Entrepreneurship Theories

The External Enabler Framework (Davidsson, Recker & von Briel, 2020) is a conceptual toolbox developed for analyzing the strategic and fortuitous influence of changes to the business environment in entrepreneurial pursuits. External Enabler (EE) refers to significant changes to the business environment, such as new technologies, regulatory changes, macroeconomic shifts, demographic and sociocultural trends, changes to the natural environment, and the like. The basic assumption of the EE body of work is that every such change will benefit some entrepreneurial initiatives even if it disadvantages other economic activities. EE analysis focuses on those enabled; other frameworks are needed for analyzing negative consequences of change. The EE concept was introduced as a more workable alternative to “objective opportunity” for realizing the idea of entrepreneurship as a nexus of enterprising agents and favorable environmental conditions (Davidsson, 2015). Unlike the notion of objective

Informal entrepreneurship refers to economic activity that occurs outside of the formal economy, which is typically characterized by the absence of legal and regulatory frameworks. This type of entrepreneurship is often associated with small-scale, unregistered, and unregulated businesses that operate in the informal sector. The informal economy is made up of a diverse range of activities, including street vending, artisanal production, and home-based businesses, among others. While these businesses may provide a means of livelihood for individuals and communities, they often face significant barriers to growth and sustainability due to their lack of access to formal financing, legal protections, and other resources. In contrast, the formal economy is the part of the economy that is recognized and regulated by government institutions. Companies and entrepreneurs operating in the formal economy are required to pay taxes, adhere to labour laws and regulations, and obtain necessary licens

Information asymmetry refers to a conditions whereby two parties in a market or organizational relationship have access to different information about the exchange.  It can be seen as an alternative to the classical assumption of "perfect information" in economics. Information asymmetries have been acknowledged by regulators who have made laws forbidding insider trading. Insiders have special access to the real financial picture of a company and have an unfair advantage when buying and selling company stock (Aboody, 2000). Company executives, like CEOs also have fiduciary responsibilities toward their investors which require them to be truthful and forthcoming. Information asymmetry is also a potential source of problems in entrepreneurship. For example, an entrepreneur knows much more about the real potential of their ventures because they have inside access to knowledge about their customers and the issues with production. The investors, on the other hand, have less informa

What is the risk compensation theory of entrepreneurship? Peltzman’s (1975) pioneering study of automobile accidents revealed that expected positive effects of safety regulations rarely materialized upon implementation. He argued that when drivers feel safer, they take more risks, which compensate for the safety interventions. Support for what is now dubbed the ‘Pelzman effect’ (or risk compensation theory) is far reaching and extends to varying contexts including new rules in NASCAR racing, mandated visor use in hockey, consumer vigilance in response to food safety messages, and bike helmet laws. But does this phenomenon also explain greater entrepreneurial risk-taking in the presence of social safety nets? There is emerging evidence that social safety nets can have positive benefits for entrepreneurs by reducing the risk associated with entry. Olds (2016a) finds that states that provided more food stamps have more limited liability company registrations among members of newly

What is Hoselitz theory of entrepreneurship? Burt F. Hoselitz was a professor of economics at the University of Chicago. Hoselitz argues that entrepreneurship tends to come from socially marginalized groups in a given society. This is very similar to the withdrawal of status respect theory and the misfit theory of entrepreneurship , which both deal with marginalized populations. Hoselitz (1963) assumes that entrepreneurship can only come out of a developed cultural base. His theory is that marginalized populations must be considered culturally developed in order to be considered eligible for entrepreneurship. He refers to entrepreneurship by marginalized groups as "pariah entrepreneurship". U.S. Coast Guard Photo Hoselitz claimed that his theory helps to explain to the highly entrepreneurial behaviors of Greeks and Jewish people in medieval Europe, Lebanese in West Africa, Chinese in Southeast Asia, and Indians in East Africa. The concept of cultural develo

