Posts filed under ‘Recommended Reading’

A Paper You Might Want to Read

| 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.

2 December 2012 at 6:51 pm Leave a comment

Behavioral Agency Theory

| 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.

28 November 2012 at 9:12 am 1 comment

Book Seminar: Institutional Foundations of Impersonal Exchange: The Theory and Policy of Contractual Registries

| Lasse Lien |

Very shortly O&M will host a Virtual Seminar on former guest blogger Benito Arruñada’s important new book, Institutional Foundations of Impersonal Exchange: The Theory and Policy of Contractual Registries (University of Chicago Press, 2012). The blurb:

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.

So stay tuned for this. While we are finalizing the last details of the virtual seminar, you may want to attend one of Benito’s presentations:

27 November 2012 at 3:23 am 1 comment

A New Approach to Multitask Agency Problems

| Peter Klein |

The standard approach to multiask agency problems is to recognize that, if the output of some tasks is more easily measured than the output of other tasks, than others, then piece-rate incentive schemes will lead to a distortion of effort toward the more easily monitored tasks. Ask a sales clerk to sell merchandise and keep the store clean and the displays spiffy, and pay on a commission basis, and you’ll get a messy store. A new paper by Omar Al-Ubaydli, Steffen Andersen, Uri Gneezy, and John List challenges this view, arguing that using a piece-rate schemes signals that the principal is a good monitor in general, which can motivate performance even on the not-easily-measured tasks in a multitask setting:

Carrots that Look Like Sticks: Toward an Understanding of Multitasking Incentive Schemes
Omar Al-Ubaydli, Steffen Andersen, Uri Gneezy, John A. List
NBER Working Paper No. 18453, October 2012

Constructing compensation schemes for effort in multi-dimensional tasks is complex, particularly when some dimensions are not easily observable. When incentive schemes contractually reward workers for easily observed measures, such as quantity produced, the standard model predicts that unrewarded dimensions, such as quality, will be neglected. Yet, there remains mixed empirical evidence in favor of this standard principal-agent model prediction. This paper reconciles the literature by using both theory and empirical evidence. The theory outlines conditions under which principals can use a piece rate scheme to induce higher quantity and quality levels than analogous fixed wage schemes. Making use of a series of complementary laboratory and field experiments we show that this effect occurs because the agent is uncertain about the principal’s monitoring ability and the principal’s choice of a piece rate signals to the agent that she is efficient at monitoring.

22 October 2012 at 12:44 am 8 comments

Luigi Zingales Blogging on EconLog

| Peter Klein |

Luigi Zingales, an important contributor to organizational economics as well as finance and macroeconomics, and frequently cited here at O&M, is guest blogging at EconLog. I’m looking forward to his posts!

1 October 2012 at 11:06 pm 1 comment

Arruñada’s Institutional Foundations of Impersonal Exchange

| Peter Klein |

Former O&M guest blogger Benito Arruñada has a new book, Institutional Foundations of Impersonal Exchange: Theory and Policy of Contractual Registries (University of Chicago Press, 2012), presenting his influential and important work on the measurement of property rights and transaction costs. Here’s the blurb:

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.

Benito Arruñada aims 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, he analyzes the major trade-offs and proposes principles for successfully building registries in countries at different stages of development. Arruñada focuses on land and company registries, explaining the difficulties they face, including current challenges like the subprime mortgage crisis in the United States and the dubious efforts made in developing countries toward universal land titling. Broadening the account, he extends his analytical framework to other registries, including intellectual property and organized exchanges of financial derivatives. With its nuanced presentation of the theoretical and practical implications, Institutional Foundations of Impersonal Exchange significantly expands our understanding of how public registries facilitate economic growth.

My copy is on the way, and I’m eagerly looking forward to reading it!

18 September 2012 at 12:04 pm Leave a comment

Interesting Paper on Entrepreneurship and Growth

| Peter Klein |

Does entrepreneurship cause economic growth, or do high growth rates stimulate entrepreneurship? Ed Glaeser, Sari Pekkala Kerr, and William Kerr have an interesting new paper that uses the presence of heavy industry to instrument for the population of potential entrepreneurs (using startups as the proxy for entrepreneurship).

