Incomplete Contracts and

the Allocation of Entrepreneurship in Society

Erik Stam Utrecht University School of Economics

Joint with Niels Bosma & Sander Wennekers

Global Entrepreneurship Monitor:

people who are involved in setting up an

independent business or

owners-managers of new businesses

Arthur Fry

Ken Kutaragi

Jef Raskin (#31)

Paul Buchheit (#23)

Key question

• What explains the allocation of

entrepreneurship over new and established

organizations in society? (cf. Baumol 1990)

Entrepreneurship

• Recognition, evaluation and pursuit of

entrepreneurial opportunities by individuals

(Shane & Venkatamaran, 2000)

• Only in independent start-ups or owner-

managed businesses, for own risk and

reward (Knight 1921; Jensen & Meckling

1976)? Or…

• Governed within established organizations,

as entrepreneurial employee activity

(intrapreneurship)?

Schumpeter (1934: 74-75)

• ‘(...) in the first place we call entrepreneurs

not only those “independent”

businessmen in an exchange economy

who are usually so designated, but all who

actually fulfill the function by which we

define the concept, even if they are, as is

becoming the rule, “dependent”

employees of a company’.

Arthur Fry

Ken Kutaragi

Jef Raskin (#31)

Paul Buchheit (#23)

...employees developing new business activities

for their employer

e.g. establishing a new outlet or subsidiary

and launching new products

or new product-market combinations

Entrepreneurial

Employee Activity

Independent

Entrepreneurship

Share of Entrepreneurial Employee Activity = EEA / (EEA+IE)

Entrepreneurial Activity

Theory of the Firm

• Default corporate governance situation in

entrepreneurship studies = independent

entrepreneurship: no separation of ownership

and management

• Employees will not pursue entrepreneurial

activities because:

– The employer perceives this to be too risky (probable

big losses); destructive entrepreneurship

– The employee expects rewards to be creamed off by

the employer

Arthur Fry

Ken Kutaragi

Jef Raskin (#31)

Paul Buchheit (#23)

Proxy entrepreneurs: derived judgement

(Knight 1921 -> Foss et al. 2007)

Incompleteness of labour contracts

• Positively related with returns productive proxy

entrepreneurship (but with diminishing returns)

• Positively related with costs destructive proxy

entrepreneurship (with increasing costs)

• Positively related to opportunity costs (loss of

productive routine work)

• Negatively related to probability of independent

(spin-off) entrepreneurship

Incompleteness

of the contract

Co

sts

an

d b

en

efi

ts

Opportunity costs

Employer

P: Productive proxy

entrepreneurship

D: Destructive proxy entrepreneurship

I*

Theoretical model:

benefits and costs, incompleteness of contract

• Opportunistic behavior will lead to higher

prevalence of complete, on the spot, contracting

in a product market (i.e. independent

entrepreneurship); even more so in societal

settings in which levels of generalized trust are

low

• In a societal setting in which social obligations

and reciprocity dominate, i.e. high levels of

generalized trust, more incomplete contracts

are prevalent, e.g. within organizations

Trust & Theory of the Firm

Key micro-macro assumption

• The degree of incompleteness of labor

contracts in organizations is reflected in

the share of Entrepreneurial Employee

Activity in the economy.

Institutions

Incompleteness

of contracts

Share of EEA in society

EEA

The share of entrepreneurial employee activity is

positively associated with the level of generalized trust

in society.

Hypothesis

Effect of increasing levels of generalized trust

on benefits and costs curves

and preferred degree of incompleteness

Incompleteness

of the contract

Co

sts

an

d b

en

efi

ts

P

D0

I0*

D1

I1*

Opportunity costs employer

DATA

70,000 employees were asked about their entrepreneurial activities;

52 countries (GEM sample):

Operational definitions

• Independent entrepreneurship: GEM

– People who are involved in setting up an independent business or owners-managers of new businesses

• EEA: employees developing new business activities for their employer, including establishing a new outlet or subsidiary and launching new products or new product-market combinations

– Leading role in idea development and/or preparation and implementation of new activities

TEA vs EEA

TEA

• 37% product innovative

• 15% growth ambitious

(>20 jobs)

EEA

• 64% product innovative

• 45% growth ambitious

(>20 jobs)

Macro level:

