Entrepreneurship Theories

What is the population ecology theory of entrepreneurship? Hannan and Freeman's (1977) population ecology theory hangs on the assumption that environments can only handle a fixed number of organizations of each type. After a certain point is reached, there are diminishing returns to density that eventually balance out through the mortality of organizations. The theory is about the tension between the need to be considered as legitimate in order to compete, but also the need to be competitive. As more organizations enter the market, they become increasingly legitimate, but this leads to greater competition making survival more challenging. Thus, the early market is dominated by the need for legitimacy , while the later market is dominated by competitive forces of selection. As environments change, often due to innovations introduced by organizations within them, mortality rates increase for organizations experiencing high levels of resistance to change. Inertial forces guaran

Stewardship theory was put forward by Lex Donaldson and James Davis in the late 1980s as an alternative to agency theory, which they viewed as having negative assumptions about managers. Agency theory views agents (managers and entrepreneurs) as self-interested and opportunistic and views the relationship between principals (investors) and agents as necessarily conflicting. Agency theory is the logic behind providing managers and other employees with stock-based compensation to align the interests of the employees with those of the shareholders by making the employees into shareholders. In contrast to agency theory, stewardship theory posits that managers and entrepreneurs are motivated to act in the interests of their organizations and principals. The core idea is that the rewards from pro-social behavior have greater utility than individualistic or self-serving behaviors. The steward receives greater personal satisfaction when the organization is successful and therefore act

Too often, entrepreneurship is viewed as a solo job. This myth is perpetuated because of the heroic status that many entrepreneurs are conferred. For instance, the stories of Richard Branson, Steve Jobs, Bill Gates, Elon Musk and others reinforce the idea that entrepreneurs are individuals carving out a new world on their own. More often entrepreneurs work in social networks to get their ventures up and running, to grow and to thrive. From a social network theory perspective, entrepreneurship is viewed as embedded in networks of enduring social relations (Walker et al., 1997). Research on entrepreneurship from a social network perspective has gained steam and evidence that networks are useful tools for gaining access to resources has emerged. Social capital is loosely defined as the value of venture founders’ network resources! Networks may act as substitutes for investment capital. Private information flows over networks that can only be accessed through social interactions. An e

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

Jeffrey Pfeffer and Gerald R. Salancik (1978) proposed the resource dependency theory as a way to explain the behavior of organizations by looking to the contexts in which they operate. Organizations are influenced by numerous external contingencies, thus the theory views the role of the manager as acting to reduce dependencies, especially the power of other actors to exert control over vital resources, often by increasing the power of the focal organization. The assumptions of the theory are that organizations are the main units of analysis for understanding society. Organizations are viewed not as autonomous, but rather, they are seen as constrained by webs of dependence relationships with other organizations that can exercise power. Success and survival are uncertain because of the ever-changing power relations among organizations. Organizations manage inter-dependencies creating new patterns of inter-dependence and inter-organizational power. Power is typically exerted in

What is the planned behavior theory of entrepreneurship? The theory of planned behavior was developed by Polish social psychologist Icek Ajzen (1991) to predict a variety of social behaviors in different fields including consumer behavior, politics, and healthcare. According to the theory, the most important determinants of an individual’s behaviors is their intention to engage in the behavior—not their attitudes toward behaviors as these are only expected to affect intentions. Thus, for example, if a potential voter has the intention to vote they are more likely to vote than if they merely think voting is a good thing to do. The theory hangs on the concept of intentions, which are defined as an individual’s motivation and conscious decision or plan to expend effort to bring about a behavior. The link between intention and action is expected to be stronger when there is a short time gap between them and when there is an appropriate level of specificity between the intention an

Signaling theory has been used to explain how firms communicate their quality and intentions to investors. For instance, debt and dividends signal quality because low quality firms presumably cannot keep up interest payments over the long run (Bhattacharya, 1979). Signaling theory is used to explain which startups get funded by investors and which do not raise capital. The typical study identifies a set of signals sent by a firm around the time of an initial public offering (IPO). Signals may include top management team characteristics, founder involvement, or the presence of venture capitalists or angel investors. Signalling theory predicts how these signals will affect the signal receiver’s decisions. The next step is to characterize the signals as either positive or negative in terms of their effects on subsequent investments or valuations by public or private investors (see review by Connelly, Certo, Ireland and Reutzel, 2011). For example, founder involvement may be viewed as a po

Institutional theory is about the rules of the game in a given context (Scott, 2001), such as a business environment. The rules of the game may be formal, informal, or cognitive (taken-for-granted assumptions) about the nature of the business environment.    The main proposition of institutional theory when applied to entrepreneurship may be that: Context-varying social forces shape entrepreneurial success more than does economic efficiency, therefore, entrepreneurs should seek to align their strategies with the norms, beliefs and regulations of their host societies' institutions or change the rules of the game in their favour.   Institutional Entrepreneurship   Levy and Scully (2007) use the idea of the institutional entrepreneur as a "collective agent who organizes and strategizes counter-hegemonic challenges". In other words, whereas for many, the rules of the game are to be followed, institutional entrepreneurs change the rules of the game.    The theory has start

What is the pecking order theory of entrepreneurship? The pecking order theory was developed by in the 1980’s by finance scholars seeking to understand the financing preferences of firms. Pecking order theory also relates to entrepreneurs’ preferences about financing choices. Financing options include using one’s own personal funds, reinvesting profits back into the business, selling equity to outside investors, and bank debt or loans. At the core of the theory are information asymmetries between the entrepreneur or the startups’ executive team, and the prospective sources of funds for the business—that is, the financiers. Entrepreneurs and other insiders have better information about the business’ operations and potential than do prospective financiers because the former deal with stakeholders and problems on a day to day basis. Financiers usually have to rely on second hand information provided by the leadership team of the startup and the financial statements they provide.