Entrepreneurship and Urban Growth: An Empirical Assessment with Historical Mines
Edward L. Glaeser, Sari Pekkala Kerr, William R. Kerr
NBER Working Paper No. 18333, August 2012

Measures of entrepreneurship, such as average establishment size and the prevalence of start-ups, correlate strongly with employment growth across and within metropolitan areas, but the endogeneity of these measures bedevils interpretation. Chinitz (1961) hypothesized that coal mines near Pittsburgh led that city to specialization in industries, like steel, with significant scale economies and that those big firms led to a dearth of entrepreneurial human capital across several generations. We test this idea by looking at the spatial location of past mines across the United States: proximity to historical mining deposits is associated with bigger firms and fewer start-ups in the middle of the 20th century. We use mines as an instrument for our entrepreneurship measures and find a persistent link between entrepreneurship and city employment growth; this connection works primarily through lower employment growth of start-ups in cities that are closer to mines. These effects hold in cold and warm regions alike and in industries that are not directly related to mining, such as trade, finance and services. We use quantile instrumental variable regression techniques and identify mostly homogeneous effects throughout the conditional city growth distribution.

12 September 2012 at 3:58 pm 3 comments

Do Bosses Matter?

| Peter Klein |

Do bosses matter? Stephen Marglin famously argued that management doesn’t affect productivity, just the share of output appropriated by managers. (I’ll take David Landes instead, thank you very much.) Despite a huge management literature on bosses, economists have not quite known how to answer the question. Ed Lazear, Kathryn Shaw (ironically, a former boss of mine), and Christopher Stanton have an interesting new take on this using detailed microdata, showing substantial effects of supervisor on worker productivity:

The Value of Bosses
Edward P. Lazear, Kathryn L. Shaw, Christopher T. Stanton
NBER Working Paper No. 18317, August 2012

Do supervisors enhance productivity? Arguably, the most important relationship in the firm is between worker and supervisor. The supervisor may hire, fire, assign work, instruct, motivate and reward workers. Models of incentives and productivity build at least some subset of these functions in explicitly, but because of lack of data, little work exists that demonstrates the importance of bosses and the channels through which their productivity enhancing effects operate. As more data become available, it is possible to examine the effects of people and practices on productivity. Using a company-based data set on the productivity of technology-based services workers, supervisor effects are estimated and found to be large. Three findings stand out. First, the choice of boss matters. There is substantial variation in boss quality as measured by the effect on worker productivity. Replacing a boss who is in the lower 10% of boss quality with one who is in the upper 10% of boss quality increases a team’s total output by about the same amount as would adding one worker to a nine member team. Using a normalization, this implies that the average boss is about 1.75 times as productive as the average worker. Second, boss’s primary activity is teaching skills that persist. Third, efficient assignment allocates the better bosses to the better workers because good bosses increase the productivity of high quality workers by more than that of low quality workers.

NB: For some reason, my graduate students are circulating this piece from last week’s WSJ.

21 August 2012 at 1:46 pm 1 comment

Summer Readings

| Nicolai Foss |

OK, my eleven weeks, Euro-style, full-tax-payer-paid, summer vacation starts today. In the time-honored tradition of narcissistic academic bloggers, here is what I plan to (hope to) read while frolicking on the beaches of the Riviera and relaxing in those small Spanish villages:

  • Jonathan Haidt: The Righteous Mind.  This will be a re-read. I read Haidt’s book 2 months ago and loved most of it, although I thought it was rather weak towards to the end. The whole argument is basically founded on the notion of group selection, and while group selection has made a huge comeback in terms of scientific respectability, perhaps Haidt is overdoing it?
  • Mark Pagel: Wired for Culture.  Interest in group selection is also why I will read Pagel’s book, which seems to be all about human group selection, written by a leading British expert on human evolution. A reason why I take an interest in group selection stems from my interest in Hayek’s work on cultural evolution which is basically a group selection story — and which has been strongly criticized for exactly this reason.
  • Ezequiel Morsella, John A Bargh and Peter M. Gollwitzer: Oxford Handbook on Human Action.  No, this is not a commentary on Mises, but a collection of essays that” … brings together the current thinking of eminent researchers in the domains of motor control, behavioral and cognitive neuroscience, psycholinguistics, biology, as well as cognitive, developmental, social, and motivational psychology. It represents a determined multidisciplinary effort, spanning across various areas of science as well as national boundaries.”   Great and accessible reading for anyone with an interest in human action and behavior that goes beyond simplistic economics treatments.
  • Steven Pinker: The Better Angels of Our Nature: Why Violence Has Declined.  Pinker is always worth a read!