Prospect theory was developed by behavioural economists Daniel Kahneman and Amos Tversky in the 1970s. Their aim was to better understand decision making processes by looking at how individuals assess the potential gains and losses from a decision separately. The most famous hypothesis tied to the theory is that most individuals fear losses more than they value gains. The theory posits that when individuals think they are winning (gain domain frame), they become more risk-averse, whereas when they think they are losing (loss domain frame), they become inclined to take bigger risks to get back to a break-even position. According to Hsu et al. (2017): "So essentially, whether a person frames a situation as associated with gains or losses influences his or her attitude toward engaging in risky behaviors such as reentering entrepreneurship."    Entrepreneurs judge whether they are in a gain or loss position based on a reference point. For instance, Hsu et al. use the entrepre

What is Cantillon's theory of entrepreneurship? The word "entrepreneur" has been traced back to Richard Cantillon, an Irish banker with French roots writing in the early 1700s, before Adam Smith. Cantillon distinguished between entrepreneurs with nonfixed incomes and employees with fixed incomes. Cantillon considered the entrepreneurs as those who undertake to bear and overcome uncertainty by investing, paying expenses and hoping for a return. Cantillon viewed a wide slice of society as entrepreneurial because they bear uncertainty, including: "All the other entrepreneurs, like those who take charge of mines, theaters, buildings, the traders by sea and land, restaurateurs, pastry cooks, innkeepers, etc., as well as the entrepreneurs of their own labor who need no capital to establish themselves, like journeymen artisans, coppersmiths, seamstresses, chimney sweeps, water transporters, live with uncertainty and proportion themselves to their customers. Master

Scholars have divided entrepreneurship into different categories. For example, self-employed individuals are often not considered entrepreneurs. To be an entrepreneur, there has to be an organization being built. There is even a growing sense that only scalable forms of entrepreneurship should be encouraged (Shane, 2009). Another way to slice up entrepreneurs is to separate between necessity and opportunity entrepreneurs (Harding, 2002). Most entrepreneurship theories focus on opportunity entrepreneurship, but perhaps scholars should also embrace broader views that include entrepreneurship that is based on necessity, or at least consider a greater diversity of entrepreneurship (Welter et al., 2017). This approach looks at the motivations of the entrepreneurs, thus can be considered a motivational theory. Basically, if you have one of the two motives, you are more likely become an entrepreneur. Necessity entrepreneurs are individuals who start businesses because they cannot find a

For some time there has been interest in the question of whether clusters form because of entrepreneurship, or whether clusters benefit entrepreneurs ( Delgado, Porter, and Stern, 2010 ). Clusters refer to geographic concentrations of similar firms, such the technology firms in Silicon Valley. Researchers are interested to know if clusters breed and boost entrepreneurs to see if pro-cluster policies, such as smart parks, make economic sense. Researchers also want to know if entrepreneurs are better off in clusters or not to inform industrial policy around entrepreneurship education and training ( Cusmano, Morrison and Pandolfo, 2015 ). Spinouts: where employees from firms in a cluster leave to start complementary or competing independent ventures, are seen as important to the diversity and competitiveness of clusters. They are especially important because spinouts tend to stay close to their parent firms and their own networks. Thus, where there are many spinouts, there tends to b

What is the radical subjectivist theory of entrepreneurship? Ludwig M. Lachmann was a German Economist who proposed a radical subjectivist theory of entrepreneurship as an alternative to existing Austrian School theories of entrepreneurship (e.g., altertness theory or uncertainty-bearing theory or creative destruction theory ). According to Lachmann, entrepreneurs develop plans according to their subjective knowledge and expectations. Expectations form as a result of the creative imagination of entrepreneurs, who may envision many competing futures. Entrepreneurs continually revise their plans as they encounter new bits of market information during exchange experiences. Capital is seen as continually recombining due to the process of capital regrouping. As capital is invested sub-optimally, errors lead to new temporary stocks of capital that need to be redeployed toward new purposes. Institutions are viewed as signposts that provide the rules of the game for millions of individu

