Posts filed under ‘Recommended Reading’
| Peter Klein |
Two interesting new papers on entrepreneurship. The first deals with financial capital — specifically, the degree to which entrepreneurship (defined as self-employment) is constrained by credit availability. As regular readers know, I’ve been crusading against the idea that entrepreneurship consists of recognizing opportunities, in favor of the alternative idea that entrepreneurship involves putting assets at risk. The latter view directs our attention to how entrepreneurial activities are funded; rather than assuming that all positive-NPV opportunities are exploited, we should focus on the investor’s decision to allocate risk capital to one or another potential project. Put simply, “entrepreneurship is exercised not only by founders, but by funders.”
Funders care about collateral, which suggests that self-employment is constrained by the availability of durable personal assets like housing. In a new NBER working paper, “Housing Collateral and Entrepreneurship,” Martin Schmalz, David Sraer, and David Thesmar find a strong correlation between self-employment and house prices. “Our empirical strategy uses variations in local house prices as shocks to the value of collateral available to individuals owning a house and controls for local demand shocks by comparing entrepreneurial activity of homeowners and renters operating in the same region. We find that an increase in collateral value leads to a higher probability of becoming an entrepreneur. Conditional on entry, entrepreneurs with access to more valuable collateral create larger firms and more value added, and are more likely to survive, even in the long run.”
My Missouri colleague Colleen Heflin, along with Seok-Woo Kwon and Martin Ruef, have a new paper in the American Sociological Review on social capital and self-employment. Many papers have examined how an individual’s “social capital” — defined as networks of social and professional relationships — affects various economic outcomes, including the propensity to start a firm. Colleen and her colleagues focus at the community level and find that “individuals in communities with high levels of social trust are more likely to be self-employed compared to individuals in communities with lower levels of social trust. Additionally, membership in organizations connected to the larger community is associated with higher levels of self-employment, but membership in isolated organizations that lack connections to the larger community is associated with lower levels of self-employment.”
Of course, self-employment is only a crude proxy for entrepreneurship in the functional sense, but it is a widely used proxy in the empirical literature. I suppose entrepreneurship researchers, like other social scientists, resemble the drunk looking for his car keys under the lamppost. Who am I to complain?
| Peter Klein |
Craig Newmark pointed me to this list of “15 Famous Business Books Summarized In One Sentence Each.” I don’t think highly of any of the books on the list except Innovator’s Dilemma, but it’s an interesting exercise. Care to try your hand? I’ll start:
Oliver Williamson, Economic Institutions of Capitalism: Be shrewd in your dealings with suppliers and customers; they may not do what they promised.
Edith Penrose, Theory of the Growth of the Firm: The more you do what you’re good at, the better you get at similar things that may surprise you.
Ludwig von Mises, Bureaucracy: Fixed rules are better than employee discretion when you’re producing stuff that isn’t bought and sold on markets.
Michael Porter, Competitive Strategy: Be efficient and productive, but pay attention to your rivals and partners, or they’ll eat you for lunch.
John Maynard Keynes, The General Theory: Chicken chicken chicken, chicken chicken chicken chicken chicken.
| Peter Klein |
Central to the “Austrian” understanding of business cycles is the idea that monetary expansion — in Wicksellian terms, money printing that pushes interest rates below their “natural” levels — leads to overinvestment in long-term, capital-intensive projects and long-lived, durable assets (and underinvestment in other types of projects, hence the more general term “malinvestment”). As one example, Austrians interpret asset price bubbles — such as the US housing price bubble of the 1990s and 2000s, the tech bubble of the 1990s, the farmland bubble that may now be going on — as the result, at least partly, of loose monetary policy coming from the central bank. In contrast, some financial economists, such as Laureate Fama, deny that bubbles exist (or can even be defined), while others, such as Laureate Shiller, see bubbles as endemic but unrelated to government policy, resulting simply from irrationality on the part of market participants.
