none of which is “optimal.” At the level of a firm, the advantages of centralization in “urgent” situations typically outweigh the costs. But I don’t think the argument scales up very far. In the case of a city, region, or country, the central coordinator lacks specific knowledge, appropriate incentives, and ex post accountability, which likely makes centralization a cure worse than the disease. Certainly the US government’s reaction to the 2008 financial crisis, which made a bad situation worse, does not inspire confidence.
Sintetia: What can economic theory teach us about how to determine the optimal financial structure of firms?
Klein: At best economic theory can help entrepreneurs identify tradeoffs, e.g., between debt and equity, concentrated and dispersed ownership, internal capital markets and arms-length finance, etc. As with organizational structure, no financial structure is “optimal”; we are always choosing among imperfect alternatives. I should add that modern corporate finance has begun to take organizational issues more seriously, though there is still a lot of research (and teaching and outreach) that treats management and governance as a black box.
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Sintetia: Does monetary policy have an important impact on this in general, and the Fed policies of the recent decade and current days in particular?
Klein: Monetary policy does have some important microeconomic consequences. Low interest rates, and “easy-money” policies more generally, tend to distort entrepreneurial incentives. As emphasized in the “Austrian” business cycle theories of Mises and Hayek, monetary stimulus encourages entrepreneurs to invest in capital-intensive, long-term production processes, even if these wouldn’t be chosen under normal conditions. Expansionary monetary policy also introduces “noise” into the price mechanisms — prices not only rise on average, but relative prices change more frequently and less predictably — which increases the cost of contracting and makes firms more likely to internalize activities they would have otherwise procured on the market. Finally, both monetary and fiscal stimulus, along with bailouts and other subsidies, reward unsuccessful entrepreneurs at the expense of successful ones, to the detriment of the economy as a whole. (Our 2009 article in Strategic Organization, with Rajshree Agarwal and Jay Barney, elaborates on these points.)
Sintetia: What lessons can your approach teach long-term equity investors (e.g., on how to identify sustainable competitive advantages (‘moats’) or other issues related to the importance of the management team)?
Klein: Successful entrepreneurial judgment is difficult to identify ex ante — otherwise it wouldn’t be entrepreneurial judgment! Our approach suggests that quantitative, predictive models are unlikely to be successful in the long run; investors should rely on their own, specific understanding of particular firms and markets, and trust their gut instincts.
Foss: I agree that our approach does not allow for the formulation of clear decision-rules here. However, I think there are some valid key characteristics of successful entrepreneurs, identified by previous research. For example, confidence does seem to be an important factor. So does certain kinds of experience. Successful entrepreneurs also seem to be good at multitasking. So, although successful entrepreneurial judgment cannot be identified ex ante, it is still possible to be more specific about the individuals who are likely to exercise successful entrepreneurial judgment.
Sintetia: Which are the most important insights an entrepreneur or manager should learn from your book? For instance, when confronted with whether he should sell his firm or not, or growing his firm through acquisitions?
Klein: In general, exercising judgment means taking chances, experimenting, and learning from mistakes. Second, as noted above, we encourage entrepreneurs to go with their instincts, and not spend too much time listening to the “experts” (even us!). Third, entrepreneurship takes not only great ideas, but also resources, including risk capital, so founders and managers should treat input providers — especially funders — with respect. Regarding specific questions like ownership changes, the make-or-buy decision, growth through acquisitions, etc., we urge decision-makers to think about how entrepreneurial judgment is distributed throughout a firm or economic system. Decision rights should be placed in the hands of those with better judgment, which implies a system where assets change hands, and contracts are written, to align ownership and judgment as circumstances require.
Sintetia: A recent report argues that business dynamism is in decline in the US, even in high-tech. What is your view on this? Which region do you think is now the most dynamic and why?
Klein: We don’t favor dynamism per se, but economic freedom. What entrepreneurs need is an environment in which they can experiment and learn, and that requires property rights, the rule of law, sound money, and free and open competition. Government attempts to stimulate entrepreneurship through targeted subsidies, infrastructure spending, tax and regulatory codes that favor one type of firm or location over another, and other attempts to create geographic or industrial clusters of innovation are not likely to be successful. So, to answer your question, those US states that score the highest on the standard economic freedom indexes are the most favorable to entrepreneurship, other things equal. But of course you already have successful clusters in places like California and Massachusetts, which fare poorly in terms of economic freedom. We think the success of these clusters is despite, not because of, state-level policies.
Foss: Some of my cross-country work on entrepreneurship with Christian Bjørnskov speaks directly to these issues. For example, in a paper in Public Choice (2008) we indeed find that sound money and less government meddling with the economy are conducive to entrepreneurship (narrowly defined as start-up activity). In another paper (Strategic Entrepreneurship Journal, 2013), we find that entrepreneurship is highly conducive to productivity advances and economic growth. Jointly these findings indeed suggest that free environments with low transaction costs are good for entrepreneurship and growth across the nations we consider.