1. The increasing importance of entrepreneurship

Entrepreneurship is one of the fastest-growing subfields in management research, and is increasingly appearing in economics, sociology, anthropology, finance, and even law. Although the popularity of entrepreneurship in management research is not completely matched by a corresponding popularity in economics, at least the subject field has its own code (L26) in the Journal of Economic Literature classification scheme. Research and policy organizations (e.g., the OECD, the World Bank, the U.S. Federal Reserve System, the European Commission, the United Nation's FAO, etc.), and others show a growing interest studying and encouraging entrepreneurship. The Kauffman Foundation has substantially increased its funding for data collection, academic research, and education on entrepreneurship.

Why the increased interest in entrepreneurship? One source is the fact that the economy often appears more ‘entrepreneurial’ than before. Phenomena associated with entrepreneurship such as startups, angel and venture capital, intellectual property, IPOs, and the like are popularly described as the main drivers of technological progress and economic growth. In terms of industry dynamics, the ‘churn’ caused by new firm formation was a phenomenon of huge empirical importance in the mid-1970s, which is also when the entrepreneurship field was slowly getting established in management research and economics. Following Schumpeter (Reference Schumpeter1911) much management research points to the inherently temporary nature of competitive advantages (e.g., D’Aveni, Reference D’Aveni1994). Empirical work broadly suggests that firm-specific returns that can be linked to specific competitive advantages regress to the industry mean, and that, moreover, the pace of regression has accelerated over the last few decades (Pacheco-de-Almeida, Reference Pacheco-de-Almeida2010).

Given the importance of entrepreneurship in the economy, one would expect its incorporation into economics to be a main priority of the profession. And yet, modern economics maintains an ambivalent relationship with entrepreneurship. While it is acknowledged that entrepreneurial phenomena such as self-employment, startups, and innovation are important, there is a little consensus about how the entrepreneurial role should be conceptualized, modeled and incorporated into economic theory (Bianchi and Henreksson, Reference Bianchi and Henrekson2005; Foss and Klein, Reference Foss, Klein, Agarwal, Alvarez and Sorenson2005). Indeed, the historical ‘classics’ in the economic literature on entrepreneurship – Schumpeter's account of innovation, Knight's theory of profit, and Kirzner's analysis of entrepreneurial discovery – are typically viewed as interesting, but idiosyncratic insights that do not easily generalize to other contexts and problems and are difficult, and perhaps impossible to formally model.

More generally, mainstream economists have tended to conceptualize entrepreneurship as an outcome or empirical phenomenon, one that can be measured, compared, and analyzed using conventional empirical methods. Thus an ‘entrepreneurial’ society is one with a high percentage of self-employed to employed-individuals, a large number of new firms and small firms, and healthy rates of R&D expenditures and patenting. The problem with the outcome-based view of entrepreneurship is that it does not relate in an obvious way to the classic contributions in the economics of entrepreneurship from Schumpeter, Knight, Kirzner, and so on. As Klein (Reference Klein2008) argues, entrepreneurship was traditionally understood by economists as a generalized function such as ownership and responsibility, uncertainty-bearing, alertness, and innovation. Obviously, those functions are not the exclusive domain of startup companies, proprietorships, or venture-funded technology firms, but are performed by a variety of agents in a variety of circumstances.

2. Entrepreneurship and economic organization

Entrepreneurship researchers generally recognize that entrepreneurship (i.e., the exercise of judgment in a commercial context) is embedded in firms and that firms do not spring into existence by themselves, but are created and operated by entrepreneurs (Foss and Klein, Reference Foss, Klein, Agarwal, Alvarez and Sorenson2005).Footnote ² At the same time, the literature often describes the ‘entrepreneurial firm’ as a special class of firm – one that is new, small, venture-funded, rapidly growing, technology oriented, or otherwise distinct from established enterprises in mature industries (Alvarez and Barney, Reference Alvarez and Barney2004; Langlois, Reference Langlois2007). In this perspective, firms may begin as entrepreneurial, and run by entrepreneurs, but at some point they become established firms, run by managers.