13 July 2012 at 11:45 am 3 comments

Handbook of Economic Organization

| Peter Klein |

Kudos to Anna Grandori for her edited volume, Handbook of Economic Organization: Integrating Economic and Organization Theory, currently making its way through the editorial process at Edward Elgar. Blurb:

The volume distinctively aims at integrating economic and organization theories for the explanation and design of economic organization. Economic organization is therefore intended both as an object of enquiry and as an emerging disciplinary field: not economics applied to organization as an object, but a forefront interdisciplinary  field attracting researches and integrating insights from  economics,  organization theory, strategy and management, economic sociology, and cognitive psychology. The authors are distinguished scholars at their productive peak in those fields, sharing an in interest in an integrated and enlarged approach to economic organization. Each chapter not only addresses foundational issues and provides a state-of-art, but also offers original contributions and identifies key issues for future research.

Table of Contents is below the fold. You”ll find many of your favorite authors. (more…)

3 July 2012 at 4:42 pm Leave a comment

Organizing Entrepreneurial Judgment: Kindle Edition Now Available

| Peter Klein |

Here’s the link — and the price is right, just $16.50!

According to the latest sales figures, we’re up to #1,070,026 on Amazon. So close to the top spot! Incidentally, my sole-authored Capitalist and the Entrepreneur is just behind at #1,210,245, suggesting that the market places only a small value on the marginal Foss contribution. That’s the correct inference, right?

23 May 2012 at 2:01 pm 6 comments

Qantum + Politics = Ψ(Fun)

| Lasse Lien |

O&M is nonpartisan, but this description of Mitt Romney as the first quantum politician is IMHO so funny that it would be downright irresponsible to ignore it.

After describing how other candidates operate under Newtonian principles, where a candidate’s position on an issue remains constant until acted upon by some outside force, David Javerbaum goes on to describe how things are very different in the quantum Romneality (excerpt):

Complementarity. In much the same way that light is both a particle and a wave, Mitt Romney is both a moderate and a conservative, depending on the situation. It is not that he is one or the other; it is not that he is one and then the other. He is both at the same time.

Probability. Mitt Romney’s political viewpoints can be expressed only in terms of likelihood, not certainty. While some views are obviously far less likely than others, no view can be thought of as absolutely impossible. Thus, for instance, there is at any given moment a nonzero chance that Mitt Romney supports child slavery.

Uncertainty. Frustrating as it may be, the rules of quantum campaigning dictate that no human being can ever simultaneously know both what Mitt Romney’s current position is and where that position will be at some future date. This is known as the “uncertainty principle.”

Entanglement. It doesn’t matter whether it’s a proton, neutron or Mormon: the act of observing cannot be separated from the outcome of the observation. By asking Mitt Romney how he feels about an issue, you unavoidably affect how he feels about it. More precisely, Mitt Romney will feel every possible way about an issue until the moment he is asked about it, at which point the many feelings decohere into the single answer most likely to please the asker.

Noncausality. The Romney campaign often violates, and even reverses, the law of cause and effect. For example, ordinarily the cause of getting the most votes leads to the effect of being considered the most electable candidate. But in the case of Mitt Romney, the cause of being considered the most electable candidate actually produces the effect of getting the most votes.

Duality. Many conservatives believe the existence of Mitt Romney allows for the possibility of the spontaneous creation of an “anti-Romney” that leaps into existence and annihilates Mitt Romney. (However, the science behind this is somewhat suspect, as it is financed by Rick Santorum, for whom science itself is suspect.)

What does all this bode for the general election? By this point it won’t surprise you to learn the answer is, “We don’t know.” Because according to the latest theories, the “Mitt Romney” who seems poised to be the Republican nominee is but one of countless Mitt Romneys, each occupying his own cosmos, each supporting a different platform, each being compared to a different beloved children’s toy but all of them equally real, all of them equally valid and all of them running for president at the same time, in their own alternative Romnealities, somewhere in the vast Romniverse.