Michael Bordo and John Landon-Lane have released two new working papers on monetary policy and asset price bubbles, “Does Expansionary Monetary Policy Cause Asset Price Booms; Some Historical and Empirical Evidence,” and “What Explains House Price Booms?: History and Empirical Evidence.” (Both are gated by NBER, unfortunately, but there may be ungated copies floating around.) These are technical, time-series econometrics papers, but in both cases, the conclusions are straightforward: easy money is a main cause of asset price bubbles. Other factors are also important, particularly regarding the recent US housing bubble (I suspect that housing regulation shows up in their residual terms), but the link between monetary policy and bubbles is very clear. To be sure, Bordo and Landon-Lane don’t define easy money in exactly the Austrian-Wicksellian way, which references natural rates (the rates that reflect the time preferences of borrowers and savers), but as interest rates below (or money growth rates above) the targets set by policymakers. Still, the general recognition that bubbles are not random, or endogenous to financial markets, but connected to specific government policies designed to stimulate the economy, is a very important result that will hopefully influence current economic policy debates.
| Peter Klein |
Kudos to Richard Ebeling for a nice piece on Herbert J. Davenport, one of the most American economists of the early twentieth century, mostly forgotten today. (One exception: Daveport was the founding Dean of the University of Missouri’s business school, which named its donor society after him.) Davenport, one of Frank Knight’s teachers, was an early adopter of the subjective theory of value introduced by Carl Menger and, along with Philip Wicksteed and Frank Fetter, helped to spread the marginal revolution in the English-speaking world.
Davenport was also a contributor to the economic theory of entrepreneurship, as noted by Ebeling:
Here was the mechanism by which the logical causality between demands and supplies was brought into actual implementation in the complexity of market activities. The entrepreneur stood, Davenport argued, “as the intermediary in the case, representing in his hiring and buying of productive factors, the demand of the purchasing public, and representing in his cost computations, the degree of scarcity of the productive factors relative to the demand for their products.”
On the one hand, it was “the entrepreneurs who furnished the demand for all . . . the things which are called production goods,” he explained. On the other hand, it was “the competition of the entrepreneurs of each industry with the other entrepreneurs of the same industry, and the competition of the entrepreneurs of each industry with those of other industries” that brought about the emergence of factor prices. All the money outlays, the objectified market “costs” that an entrepreneur had to incur, all traced back to the demand for other things as reflected in the bids of competing entrepreneurs. . . .
“The various markets in which he [the entrepreneur] must hire and buy are fluctuating in their prices,” he said. “And the price at which he will finally market his product is uncertain . . . His alternative lines of activities, also, are subject to uncertainties.” All of the entrepreneur’s calculations, therefore, were expectiational.
His computations of “costs of production,” Davenport went on, “appears to be backward-looking computation,” but in reality was “only a basis for a further and forward-looking computation.” The entrepreneur’s glance was turned towards those future – uncertain – opportunities that still lie before him, and from which he would have to choose the one that he believed offered the greatest net advantages.
Ultimately, then, the entrepreneur’s “cost” of production was reducible to his individual judgments,
Ebeling is quoting Davenport’s 1913 book The Economics of Enterprise, which hints at the “judgment-based view” of entrepreneurship elucidated more fully by Knight.
| Peter Klein |
Three recent NBER papers on compensation, performance, and productivity:
Ann Bartel, Brianna Cardiff-Hicks, Kathryn Shaw
NBER Working Paper No. 19412, September 2013
Due to the limited availability of firm-level compensation data, there is little empirical evidence on the impact of compensation plans on personal productivity. We study an international law firm that moves from high-powered individual incentives towards incentives for “leadership” activities that contribute to the firm’s long run profitability. The effect of this change on the task allocation of the firm’s team leaders is large and robust; team leaders increase their non-billable hours and shift billable hours to team members. Although the motivation for the change in the compensation plan was the multitasking problem, this change also impacted the way tasks were allocated within each team, resulting in greater teamwork.
William Mullins, Antoinette Schoar
NBER Working Paper No. 19395, September 2013
Using a survey of 800 CEOs in 22 emerging economies we show that CEOs’ management styles and philosophy vary with the control rights and involvement of the owning family and founder: CEOs of firms with greater family involvement have more hierarchical management, and feel more accountable to stakeholders such as employees and banks than they do to shareholders. They also see their role as maintaining the status quo rather than bringing about change. In contrast, professional CEOs of non-family firms display a more textbook approach of shareholder-value-maximization. Finally, we find a continuum of leadership arrangements in how intensively family members are involved in management.