We find such distinctions conceptually elusive, and empirically arbitrary. At what point in the firm, industry, or technology life-cycle does this transformation take place? How many employees can the entrepreneur direct before she becomes a manager? When does the founder or supervisor cease exercising judgment, being alert to opportunities, or introducing novelty? To some extent, the management and economics literatures recognize the artificiality of such distinctions – obviously, both large and small firms can innovate, and much research has gone into investigating Schumpeter's famous claim that small firms face an innovation deficit (Acs and Audretsch, Reference Acs and Audretsch2003; Baumol, Reference Baumol2010). However, management scholars have tended to label large-firm innovation, experimentation, and new-business-unit creation ‘intrapreneurship’, to distinguish it from the same activities in smaller and younger firms (De Clercq et al., Reference De Clercq, Castañer and Belausteguigoitia2007).

In the judgment-based view, judgment is exercised by resource owners, who combine and combine productive assets under conditions of uncertainty (Foss et al., Reference Foss, Klein, Lien and Zenger2015). As Lachmann (Reference Lachmann1956: 16) put it: ‘We are living in a world of unexpected change; hence capital combinations . . . will be ever changing, will be dissolved and reformed. In this activity, we find the real function of the entrepreneur’. Entrepreneurship is thus not merely a perceptive behavior such as idea generation or creative thinking, but the act of taking responsibility for real assets, investing them in anticipation of uncertain future rewards. As Knight (Reference Knight1921) famously argued, to exercise such responsibility, the actor must put resources in play – i.e., must establish and operate a business firm. Hence, the theory of entrepreneurship and the theory of the firm are two sides of the same coin.

3. Judgment: unpacking the black box

The judgment-based view starts with the fact of judgment – the need for individuals to make decisions about the future without access to a formal model of decision rule, as would apply to situations of ‘rational’ behavior under probabilistic risk. Without access to such a model, the decision-maker uses intuition or gut feeling (Huang, Reference Huang2012), what Mises called Verstehen, or ‘understanding’. For Mises, and to a lesser extent for Knight, the exact mechanisms of judgment, the behavioral and cognitive processes by which entrepreneurs form their beliefs about future conditions, are a black box. Mises (Reference Mises1949: 582) says the entrepreneur relies on a ‘specific anticipative understanding of the future’, one that ‘defies any rules and systematization’. As Casson (Reference Casson1982: 14) notes, ‘[t]he entrepreneur believes he is right, while everyone else is wrong. Thus, the essence of entrepreneurship is being different––being different because one has a different perception of the situation’.

For explaining firm existence, boundaries, and internal structure, such a general, abstract conception of judgment may suffice. But we may also wish to understand the microfoundations of judgment in more detail. First, the judgment-based approach assumes some distinction between uncertainty and probabilistic risk, such as Knight's concept of genuine uncertainty, Mises's frequentist notion of case probability, or Shackle's (Reference Shackle1972) idea of genuine surprise. In our book (Foss and Klein, Reference Foss and Klein2012, ch. 4), we discuss some modern attempts to analyze uncertainty, such as Bewley (Reference Bewley1986, Reference Bewley1989)'s formal Bayesian analysis. A related literature in management focuses on ‘judgments and decisions’, focusing on behavioral biases that deviate from the neoclassical economics notion of rationality (e.g., Hastie, Reference Hastie2001; Holcombe et al., Reference Holcombe, Holmes, Klein and Duane2014). Some of this literature uses the term ‘intuition’ for something close to Knightian judgment; for example, Dane and Pratt (Reference Dane and Pratt2007) define intuition as ‘the non-conscious use of heuristics and internalized patterns of information’. By contrast, ‘rational’ decision making

McMullen's (Reference McMullen2013) notion of judgment as empathic accuracy and Godley and Casson's (Reference Godley and Casson2014) picture of entrepreneurial diagnosis, discussed below, suggest additional approaches to dimensionalizing judgment.