Israel Kirzner is a British-American economist and emeritus professor at New York University. He is associated with the Austrian school of economics. Below, we review Kirzner's alertness theory of entrepreneurship. Kirzner argues that entrepreneurs balance supply and demand by detecting market imperfections and exploiting them. Market imperfections are caused by information asymmetry and bounded rationality.   Information asymmetry refers to cases where different stakeholders have varying information about a business venture. If one stakeholder uses the information advantage to profit from the another, it is engaging in opportunistic bargaining. Bounded rationality refers to the idea that humans are not perfectly rational. Neo-classical and Classical economics model the assumptions of economic man, and tend to ignore bounded rationality. According to Kirzner, the profits entrepreneurs receive from entrepreneurship are their reward for their tolerance of uncertainty as th

What is the x-efficiency theory of entrepreneurship? Harvey Leibenstein , American economist, developed X-efficiency theory in the 1960s. He views entrepreneurs as gap-fillers and input complementors. Gaps (X-inefficiency) emerge when there are inefficiencies in markets, such as when incumbents do not utilize their resources efficiently (Leibenstein, 1966;1978) because of political, normative, cognitive, and structural factors. A classic example is the startup without a union that enters a market where all the incumbents have strong unions. The cost advantage of disorganized labor may help firms with low cost business models to thrive at the bottom of the market at margins that are uneconomical for incumbent firms to pursue within the target ranges given to them by their shareholders. If the maximum possible productive use of a resources is greater than the actual use by incumbents , an arbitrage opportunity emerges that an entrepreneur can exploit for profit. Entrepreneurs can

What is the jack of all trades theory of entrepreneurship? The jack of all trades theory of entrepreneurship was proposed by Stanford University economist Edward P. Lazear in a working paper that was eventually published in The American Economic Review in 2004, entitle Balanced Skills and Entrepreneurship . The theory seeks to explain and predict who becomes and entrepreneur, and which entrepreneurs will be successful. According to Lazear, individuals that become entrepreneurs may have more balance in their investment strategy (on average) as compared with individuals that specialize employee roles. Jack of all trades, master of none, still better than a master of one? Lazear's core idea is that entrepreneurs need to be good at many different things, that is, they are generalists rather than specialists. For instance, when first starting out, a restaurant entrepreneur needs to select vendors for inputs such as food, furniture, equipment, and construction. He or she may als

What is the resource scarcity theory of entrepreneurship? New ventures need to grow at a fast pace to keep up with incumbent firms. Oxenfeld and Kelly (1969) propose resource scarcity theory to explain which some new ventures choose franchising instead of chaining as a means of growth. A core assumption of the theory is that new ventures are founded below minimum efficient scale , such that there is a negative relationship between growth rate and failure of new ventures (Audretsch, 1995). Franchising  is  a quick way to expand a new venture with little upfront capital because the franchisees provide their own capital for their franchises. Since new ventures are often not able to access mainstream financial markets (e.g., for loans, bonds, and equity), franchising is an important alternative. Startups may also be less able to retain earnings to expand, given their commitments to initial investors who may want a quick return (Combs and Ketchen, 1999). Shane (1996) argues that new ve

The knowledge spillover theory suggests that productive innovation comes from both incumbents (established firms) and new entrants (entrepreneurs and their organizations) (Acs et al., 2009; Audretsch and Lehmann, 2005). Knowledge is inherently leaky, and moves through networks and via stakeholder mobility. This is probably a good assumption given that many organizations find it very difficult to keep secrets. Whistleblowers, for example, demonstrate the limits secrecy when they leak information that is damning to their employers. Knowledge spillovers are an important driver of economic growth and development because they enable entrepreneurs to identify and exploit new opportunities. In the context of entrepreneurship, spillovers refer to the diffusion of knowledge and ideas from one organization or individual to another. This can happen in a variety of ways, including through informal networks, collaborations, and formal knowledge-sharing mechanisms. Entrepreneurship is fundament