George J. Borjas, Kirk B. Doran
NBER Working Paper No. 19445, September 2013
Knowledge generation is key to economic growth, and scientific prizes are designed to encourage it. But how does winning a prestigious prize affect future output? We compare the productivity of Fields medalists (winners of the top mathematics prize) to that of similarly brilliant contenders. The two groups have similar publication rates until the award year, after which the winners’ productivity declines. The medalists begin to “play the field,” studying unfamiliar topics at the expense of writing papers. It appears that tournaments can have large post-prize effects on the effort allocation of knowledge producers.
Thank goodness I haven’t won the Clark Medal, Nobel Prize, or a MacArthur Award. I want to keep my productivity high!
| Nicolai Foss |
“IJEB” is the International Journal of the Economics of Business. The inaugural issue contained a veritable who-is-who in the management/economics intersection, and the journal has published much good stuff over the years (including papers by Peter Klein and yours truly, as well as lesser known people like Reinhart Selten, Richard Nelson, and Frederick Scherer). To mark the journal’s first twenty years, twenty of the more influential papers have been made available for free online (here), and the first issue of 2014 will be like the inaugural issue in that it will be composed of many short papers on the directions that the economics of business is going to take in the future.
| Peter Klein |
A really interesting NBER paper from Thomas Triebs and Justin Tumlinson confirms what you may suspect, that firms operating outside the market system — in this case, in the former East Germany — do not learn the capabilities for judging market signals. Triebs and Tumlinson compare East and West German firms after unification and find that East German firms did not anticipate, or respond to, market information as well as their West German counterparts, other things equal, suggesting that during the Communist period, firms lost (or failed to acquire) the ability to work within a market setting. The paper is based on a formal learning model but the empirical results seem to square with a variety of approaches, including resource-based and managerial capabilities theories.
Learning Capitalism the Hard Way—Evidence from Germany’s Reunification
Thomas P. Triebs, Justin Tumlinson
NBER Working Paper No. 19209, July 2013
Communism in East Germany sought to dampen the effect of market forces on firm productivity for nearly 40 years. How did East German firms respond to the free market after being thrust into it in 1990? We use a formal learning model and German business survey data to analyze the lasting impact of this far-reaching treatment on the way firms in former East Germany predicted their own productivity relative to firms in former West Germany during the two decades since Reunification. We find in confirmation of our formal model’s predictions, that Eastern firms forecast productivity less accurately, particularly in dynamic and uncertain markets, but that the gap gradually closed over 12 to 13 years. Second, by analyzing the direction of firm level errors in conjunction with contemporaneous market signals we find that, in the years immediately following Reunification, Eastern firms estimate the market’s role as generally less potent than Western firm do, an observation consistent with overweighting experiences from the communist era; however, over roughly 14 years both converge to the same (incorrect) overestimate of the market’s role on their productivity.
I’m reminded of Mises’s remark that entrepreneurs, in a socialist economy, learn to excel at “diplomacy and bribery.” I suspect a study like Triebs and Tumlinson’s on political capabilities or skill at political entrepreneurship might yield the opposite result.
| Peter Klein |
I am wary of adding yet another conceptual margin for entrepreneurial action but I highly recommend a new (and for the moment, ungated) paper in the Scandinavian Economic History Review by the distinguished economic historian Joel Mokyr on “cultural entrepreneurship.” Starting from a broadly Schumpeterian perspective, Mokyr focuses on individuals who introduce and disseminate novel ideas:
[E]ach individual makes cultural choices taking as given what others believe. It is not a priori obvious how that affects one’s choices. It may affect them positively because conformism implies that there is some social cost associated with deviancy, or because people may reason that if the majority believes a certain thing, there may be wisdom in it (thus saving on information costs). But there can be a reverse reaction as well, with non-conformists perversely rebelling against existing beliefs. What matters for my purposes is that for a small number of individuals, the beliefs of others are not given but can be changed. I shall refer to those people as cultural entrepreneurs. Their function is much like entrepreneurs in the realm of production: individuals who refuse to take the existing technology or market structure as given and try to change it and, of course, benefit personally in the process. Much like other entrepreneurs, the vast bulk of them make fairly marginal changes in our cultural menus, but a few stand out as having affected them in substantial and palpable ways.
Succinctly expressed: “cultural entrepreneurs are the creators of epistemic focal points that people can coordinate their beliefs on.”