4. Judgment versus good judgment

Another confusion about the judgment-based view arises from the term ‘judgment’ itself. The Oxford English Dictionary defines judgment as ‘The ability to make considered decisions or to arrive at reasonable conclusions or opinions on the basis of the available information; the critical faculty; discernment, discrimination’. This is similar to Knight's and Mises's general usage, although technically, they refer to any sort or purposeful action under uncertainty as judgment, regardless of the skill of the decision-maker. The OED also gives a second definition: ‘The fact of possessing this ability to a high degree or in a sophisticated form; discretion, good sense, wisdom’. This is the sense in which people use ‘judgment’ in ordinary language. Hence, describing entrepreneurs as exercising judgment sounds like a compliment: they must have extraordinary skill in anticipating the future! But in the judgment-based entrepreneurship literature, even those making poor decisions about resource deployment under uncertainty are acting entrepreneurially – although those who consistently make poor decisions will find their capital consumed, credit markets closed, and the option of further entrepreneurial activity unavailable to them. Bhidé (Reference Bhidé2010), building on Hayek (Reference Hayek1945: 33), defines judgment as ‘[e]ffective adaptation to unpredictable but repeated patterns of change’, which we take as close to the OED's second definition. He argues for a more decentralized financial system to make better use of good judgment––an argument we support, while not directly related to judgment in our sense.

Likewise, Sarasvathy and Dew (Reference Sarasvathy and Dew2013) criticize our approach by arguing that entrepreneurs suffer from limited knowledge, systematic bias, and ill-specified objectives. We agree that entrepreneurs (may) suffer from these problems, but this is not to deny that they exercise judgment in our sense. Sarasvathy and Dew (Reference Sarasvathy and Dew2013) associate ‘judgment’ with prudence, wisdom, and rationality, not with the general function of allocating productive resources under uncertainty. We think the difference between our approach and the effectuation approach is largely semantic, not substantive (Foss and Klein, Reference Foss and Klein2012: 95–96). Indeed, exercising judgment in the functional sense typically means taking chances, experimenting, and learning from mistakes, the core aspects of effectual reasoning.

5. Judgment versus luck

Demsetz (Reference Demsetz and Ronen1983) challenged Kirzner's notion of discovery by asking how, analytically, discovery can be distinguished from luck. Schultz (Reference Schultz1980) asked the same question, putting it this way:

The key to understanding this passage is to recognize Schultz's rejection, following Friedman and Savage (Reference Friedman and Savage1948), of the concept of Knightian uncertainty. If all uncertainty can be parametrized in terms of (subjective) probabilities, then decision-making in the absence of such probabilities must be random. Any valuable kind of decision-making must be modelable, must have a marginal revenue product, and must be determined by supply and demand. For Knight, however, decision-making in the absence of a formal decision rule or model – what Knight calls judgment – is not random, it is simply not modelable. It does not have a supply curve, because it is a residual or controlling factor that is inextricably linked with resource ownership. It is a kind of understanding, or Verstehen, that defies formal explanation but is rare and valuable.

Without the concept of Knightian uncertainty, then, Knight's concept of entrepreneurial judgment makes little sense. Indeed, in our view the prime challenge to incorporating judgment into mainstream economics is the profession's general unease with Knightian uncertainty. Despite some useful attempt to model uncertainty formally (see Foss and Klein, Reference Foss and Klein2012, ch. 4), most economists remain uncomfortable with something like judgment which lies between ‘rational’, articulable decision-making and random behavior.