What is the resource based theory of entrepreneurship? Jay Barney developed the resource based view of the firm, which is a strategic management theory designed to explain why some firms perform better than others even when they occupy a very similar business environment. The resource-based view seeks to explain why some firms perform better than others by looking to the firms’ resources. This contrasts with earlier perspectives, such as  Porter's five forces , which focus on the external environment as sources of threats and opportunities. The core idea behind the resource-based view is that  competitive advantage  comes from a firm’s effective use of tangible and intangible resources or assets. Tangible assets include plant, equipment and even human resources, whereas intangible assets include things like  trade secrets  and  corporate reputation . VRIO Resources that are valuable, rare, and difficult to imitate or substitute are considered to be sources of sustained

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

Bricolage theory is credited to Levi-Strauss (1962) who was a French anthropologist who introduced the concept of bricolage entrepreneurship as he tried to show that indigenous peoples were just as entrepreneurial as “civilized” peoples. He compared the “bricoleur” to the “engineer” in his book unfortunately entitled The Savage Mind . Unlike the engineer, the bricoleur “makes do” with the inputs "at hand" to concoct whatever process needed to accomplish a particular project as it develops. By contrast, the engineer plans ahead, gains access to all that is needed to complete a project before starting. Thus, the bricoleur is seen as contrasting with the rational view as projects are accomplished by solving problems as they emerge, with whatever is available rather than what is really needed. The bricoleur practices radical experimentation rather than planning ahead. Bricolage theory is mainly focused on explaining how entrepreneurship emerges in economically depressed,

What is the effectuation theory of entrepreneurship? Dr. Saras Sarasvathy is an Indian born business school professor researching strategy, entrepreneurship and business ethics, currently appointed at the University of Virginia. Sarasvathy proposed the theory of effectuation in the early 2000s after studying a sample of expert entrepreneurs with diverse backgrounds. Effectuation theory is often considered a process theory because it explains the process that entrepreneurs use to create new ventures. Effectuation theory stems from the way that expert entrepreneurs think about problems and how they go about solving them. Effectuation logic contrasts with what Sarasvathy calls "causation theories" of entrepreneurship, where it is proposed that entrepreneurs start with a goal and then acquire the resources needed to achieve the goal, in a linear fashion. Each resource acquisition is a step toward the goal. In stark contrast, effectuation logic involves evaluating resourc

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

What is the withdrawal of status respect theory of entrepreneurship? Everett E. Hagen was a political scientist and economist writing at MIT in the 1950s and 1960s. He sought to explain how traditional societies changed into those with continual technological progress and hence rising incomes. Here we discuss Hagen's (1963) theory of entrepreneurship. Hagen argues that a process eventually leading to entrepreneurship is triggered when a social group loses status in relation to other groups in a society. When members of a given social group perceive that they are given their due respected by the dominant groups in society, it triggers a creative spark that encourages entrepreneurial behaviors (Dana, 1995). Some examples of "withdrawal of status respect" include when: 1) a formerly higher status group is displaced by a new group; 2) a social group's symbols are insulted by the dominant group; 3) a group's symbols become unaligned with their actual economic

Max Weber was a German sociologist writing in the early 1900s who theorized that religious beliefs are a key determinant of entrepreneurial development. He argued that entrepreneurial energies are driven by beliefs about causes and consequences. In particular, he emphasized how religions encourage investment in economic growth and development (and compound interest). A religious belief in saving for the future was key, he believed, to the capitalistic spirit . Weber distinguished between religions that encourage capitalism from those that do not. In particular, Weber noted that Hinduism, Buddhism and Islam may not be conducive to entrepreneurship. Hinduism and Buddhism purportedly have a focus on the present moment and tend to shun materialism, making them problematic to the pursuit of entrepreneurial goals. He suggested that Islam’s focus on the rewards of the afterlife make material accumulation problematic.    By contrast, he argued that the protestant work ethic prevalent in

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

Joseph Schumpeter, a prominent economist, is widely recognized as a pioneer in the field of entrepreneurship. He placed human actors at the center of economic development processes and argued that entrepreneurs played a critical role in driving innovation and economic growth. Schumpeter's view of entrepreneurship was unique in that he saw it as a disruptive force that challenged the status quo and led to the creation of new markets and industries. He believed that entrepreneurs were not simply passive actors responding to market forces, but were active agents who sought to gain power through their ability to resist social pressure and overcome limitations in existing skill sets. According to Schumpeter, entrepreneurs played a key role in driving the process of "creative destruction." This process involved the destruction of established industries and the creation of new ones through the introduction of innovative products, services, and production methods. Entrepreneurs