Mokyr’s focus, like Schumpeter’s, is not entrepreneurship per se, but its effects, particularly on long-run economic growth, and his entrepreneurship construct is somewhat undertheorized. But he provides fascinating examples, ranging from Mohammed and Luther to Francis Bacon, Isaac Newton, and Adam Smith. He focuses in particular on Bacon and Newton, describing Bacon’s work as “the coordination device which served as the point of departure for thinkers and experimentalists for two centuries to come. The economic effects of these changes remained latent and subterranean for many decades, but eventually they erupted in the Industrial Revolution and the subsequent processes of technological change.” Newton and the Royal Society “raise[d] the social standing of scientists and researchers as people who should be respected and supported and [provided] them with a comfortable material existence.” (Mostly good.)
I’m not an expert on cultural theory or history and am not sure how much the “cultural entrepreneur” construct ads to our understanding of cultural change (other than relabeling, a frequent worry in entrepreneurship studies). But the paper is a great read, highly provocative and informative, and addresses big questions. Check it out.
| Peter Klein |
The Story of French, a fun and interesting history of the French language by Jean-Benoit Nadeau and Julie Barlow, offers a number of valuable insights for writers and editors. Aspiring journal editors could learn from François de Malherbe (1555–1628), described by Nadeau and Barlow as “the biggest and most brazen language snob the world has ever seen.” Despite being “a fretful fault-finder who spent his life attacking, both verbally and in writing, every mistake — or what he regarded as mistakes — he could find and anyone who made one,” Malherbe had sound editorial instincts. In particular, he valued simplicity and clarity and despised unnecessary verbiage.
As a pastime, Malherbe edited Ronsard’s poetry, removing about half the words. His future biographer, Honorat de Racan, once asked him, “Does this mean you approve of the rest?” Malherbe responded by erasing what was left on the page.
Tough, but fair. . . . Anyway, Malherbe was clearly onto something. He “preached the virtues of clarity, precision, and rigor” while denouncing “ornamentation, repetition, archaisms, regionalisms, and hyperbole.” Perhaps academic journals need a few more Malherbes.
| Peter Klein |
That’s the title of a new review paper by Aaron Chatterji, Ed Glaeser, and William Kerr (a gated NBER working paper, unfortunately). Agglomeration has been a huge issue in the entrepreneurship, technology strategy, innovation policy, and economic growth literatures and it’s nice to have an up-to-date, not-very-technical review paper. (Hopefully there is an ungated copy out there somewhere.)
Clusters of Entrepreneurship and Innovation
Aaron Chatterji, Edward L. Glaeser, William R. Kerr
NBER Working Paper No. 19013, May 2013
This paper reviews recent academic work on the spatial concentration of entrepreneurship and innovation in the United States. We discuss rationales for the agglomeration of these activities and the economic consequences of clusters. We identify and discuss policies that are being pursued in the United States to encourage local entrepreneurship and innovation. While arguments exist for and against policy support of entrepreneurial clusters, our understanding of what works and how it works is quite limited. The best path forward involves extensive experimentation and careful evaluation.
Update: ungated version here.
| Peter Klein |
Transaction cost economics, the property-rights approach to the firm, and the judgment-based view all assume that contracting parties cannot sign complete, contingent contracts, in which case firm boundaries would be arbitrary and unimportant. TCE tends to attribute incompleteness to bounded rationality, while the judgment-based view appeals to Knightian uncertainty and subjectivism to describe markets for judgment are incomplete. The property-rights approach of Grossman, Hart, and Moore did not have an explicit theory of incompleteness, which critics such as Maskin and Tirole saw as a major weakness.
Oliver Hart has written a series of recent papers on “reference points” as a new explanation for incompleteness. The newest, released today as an NBER working paper (with Maija Halonen-Akatwijuka), is the most explicit. It argues that parties deliberately leave gaps in contracts because explicit clauses can make it more difficult for parties to parties to renegotiate after the fact. Check it out and see what you think.