David Javerbaum (NYT March 31).
HT: Svein T. Johansen

13 April 2012 at 4:47 am 3 comments

Stylish Academic Writing

| Peter Klein |

Helen Sword’s recent WSJ piece — “Yes, Even Professors Can Write Stylishly” — takes me back to an early O&M entry on academic writing. Sword offers some great pairwise comparisons:

Stodgy: The human capacity to synthesize linguistic complexity is exemplified by the grammatical phenomenon of verb irregularity.

Stylish: “This book tries to illuminate the nature of language and mind by choosing a single phenomenon and examining it from every angle imaginable. That phenomenon is regular and irregular verbs, the bane of every language student.” (Steven Pinker)


Stodgy: A significant variability in nutrient-gathering behaviors has been observed in various insect species.

Stylish: “Insects suck, chew, parasitize, bore, store, and even cultivate their foods to a highly sophisticated degree of specialization.” (Richard Leschen and Thomas Buckley)

Plenty more are in her new book, Stylish Academic Writing. As I noted in the earlier post, economics and management scholarship has been blessed with some terrific prose stylists, but plenty of awful ones too.

10 April 2012 at 9:05 am 2 comments

The Socialist Car

| Peter Klein |

I blogged previously about Lewis Siegelbaum’s 2008 book Cars for Comrades: The Life of the Soviet Automobile (or, more precisely, Perry Patterson’s EH.Net review). So I need to say something about the follow up, The Socialist Car: Automobility in the Eastern Bloc (Cornell University Press, 2011), an essay collection edited by Siegelbaum. Once again, here’s Patterson:

As was true for Cars for Comrades, this book takes the modern upper-middle-class Western reader far from the contemporary world where drivers need not know what’s “under the hood,” where synthetic oil might not need attention for 15,000 miles or more, and where long-standing institutions for finance, distribution and service of vehicles are seemingly ubiquitous.  Rather, this is a world where two-stroke engines are designed for easy (and frequent) self-service, new car owners are required to install windshield wipers, and new automobiles are provided with extensive repair kits and instructions for disassembly.  This world is also one where private automobiles – and even socially-owned trucks – represent potential threats to the Soviet-style socialist undertaking by providing opportunities for generating illegal incomes and diverting resources toward consumption.  At the core of the rich set of stories contained here are the compromises that everyday citizens, urban planners, and Party officials routinely made as the powerful forces associated with the automobile became more and more apparent throughout the socialist bloc.  In addition, the examples presented in this eleven-chapter volume say much about the increasingly complex information flows required and implied by automobiles that became more and more technically complex over time.

Speaking of, the performativity crowd may get a kick out of another recent review, Bruce Carruthers’s discussion of Carl Wennerlind, Casualties of Credit: The English Financial Revolution, 1620-1720 (Harvard University Press, 2011). Notes Carruthers: “It was not simply that early modern capital markets evolved, that financial systems developed, or that English economic institutions changed. These critical transformations were accompanied and even shaped by the analyses offered by people who witnessed the events of the time.”

23 March 2012 at 9:32 am 2 comments

First Copies of the New Book

| Peter Klein |

Nicolai was in town yesterday to deliver the 2012 Sherlock Hibbs Distinguished Lecture in Economics and Business, and he gave a terrific talk about “open entrepreneurship,” the application of concepts and principles from the open innovation literature to the discovery, evaluation, and exploitation of entrepreneurial opportunities. Upon returning to my office after the lecture, I found a surprise waiting for me: the first hardcopies of our new book, Organizing Entrepreneurial Judgment: A New Approach to the Firm (Cambridge University Press, 2012). As both authors happened to be together, we preserved the moment for posterity.

You can order today on Amazon’s UK site (or pre-order on the US site, which shows a publication date of 30 April). You can order directly from Cambridge (UK or US).

A brief description and some endorsements are below the fold.

NB: Tomorrow Nicolai is giving the Hayek Lecture at the Austrian Scholars Conference, which you can watch live online.

Update: O&M readers can order directly from Cambridge and receive a 20% discount! Use this link.