Intrapreneurship is much more strongly (positively) related to innovation

than independent entrepreneurship is

(Stam 2013 SBE)

US

RU

ZA

GR

NL

BE

FR

ES

HU

RO SW

UK

DK

SE

PL

DE

PE MX

AR

BR

CL

CO

MY

AU

SG

TH

JP KR

CN

TR

PK IR

DZ BB

PT

IE

FI

LT

LV

HR

SI

BA

CZ SK

PA VE

UY

TT JM

BD

TW

AE

R² = 0.1742

0

2

4

6

8

10

12

14

16

0 5 10 15 20 25 30

% o

f 1

8-6

4 p

op

ula

tio

n in

vo

lve

d i

n E

mp

loye

e E

ntr

ep

ren

eu

ria

l A

cti

vit

y

% of 18-64 population involved in Total early-stage independent Entrepreneurial

Activity

Algeria DZ Hungary HU Russia RU

Argentina AR Iran IR Singapore SG

Australia AU Ireland IE Slovakia SK

Bangladesh BD Jamaica JM Slovenia SI

Barbados BB Japan JP South Africa ZA

Belgium BE Korea KR Spain ES

Bosnia & Herz. BA Latvia LV Sweden SE

Brazil BR Lithuania LT Switzerland SW

Chile CL Malaysia MY Taiwan TW

China CN Mexico MX Thailand TH

Croatia HR Netherlands NL Trinidad & Tobago TT

Czech Republic CZ Pakistan PK Turkey TR

Denmark DK Panama PA United Arab Emir. UE

Finland FI Peru PE United Kingdom UK

France FR Poland PL United States US

Germany DE Portugal PT Uruguay UY

Greece GR Romania RO Venezuela VE

Dependent variable - II

UE

TW

JMTT

UY

VE

SK

CZ

BA

SI

HR

LV

LH

FI

IE

PT

BBDZ

IR

TRCN

KR

JP

TH

SG

AU

MY

COCL

BR

AR

MX PE

DE

PL

SEDK

UKSW

ROHU

ES

FR

BE

NL

GR

SA

RU

US

0%

10%

20%

30%

40%

50%

60%

70%

80%

0 5 10 15 20 25

Independent Entrepreneurial Activity

Shar

e o

f EE

A in

OEA

Algeria DZ Hungary HU Russia RU

Argentina AR Iran IR Singapore SGAustralia AU Ireland IE Slovakia SK

Bangladesh BD Jamaica JM Slovenia SIBarbados BB Japan JP South Africa ZA

Belgium BE Korea KR Spain ESBosnia & Herz. BA Latvia LV Sweden SE

Brazil BR Lithuania LT Switzerland SWChile CL Malaysia MY Taiwan TW

China CN Mexico MX Thailand THCroatia HR Netherlands NL Trinidad & Tobago TT

Czech Republic CZ Pakistan PK Turkey TRDenmark DK Panama PA United Arab Emir. UE

Finland FI Peru PE United Kingdom UKFrance FR Poland PL United States US

Germany DE Portugal PT Uruguay UYGreece GR Romania RO Venezuela VE

Independent variables

• Interpersonal trust (World Values Survey)

• Social security favoring employees (Global Entrepreneurship Monitor – National Expert Survey)

• Share of knowledge workers in total employment (International Labour Organization)

• Prevalence of employment in large organizations (Global Entrepreneurship Monitor – Adult Population Survey)

Dependent variable: share of entrepreneurial employee activity

Conclusions • The share of entrepreneurial employee activity is

positively associated with the level of generalized trust in

society.

• Generalized trust lowers the level of destructive proxy

entrepreneurship, allowing more incomplete labor

contracts, which leads entrepreneurial action to be

allocated more to established organizations in society

(EEA)

Issues to discuss

• Measures of institutions

– Informal (+ Hofstede’s culture indicators,…)

– Formal (+ measures of employment protection, …)

• Too small number of cases (sensitivity to outliers)

• Causality (comparative static framework)

– Endogeneity: EEA –> large organizations

– Longitudinal research

• Theory (too narrow; too micro; better than no theory…)

• Study contracts

• Multilevel analysis: regional, organizational conditions

(and consequences)

• …

Incomplete Contracts and the

Allocation of Entrepreneurship in Society

Erik Stam Utrecht University School of Economics

Joint with Niels Bosma & Sander Wennekers