6. The papers in this forum

The three papers that form the core of this forum address various facets of the judgment-based view of entrepreneurship, filling what the contributors see as gaps left by contributors such as Knight (Reference Knight1921), Mises (Reference Mises1949), Casson (Reference Casson1982), and Foss and Klein (Reference Foss and Klein2012). Such gaps include more detail on the nature of judgment, better understanding how entrepreneurial judgment is translated into concrete action in terms of mobilizing resources, actions and investments in new product launches, innovation, etc., and more fully examining what the judgment-based view can offer to other theorizing in the economics of the firm space. These overall gaps are addressed in the papers by Godley and Casson (Reference Godley and Casson2014), Hallberg (Reference Hallberg2014), and McMullen (Reference McMullen2013), respectively.

McMullen (Reference McMullen2013) helps unpack the underlying mechanisms of judgment. His starting point is Sarasvathy and Dew's (Reference Sarasvathy and Dew2013) argument that the judgment-based view ‘pushes entrepreneurship scholars into tautological corners’. While he rejects this view and offers a judgment-based way of overcoming the problem of tautology, much of his article is construed as a sort of dialogue between the judgment view and the effectuation view of Sarasvathy and co-authors, concluding that ultimately judgment is not only ‘consistent with the effectual view’ (a position also held by Foss and Klein, Reference Foss and Klein2012: 95–96), but is actually ‘necessary for the effectual logic to function’. Specifically, McMullen draws on the psychology literature on judgments and decisions to add meat to the skeleton of the judgment construct in the entrepreneurship literature. This lets him overcome the common tendency in the entrepreneurship literature to collapse the entrepreneurial process into a point of time, and helps him paint a more realistic picture of judgment as the ‘capacity to form conclusions based on social inferences that are frequently tested and updated as one progresses through the decision making of entrepreneurial action’. This capacity revolves around ‘empathic accuracy’, that is, the ability to precisely infer the content of others’ beliefs and feeling. A final feature of McMullen's rich discussion is that he takes issue with Foss and Klein's (Reference Foss and Klein2012) argument that the unit of analysis in entrepreneurship should be investments rather than opportunities. His rescue mission on behalf of opportunities as a meaningful unit of analysis involves a subtle distinction between ‘opportunities to succeed’ (that can only be determined ex post) and ‘opportunities to try’ (which can in fact be identified ex ante).

Godley and Casson (Reference Godley and Casson2014) also offer more detail on the nature of the judgment construct, while simultaneously telling a process-oriented story of entrepreneurial activity. They rely on information economics to coin the notion of the ‘diagnostic entrepreneur’ who steps in in markets ‘where consumers are unable to diagnose their own problems and, instead, rely on the entrepreneur to diagnose them’. They posit that diagnostic entrepreneurship is particularly important in knowledge-intensive service industries, and is generally important in all industries whenever radical product innovation occurs. The capacity to engage in entrepreneurial diagnosis is a specific cognitive skill that entrepreneurs possess. As in Casson (Reference Casson1982), entrepreneurs can usually only exploit opportunities if they invest in market-making activities. This is closely related to Foss and Klein's (Reference Foss and Klein2012) point that the exercise of entrepreneurship involves taking control in these of ownership of productive asset, but expands on their view by pointing to the importance of reputation.

In the third forum paper, Hallberg (Reference Hallberg2014) uses the judgment-based view as inspiration for a discussion of epistemic and cognitive assumptions in the theory of the firm, in particular in transaction cost economics. Hallberg argues that idea of agents choosing efficient governance structures is fundamentally challenged in the presence of genuine uncertainty, a standard assumption in transaction cost economics (Williamson, Reference Williamson1985) as well as in much of the entrepreneurship literature. The problem is that standard models of choice break down in the presence of such uncertainty. As Hallberg (Reference Hallberg2014) puts it: ‘Uncertain governance choices require that agents exercise judgment in the absence of other means of estimating the payoffs associated with complex combinations of transaction attributes, contractual contingencies, and governance structures’. The process of forming and exercising judgment proceeds over time – a view that units all three papers in this forum – in an essentially experimental process that may be shot through with biases and which depends on agents’ access to decision-supporting systems. As a result, agents end up making highly heterogeneous governance choices, and predictions of governance choices in the economics of the firm should take such heterogeneity into account.