More is Less: Why Parties May Deliberately Write Incomplete Contracts
Maija Halonen-Akatwijuka, Oliver D. Hart
NBER Working Paper No. 19001, April 2013
Why are contracts incomplete? Transaction costs and bounded rationality cannot be a total explanation since states of the world are often describable, foreseeable, and yet are not mentioned in a contract. Asymmetric information theories also have limitations. We offer an explanation based on “contracts as reference points”. Including a contingency of the form, “The buyer will require a good in event E”, has a benefit and a cost. The benefit is that if E occurs there is less to argue about; the cost is that the additional reference point provided by the outcome in E can hinder (re)negotiation in states outside E. We show that if parties agree about a reasonable division of surplus, an incomplete contract can be strictly superior to a contingent contract.
| Peter Klein |
The new issue of the Academy of Management Perspectives features a symposium, edited by Mike Wright, on “Private Equity: Managerial and Policy Implications.” The symposium includes “Private Equity, HRM, and Employment” by Mike with Nick Bacon, Rod Ball, and Miguel Meuleman; “The Evolution and Strategic Positioning of Private Equity Firms” by Robert E. Hoskisson, Wei Shi, Xiwei Yi, and Jing Jin; and “Private Equity and Entrepreneurial Governance: Time for a Balanced View” by John L. Chapman, Mario P. Mondelli, and me. The symposium came out very nicely, if I may say so, covering a variety of strategic, entrepreneurial, and organizational issues related to private equity firms and companies receiving private equity finance.
In his introduction Mike highlights five main contributions:
First, the papers address the need to consider the systematic evidence on the managerial and strategic aspects of PE, in relation to both portfolio firms and PE firms, which has been largely fragmented if not nonexistent. Second, the papers analyze the impact of PE during economic downturns and demonstrate the underlying resilience of PE-backed portfolio firms. Third, the symposium provides an opportunity to develop insights that compare the managerial impact of PE with different forms of ownership and governance. Fourth, the articles in this symposium highlight the heterogeneity of the private equity phenomenon. Finally, in the context of continuing public attention to PE, which has been heightened by the U.S. presidential race and the global recession, the evidence presented in this symposium paints a rather more positive view than the hyperbole of some of the industry’s critics would suggest. Taken together, these contributions indicate a need for caution in attempts to tighten the regulation of PE lest the economic, financial, and social benefits be lost.
| Peter Klein |
That’s the title of a new NBER paper by Philippe Aghion, Nicholas Bloom, and John Van Reenen, indicating that organization design, from the perspective of incomplete-contracting theory, continues to be a hot topic among the top economists. Like all NBER papers this one is gated, but intrepid readers may be able to locate a freebie.
Incomplete Contracts and the Internal Organization of Firms
Philippe Aghion, Nicholas Bloom, John Van Reenen
NBER Working Paper No. 18842, February 2013
We survey the theoretical and empirical literature on decentralization within firms. We first discuss how the concept of incomplete contracts shapes our views about the organization of decision-making within firms. We then overview the empirical evidence on the determinants of decentralization and on the effects of decentralization on firm performance. A number of factors highlighted in the theory are shown to be important in accounting for delegation, such as heterogeneity and congruence of preferences as proxied by trust. Empirically, competition, human capital and IT also appear to foster decentralization. There are substantial gaps between theoretical and empirical work and we suggest avenues for future research in bridging this gap.
| Peter Klein |
The econ and strategy literatures on multinational firms have grown dramatically since the pioneering works of Caves, Casson, Teece, and others. Besides established journals like the Journal of International Economics and Journal of International Business Studies, there is the new Global Strategy Journal and plenty of space in the general-interest journals for issues dealing with multinationals.
Pol Antràs and Stephen Yeaple have written a new survey paper for the Handbook of International Economics, 4th edition, and it’s available as a NBER working paper, “Multinational Firms and the Structure of International Trade.” The review focuses on the mainstream economics literature but should be useful for management and organization scholars as well — particularly section 7 on firm boundaries which includes both transaction cost and property rights theories. Here’s the abstract:
This article reviews the state of the international trade literature on multinational firms. This literature addresses three main questions. First, why do some firms operate in more than one country while others do not? Second, what determines in which countries production facilities are located? Finally, why do firms own foreign facilities rather than simply contract with local producers or distributors? We organize our exposition of the trade literature on multinational firms around the workhorse monopolistic competition model with constant-elasticity-of-substitution (CES) preferences. On the theoretical side, we review alternative ways to introduce multinational activity into this unifying framework, illustrating some key mechanisms emphasized in the literature. On the empirical side, we discuss the key studies and provide updated empirical results and further robustness tests using new sources of data.
