurial “errors,” appears mainly in L4. At the same time, Schumpeter's innovative entrepreneur introduces “new combinations” through starting new firms, and therefore acts primarily in L3. Knight's judgmental entrepreneur, on the other hand, can act in L4 by allocating resources, in L3 by organizing firms, and in L2 by shaping public affairs. However, entrepreneurs can experience extreme difficulty when trying to act in L1. By mapping entrepreneurship theory onto Williamson's hierarchy, we provide a basis for research on the intersection of entrepreneurship, uncertainty, and institutions. Disaggregating institutions into groups and potential sub-groups allows us to more clearly identify the effects of institutional uncertainty on entrepreneurial action. This is especially true of institutional entrepreneurship, which we conceptualize as a choice entrepreneurs make to reposition their actions either horizontally or vertically in the institutional hierarchy.

So far, most research on institutional entrepreneurship (especially in the Schumpeterian tradition) has focused on innovation while leaving the role of uncertainty aside. We fill this gap by explaining different problems that emerge once uncertainty is allowed to thoroughly permeate the institutional order. Institutional uncertainty exists when entrepreneurs doubt the future compatibility of institutions at different levels. For example, entrepreneurs can be uncertain about whether their everyday trading (L4) will be compatible with proposed regulatory changes (L2). In such cases, entrepreneurs believe that institutions are or will become misaligned or contradictory. Entrepreneurs can usually cope with institutional uncertainty by using a combination of good judgment and institutional entrepreneurship. We focus especially on the changing cost structures entrepreneurs face when confronted with institutional uncertainty, which provide powerful incentives for abiding, evasive, and altering entrepreneurship, and in some cases, entrepreneurial exit.

Abiding action is typical entrepreneurial behavior that legitimizes and strengthens the institutional status quo. Evasive action sidesteps a specific institutional constraint and represents a horizontal relocation to a position less burdened by the relatively high costs of institutional uncertainty. Altering action can be interpreted as a vertical repositioning for the purpose of changing higher-level institutions. If none of these methods appears feasible to the entrepreneur, institutional uncertainty causes her to exit, in other words, to give up entrepreneurial action.

We elaborate this theory by explaining a case in which entrepreneurs are unable to overcome the barriers imposed by institutional uncertainty. Specifically, we apply our framework to the “regime uncertainty” faced by entrepreneurs during the Great Depression and Great Recession, and explain why the rate of entrepreneurship diminished during those crises.

Read the full article. 

Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.
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