What is the transaction cost theory of entrepreneurship? Transaction cost economics is often attributed to the work of Ronald H. Coase in the 1930s, who used it as a way to explain the existence of organizations. Transaction costs occur whenever an economic exchange happens. Search and information costs describe the work of determining the availability of inputs and identifying the most affordable source of inputs in a market, or finding the best partner for an exchange (Williamson, 1975). Oliver Williamson shared in the 2009 Nobel Prize in part for his work on transaction cost theory. Bargaining costs and policing costs are two types of transaction costs that can significantly impact the efficiency of exchange. Bargaining costs refer to the time and effort required to negotiate prices, contracts, and other agreements. In some cases, this may involve employing lawyers or other professionals with expertise in contract development to ensure that agreements are solid and legally enf

Human capital theory was developed by Dr. Gary Becker, an American economist at the University of Chicago, and others. According to Becker (1994), human capital is different kind of capital from physical and financial resources.    Education, technology and etiquette training, and health expenditures are capital too because they improve wellbeing, health, earnings, and appreciation. Expenditures on education, training, and health care are investments in human capital. Human capital also refers to an individual or group’s stock of knowledge, routines, personality characteristics and social habits. Human capital even includes creativity that can be usefully applied to an economic purpose, and thus is considered to be a type of wealth. Countries, organizations, and groups with greater human capital are expected to be better able to accomplish goals to bring about economic improvement. Several studies have found a positive association between human capital and economic development, in

Agency theory was developed in the 1980s by economist Michael C. Jensen at the Harvard Business School for the purposes of explaining and predicting the behaviors of investors and managers. Agency theory distinguishes between principals and agents, the former being parties that delegate responsibility for some set of actions to the latter. For instance, entrepreneurs and managers are often the agents of investors, who delegate the responsibility over a business organization. The theory’s underlying assumption is that both parties are self-interested and that the interests of principals and agents diverge or are in conflict. Therefore, agents may make decisions on behalf of principals that are not in the principals’ interests, which is called an agency problem. For instance, agents may take greater risks than principals would want them too because agents are betting with the principals’ capital. Agency problems are exacerbated when there is information asymmetry between pri

William J. Baumol was an American economist at New York University. His theory of entrepreneurship starts with the assumption that every society is endowed with their share of entrepreneurs. However, the way in which entrepreneurs use their energies depends upon the institutions—the rules of the game—in place in a given society. It is also sometimes called a political theory because the regime in a given country or territory may have tremendous influence on incentives. He argues that entrepreneurs may engage in productive (i.e., innovation) or unproductive (rent-seeking and crime) forms of entrepreneurship depending on what a country’s institutions encourage. Baumol argued that the notion of a "spirit of entrepreneurship" is largely useless for policymakers because it is difficult to measure and even more difficult to influence. Instead, Baumol proposed that policymakers should focus on altering the rules of the game to encourage productive entrepreneurship and discourage

Frank Hyneman Knight, an American economist at the University of Chicago, developed the uncertainty-bearing theory in the 1920s to explain the phenomenon of entrepreneurship. The Roaring 20s The roaring 20s brought with them renewed attention to the people and processes that served to bring innovations to market with increasing intensity, and the media of the day was in the habit of idealizing business tycoons. Much of the government had adopted a laissez-faire attitude toward business. Knight distinguished between risk that can be modeled probabilistically, from uncertainty, for which the probabilities are unknowable. For instance, uncertainty surrounds the implementation of new strategies, the development of new products or entry into new markets. Similarly, the positive consequences of acquiring a competitor may have unknowable probabilities. According to his theory, bearing business uncertainty creates profit and the more uncertainty taken on, the more profit can be gained. The rel