Transaction Cost Entrepreneurship

By Peter Klein*

Oliver Williamson didn’t write much on entrepreneurship but his ideas have important implications for venture formation and growth, new product introduction, the emergence and diffusion of technologies, how firms manage uncertainty, and more. His works are highly cited in the specialized entrepreneurship journals as well as economics and management writings on innovation, technical change, and economic growth.

The modern entrepreneurship literature, like that on the economic theory of the firm, emerged in the 1970s and 1980s. Both deal with similar phenomena: firms, contracts, and organizations. And yet, as Nicolai Foss and I showed, these two bodies of literature developed largely in isolation. Coase and Williamson use the term “entrepreneur” loosely, referring to the agent who decides whether to make or buy. In The Economic Institutions of Capitalism (ch. 9), Williamson compares “entrepreneurial” and “capitalist” modes of production, the former being a system where each stage of production is managed by a single worker. But he doesn’t develop a systematic theory of the entrepreneur as a firm creator, owner, or innovator. More generally, organizational economics rarely explores the personal characteristics or functional attributes – discovery, creation, disruption, judgment – of the transaction cost economizing agent. Likewise, with the exceptions of Knight and Mises, the classic contributors to the economic analysis of entrepreneurship such as Cantillon, Say, Schumpeter, and Kirzner did not say much about firm organization.

Today, the entrepreneurship and innovation literatures draw explicitly on transaction cost reasoning. Founders must procure inputs (including finance), organize production, and market and distribute. Some of their resources are owned, while others are loaned. Inventors can use, sell, or license their innovations. Entrepreneurs and financiers form partnerships, join alliances, and participate in networks. Competition is frequently between platforms, not firms. On all these issues, the comparative analysis of discrete structural alternatives, taking asset specificity, uncertainty, and frequency into account, is central to the analysis.

More abstractly, entrepreneurship involves the assembly and management of productive resources under uncertainty. For Knight, a firm is an entrepreneur plus the alienable assets she owns and controls. Under uncertainty, the owner must take responsibility for the disposition of these assets, because entrepreneurial judgment – the ultimate decisions about how assets will be used – cannot be traded on markets. Williamson (1985, p. 78) agrees with Knight: “To contend, as [Coase] does, that Knight offers no reason for superseding the price system, since ‘[w]e can imagine a system where all advice or knowledge was bought as required’ (Coase, 1952, p. 346), is essentially to deny that markets for information are beset by opportunism.” Knight’s idea that transaction costs close the market for judgment suggests an entrepreneurial theory of the firm.

Once at the 2011 ASSA meetings, Olly invited John de Figueiredo and me to join his dinner party. The rest of the group turned out to be Bob Lucas, Ed Prescott, and Ned Phelps! At one point I found myself summarizing the contemporary entrepreneurship literature for Olly and Lucas, both of whom asked pointed and insightful questions. Olly asked me to send some of my own work on the topic. Later that year, at the 2011 SIOE conference, he gave a presentation called “Entrepreneurship: A Transaction Cost Perspective.” I missed the session and asked him for the paper, which he promised to send after revision. He never did, despite a few gentle reminders. In 2012 he told me: “I am still struggling with entrepreneurship. Tough topic.” (I later learned that Rob Seamans had been working with Olly on an entrepreneurship paper in 2008-09, extending the ideas in Olly’s 1988 Journal of Finance paper on project finance to a high-uncertainty context, but the project didn’t come together. A tough topic indeed!)

I tried my own hand at summarizing the relationship between TCE and entrepreneurship in a 2013 ISNIE presentation. I thought I had the killer title: “Transaction Cost Entrepreneurship.” While preparing the talk I realized that Steven Michael had already used that title, six years earlier! Steven’s paper is excellent but deals with the narrower question of how entrepreneurs overcome transaction costs of dealing with new customers. The more general treatment is yet to be written.

Williamson’s insights will continue to be central to our thinking on new ventures, firm growth, technological and organizational innovation, decision-making under uncertainty, industry evolution, and other aspects of entrepreneurial and innovative behavior. As he remarked often, “any problem that arises or can be posed as a contracting problem can be examined to advantage in transaction cost economizing terms.” Entrepreneuring is about contracting, so TCE plays a vital role in our understanding of the entrepreneurial process.


*Peter Klein is W. W. Caruth Chair and Professor of Entrepreneurship at Baylor University’s Hankamer School of Business. He received his Ph.D. in economics under Oliver Williamson in 1995.