The NBER version is gated but I’m sure our intrepid readers can dig up an open-access copy.
| Peter Klein |
Organizational economics involves the use of economic logic and methods to understand the existence, nature, design, and performance of organizations, especially managed ones. As this handbook documents, economists working on organizational issues have now generated a large volume of exciting research, both theoretical and empirical. However, organizational economics is not yet a fully recognized field in economics — for example, it has no Journal of Economic Literature classification number, and few doctoral programs offer courses in it. The intent of this handbook is to make the existing research in organizational economics more accessible to economists and thereby to promote further research and teaching in the field.
This is a fair assessment, though some O&M readers may find the editors’ definition of the field too narrow. The volume covers a wide variety of issues, topics, and applications but nearly all from the perspective of modern neoclassical economics (there’s a chapter on TCE by Williamson and Steve Tadelis, but nothing on “old” property rights theory, capabilities, the knowledge-based view, etc.). Still, it appears to be an excellent collection of state-of-the-art papers. Besides the usual topics like incentives, authority, complementarity, innovation, ownership, vertical integration, and the like, there’s also an interesting methodological section featuring “Clinical Papers in Organizational Economics” by George Baker and Ricard Gil, “Experimental Organizational Economics” by Colin Camerer and RobertoWeber, and “Insider Econometrics by Casey Ichniowski and Kathy Shaw. Check it out.
| Lasse Lien |
Today we are proud to launch a virtual seminar over Benito Arruñada’s important new book: Institutional Foundations of Impersonal Exchange: Theory and Policy of Contractual Registries (U. of Chicago Press).
First, what on earth is a virtual seminar? In this case a virtual seminar means that we over the next two weeks will launch a series of posts that address issues in Arruñada’s book, or issues that are inspired by issues in Arruñada’s book. Our hope is that many of you will join the discussion by adding your reflections, objections, or thoughts under the lead posts in the usual O&M way. Please note that if you haven’t had the time to read the book, but have thoughts on the subjects brought up or think additional subjects should be brought up, don’t let that stop you. We want to hear your thoughts!
Who is Benito? Benito is Professor of Business Organization at the Department of Economics and Business at Pompeu Fabra University, Barcelona. Prior to joining Pompeu Fabra and after graduating from the universities of Oviedo and Rochester, he held positions at the Universities of Oviedo and León, and was John M. Olin Visiting Scholar in Law and Economics at Harvard Law School. He has also taught at the Universities of Paris (I and X), Frankfurt, Autónoma de Madrid and Pablo de Olavide in Seville, and visited UC Berkeley, Washington and George Mason Universities. Benito Arruñada was a member of the founding board of directors and served as President (2005-2006) of the International Society for New Institutional Economics, ISNIE. And most prestigious of all; he is a former guest blogger at O&M.
What about the book? As the title reveals, the essence of the book is the institutional foundations for impersonal exchange. If you are reading a blog called Organizations and Markets, it seems safe to assume that you will find this topic interesting and profoundly important. To flesh it out a bit more, what could be better than to let Benito himself explain the main thrust of the book:
| Benito Arruñada |
Governments and development agencies spend considerable resources building property and company registries to protect property rights. When these efforts succeed, owners feel secure enough to invest in their property and banks are able use it as collateral for credit. Similarly, firms prosper when entrepreneurs can transform their firms into legal entities and thus contract more safely. Unfortunately, developing registries is harder than it may seem to observers, especially in developed countries, where registries are often taken for granted. As a result, policies in this area usually disappoint.
In this book, I have aimed to avoid such failures by deepening our understanding of both the value of registries and the organizational requirements for constructing them. Presenting a theory of how registries strengthen property rights and reduce transaction costs, I analyze the major tradeoffs and propose principles for successfully building registries in countries at different stages of development. The focus is on land and company registries, explaining the difficulties entailed, including current challenges like the subprime mortgage crisis in the United States and the dubious efforts being made in developing countries toward universal land titling. But the analytical framework covers other registries, including intellectual property and organized exchanges of financial derivatives.