7 March 2012 at 5:48 pm 15 comments

Zenger, Felin, and Bigelow on “Theories of the Firm-Market Boundary”

| Peter Klein |

Here’s a nice review and synthesis of “Theories of the Firm-Market Boundary” by Todd Zenger, Teppo Felin, and Lyda Bigelow, just out in the Academy of Management Annals.

A central role of the entrepreneur-manager is assembling a strategic bundle of complementary assets and activities, either existing or foreseen, which when combined create value for the firm. This process of creating value, however, requires managers to assess which activities should be handled by the market and which should be handled within hierarchy. Indeed, for more than 40 years, economists, sociologists and organizational scholars have extensively examined the theory of the firm’s central question: what determines the boundaries of the firm? Many alternative theories have emerged and are frequently positioned as competing explanations, often with no shortage of critique for one another. In this paper, we review these theories and suggest that the core theories that have emerged to explain the boundary of the firm commonly address distinctly different directional forces on the firm boundary — forces that are tightly interrelated. We specifically address these divergent, directional forces — as they relate to organizational boundaries — by focusing on four central questions. First, what are the virtues of markets in organizing assets and activities? Second, what factors drive markets to fail? Third, what are the virtues of integration in organizing assets and activities? Fourth, what factors drive organizations to fail? We argue that a complete theory of the firm must address these four questions and we review the relevant literature regarding each of these questions and discuss extant debates and the associated implications for future research.

Lots of good stuff here, especially in integrating economic and sociological perspectives on boundary (I guess all that time Teppo spends over there has influenced his thinking).

24 February 2012 at 5:36 am 3 comments

New ebooks — Knowledge on the Cheap

| Peter Klein |

Google’s ebookstore now contains deeply discounted versions of several Edward Elgar books (which are usually priced for library use), including my Elgar Companion to Transaction Cost Economics ($48) and the Foss-Klein product Entrepreneurship and the Firm: Austrian Perspectives on Economic Organization ($31.20). Nicolai’s greatest hits collection Knowledge, Economic Organization, and Property Rights is also published by Elgar but not yet available in ebook form. However, Google has cheap ebooks of Nicolai’s Strategy, Economic Organization, and the Knowledge Economy ($40) and Dick’s Firms, Markets, and Economic Change ($60), among other items of interest. And my Capitalist and the Entrepreneur remains available at the best price of all!

14 February 2012 at 11:45 am 7 comments

Finance and the Nature of the Firm

| Peter Klein |

Raghu Rajan’s AFA presidential address is now online as an NBER working paper:

The nature of the firm and its financing are closely interlinked. To produce significant net present value, an entrepreneur has to transform her enterprise into one that is differentiated from the ordinary. To achieve the control that will allow her to execute this strategy, she needs to have substantial ownership, and thus financing. But it is hard to raise finance against differentiated assets. So an entrepreneur has to commit to undertake a second transformation, standardization, that will make the human capital in the firm, including her own, replaceable, so that outside financiers obtain rights over going-concern surplus. I argue that the availability of a vibrant stock market helps the entrepreneur commit to these two transformations in a way that a debt market would not. This helps explain why the nature of firms and the extent of innovation differ so much in different financing environments.

25 January 2012 at 6:47 am Leave a comment

Keynes-Hayek again!

| Peter Lewin |

I am not sure if this book has already been review on this blog space — I haven’t seen it. Similarly, I haven’t seen any other reviews, so these are my fresh impressions. The book is Keynes Hayek: The Clash that Defined Modern Economics by Nicholas Wapshott (W. W. Norton: 2011).

With the growing interest in Hayek as the antidote to the resuscitated Keynes, this book is timely providing for the reader lively insight into the life and times of these two key individuals. In terms of the details of the lives of Keynes and Hayek the book appears to be well researched. I learned a few things from it — interesting details about events and personalities. On Keynes particularly one gains a sense of the power of the man and how a whole generation of economists at the LSE and Cambridge were won over by his revolutionary vision. Though Wapshott provides a lot of material on Hayek, I could not fight the impression that it was Keynes who captured his interest (and admiration?) most. Hayek is presented in all of his aspects, including the not so wholesome ones. The picture of Keynes seems less forthcoming, or differently spun to cast a more favorable light. But maybe that is just me and my biases.