Arruñada, Benito, Institutional Foundations of Impersonal Exchange: Theory and Policy of Contractual Registries, University of Chicago Press, Chicago, 2012. (Amazon site: http://ow.ly/cBMU5).
| Peter Klein |
We haven’t been entirely kind to behavioral economics, but we certainly recognize its importance, and have urged our colleagues to keep up with the latest arguments and findings. A new NBER paper by Nicholas Barberis summarizes the literature, focusing on prospect theory, and is worth a read.
Thirty Years of Prospect Theory in Economics: A Review and Assessment
Nicholas C. Barberis
NBER Working Paper No. 18621, December 2012
Prospect theory, first described in a 1979 paper by Daniel Kahneman and Amos Tversky, is widely viewed as the best available description of how people evaluate risk in experimental settings. While the theory contains many remarkable insights, economists have found it challenging to apply these insights, and it is only recently that there has been real progress in doing so. In this paper, after first reviewing prospect theory and the difficulties inherent in applying it, I discuss some of this recent work. While it is too early to declare this research effort an unqualified success, the rapid progress of the last decade makes me optimistic that at least some of the insights of prospect theory will eventually find a permanent and significant place in mainstream economic analysis.
| Peter Klein |
Looking for the perfect holiday gift for that special someone? Lots of friends and family on your Nice List? Get them a book from your favorite O&M authors. If you really want to show your love, get the whole bunch! Links and ordering information are on the right-hand sidebar on the O&M home page (you may have to scroll down to see them). Several are available as e-books as well as the traditional versions. Beats the heck out of a lump of coal. (Naughty Listers can be given a complimentary one-year subscription to orgtheory.net.)
| Lasse Lien |
Here’s a link to the “online first” version of a new Org. Science paper by Peter and myself. This one has been in the pipeline for some time, and we’ve blogged about the WP version before, but this is the final and substantially upgraded version. Please read it and cite it, or we will be forced to kidnap your cat:
The survivor principle holds that the competitive process weeds out inefficient firms, so that hypotheses about efficient behavior can be tested by observing what firms actually do. This principle underlies a large body of empirical work in strategy, economics, and management. But do competitive markets really select for efficient behavior? Is the survivor principle reliable? We evaluate the survivor principle in the context of corporate diversification, asking if survivor-based measures of interindustry relatedness are good predictors of firms’ decisions to exit particular lines of business, controlling for other firm and industry characteristics that affect firms’ portfolio choices. We find strong, robust evidence that survivor-based relatedness is an important determinant of exit. This empirical regularity is consistent with an efficiency rationale for firm-level diversification, though we cannot rule out alternative explanations based on firms’ desire for legitimacy by imitation and attempts to temper multimarket competition.
| Nicolai Foss |
Kathleen Eisenhardt’s 1989 Academy of Management Review paper is likely still the first, but hopefully not the last, exposure many management scholars have to agency theory. The paper is somewhat imprecise, and it shows its age, but as an introduction to the theory, one can do worse. However, much has in fact happened in agency theory since 1989 in terms of extensions and refinements of the theory, and also in terms of critical reactions, some of which have been partly aligned with the theory.
In particular, (some) economists and (more) management scholars (e.g., Wiseman and Gomez-Mejia) have tried to bring behavioral perspectives into agency theory. In a new paper (forthcoming in the Journal of Management), Alexander Pepper of the LSE and Julie Gore of the University of Surrey provide a useful overview of “behavioral agency theory,” somewhat in the style of Eisenhardt’s earlier review (i.e., with propositions that summarize the earlier literature). They include, for example, prospect theory, work on inequity aversion and even self-determination theory under the behavioral hat, and thus bring both cognitive and motivational issues into the orbit of behavioral agency theory.
A few mildly critical comments.
- There is no claim in the paper that the various behavioral ideas are consistent and “add up,” but this is something that should perhaps have been discussed. Standard theory may make extreme assumptions but it is a highly consistent and neat theory. In contrast, behavioral agency theory is a bouillabaise of very different ingredients that are linked to the standard theory in a somewhat ad hoc manner.
- The authors position and motivate the paper in terms of gaining more insight into executive compensation, but of course the scope of behavioral agency theory is much broader.
- The authors, like Eisenhardt, repeats Michael Jensen’s distinction between “positive agency theory” and “principal-agent theory,” which makes as little sense today as it did in 1983 ;-)
Still, Pepper and Gore’s paper is definitely worth a read and I highly recommend it.