When it comes to the economics, however, the case is much clearer. Wapshott is very weak on this part of the story, especially when it comes to Austrian economics. He is able to do a fairly good job of Keynesianism, again positively spun — including the story of multiplier. It adds to the plausibility of Keynes’s appeal. But when it comes to explaining the essence of Hayek’s opposition, his treatment is very inadequate at best and complete wrong at worst. Like Keynes himself, Wapshott does not understand capital theory and the time structure of production. So he gets the story of the business cycle wrong. He simply parrots in a formulaic way the ingredients of Hayek’s case. His treatment of Mises is almost a caricature. He does not understand the nature of the Austrian turn from classical economics and has some misleading things to say about the concept of “value.” Likewise he does not understand the differences and similarities between the economics of the Austrians  and the Monetarists and invents bogus differences. I found this part of the book frustrating.

So, the question in my mind is: do I recommend this book to my macro/money students? I think I probably will, with suitable warnings, just because it is such a vital and interesting story.

13 January 2012 at 1:19 pm 6 comments

A Formal Model of Experimentation in Firms

| Peter Klein |

Following Knight, Mises, and Lachmann, we have often characterized entrepreneurship on this blog (and the McQuinn blog, which should be on your reading list) as experimentation with combinations of heterogeneous capital resources. Experimentation itself is relatively understudied in the entrepreneurship and strategy literature — we have general theories about the nature and effects of experimentation, indirect empirical evidence on competition as experimentation (e.g., my relatedness stuff with Lasse), case-study evidence about experimentation and innovation within firms, but don’t fully understand the exact mechanisms.

Here’s a new paper that will not be to everyone’s taste, but tries to get at these issues in a formal model of interaction between experimenting firms:

The Role of Information in Competitive Experimentation
Ufuk Akcigit, Qingmin Liu
NBER Working Paper No. 17602, November 2011

Technological progress is typically a result of trial-and-error research by competing firms. While some research paths lead to the innovation sought, others result in dead ends. Because firms benefit from their competitors working in the wrong direction, they do not reveal their dead-end findings. Time and resources are wasted on projects that other firms have already found to be dead ends. Consequently, technological progress is slowed down, and the society benefits from innovations with delay, if ever. To study this prevalent problem, we build a tractable two-arm bandit model with two competing firms. The risky arm could potentially lead to a dead end and the safe arm introduces further competition to make firms keep their dead-end findings private. We characterize the equilibrium in this decentralized environment and show that the equilibrium necessarily entails significant efficiency losses due to wasteful dead-end replication and a flight to safety — an early abandonment of the risky project. Finally, we design a dynamic mechanism where firms are incentivized to disclose their actions and share their private information in a timely manner. This mechanism restores efficiency and suggests a direction for welfare improvement.

21 November 2011 at 10:56 am Leave a comment

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Our Recent Books

Nicolai J. Foss and Peter G. Klein, Organizing Entrepreneurial Judgment: A New Approach to the Firm (Cambridge University Press, 2012).
Peter G. Klein and Micheal E. Sykuta, eds., The Elgar Companion to Transaction Cost Economics (Edward Elgar, 2010).
Peter G. Klein, The Capitalist and the Entrepreneur: Essays on Organizations and Markets (Mises Institute, 2010).
Richard N. Langlois, The Dynamics of Industrial Capitalism: Schumpeter, Chandler, and the New Economy (Routledge, 2007).
Nicolai J. Foss, Strategy, Economic Organization, and the Knowledge Economy: The Coordination of Firms and Resources (Oxford University Press, 2005).
Raghu Garud, Arun Kumaraswamy, and Richard N. Langlois, eds., Managing in the Modular Age: Architectures, Networks and Organizations (Blackwell, 2003).
Nicolai J. Foss and Peter G. Klein, eds., Entrepreneurship and the Firm: Austrian Perspectives on Economic Organization (Elgar, 2002).
Nicolai J. Foss and Volker Mahnke, eds., Competence, Governance, and Entrepreneurship: Advances in Economic Strategy Research (Oxford, 2000).
Nicolai J. Foss and Paul L. Robertson, eds., Resources, Technology, and Strategy: Explorations in the Resource-based Perspective (Routledge, 2000).