1Bringing Ideas to Life: Integrating Organizational Economics and Organizational CapabilitiesChuck Eesley (Stanford), David Hsu (Wharton), Edward B. Roberts (MIT)Social Science and Technology Seminar Series, SIEPRSept. 23rd, 2009

Strategy / Innovation and Technological ChangeCurrent ResearchCharles Eesley

3Motivation: What are firms and why the economy is organized as many islands of firms rather than one large firm or many sole proprietorships? (Coase, 1937)Production functionBlack box of the firm

4Motivation: Organizational Strategy and Theory of the FirmOrganizational EconomicsOrg efficiency / governance of transactionsInability to understand firm differences and performanceCapability (or Resource-based) LiteratureHeterogeneity / performance differencesInability to understand org structures and governance creating firm differences

Organizational Economics

Org efficiency / governance of transactions

Inability to understand firm differences and performance

Capability (or Resource-based) Literature

Heterogeneity / performance differences

Inability to understand org structures and

5Ideas paired with expertise in other areas (Hellmann and Perotti, 2007)First stage development of a new idea 2nd stage - pairing with expertise for commercialization (contracting/governance)Analysis only in 2nd stage misleading/partially truePossession of a valuable asset today is the result of a successful pairing of a potentially high value idea + expertise in how to form the web of relationships to realize full extent of value Goal: Origins of firms have been under-theorized

AgendaTheoryHypothesesEmpirical context – novel survey dataDescriptive statisticsAnalysis/ResultsMisleading Results When Other Theory NeglectedEndogeneity ConcernsConclusion and ImplicationsRobustness checks6

7Organizational capabilities – some identify/develop more valuable resourcesOrganizational economics - structuring transactional and governance arrangements Integrated perspective – What firms need are valuable resources identified/developed and put into the proper transactional and governance structures. Results: Preview

8Theory: Org EconTheories of FirmProperty rights approach - structure firms to get efficient effort (Hart, Moore 1990, Holmstrom 1999) Identifies firm with non-human assetsHow ownership affects incentives to develop assets (Grossman, Hart 1986) Firm as Dedicated Hierarchyhow to formulate hierarchies to incentivize specialized human capital investments (Rajan, Zingales 2001). human assets as the glue that holds the firm together (Wernerfelt 1984, Rajan, Zingales 2001, Rumelt 1984)Kaplan, Sensoy & Stromberg, JOF 2009 “a firm’s non-human assets, then, simply represent the glue that keeps the firm together . . . If non-human assets do not exist, then it is not clear what keeps the firm together.” Hart (1995, p. 57)

Novel combination of existing factors as the startup idea (Schumpeter 1942, Hellmann, Perotti 2007, Weitzman 1998)Assembling sets or bundles of complementary and unique assets, activities or resources (Rumelt 1984, Montgomery and Wernerfelt, 1988, Milgrom and Roberts 1990)Resource combinations, integrated sets of activities, and interconnected asset stocks (Dierickx, Cool 1989, Amit and Shoemaker 1993, Lippman and Rumelt 2003)Contrasting view of the theory of the firmNot rely on selfish action and opportunism as assumptionsFirms are bundles of social relationships and routines for sharing and building knowledge in certain organized ways (Kogut, Zander 1992, Nelson, Winter 1982)9Theory: Capabilities

Novel combination of existing factors as the startup idea (Schumpeter 1942, Hellmann, Perotti 2007, Weitzman 1998)

Assembling sets or bundles of complementary and unique assets, activities or resources (Rumelt 1984, Montgomery and Wernerfelt, 1988, Milgrom and Roberts 1990)

Resource combinations, integrated sets of activities, and interconnected asset stocks (Dierickx, Cool 1989, Amit and Shoemaker 1993, Lippman and Rumelt 2003)

Not rely on selfish action and opportunism as assumptions

Firms are bundles of social relationships and routines for sharing and building knowledge in certain organized ways (Kogut, Zander 1992, Nelson, Winter 1982)

H1a: Human assets specialized in idea screening/development will be associated with higher performing firms.H1b: Human assets with experience in structuring contracts (transactional or governance) will be associated with higher performing firms.H2: Controlling for contracting experience, capabilities will still explain part of the variation in firm performance.H3: Human assets providing experience in structuring internal contractual relationships (transactional/governance) will complement the development of capabilities, leading to greater firm performance.10Hypotheses:

11DataUnique data on firm origins, early composition and multiple stages of performance measures Alumni: 105,000 surveyed; 42,930 records in 2001Date of birth, country of citizenship, gender, major at MIT, highest attained degree7,798 indicated founding at least one company Survey of self-identified MIT alumni entrepreneurs in 20032,067 respondents (r.r. 27%) Hsu, Roberts, Eesley 2007

Characteristics of Non-Respondents12

Industry Breakdown13

Unique Data on Origins of the Team and Idea14

Relatively Constant Over Time15

16Team and Idea Sources

17Idea Sources

18Analysis: E[yi | x] = α + ρ’zi + θ’xi,m + ’xi,o + ’zixi,m + ’Xi + η + φ + i Dep. Variables: yi represents our measures of resources accumulation and of firm performancexi,m is a vector of characteristics representing founding conditions related to the human assets for idea screening/developmentxi,o is a vector of characteristics representing founding conditions concerning the non-human assets (idea characteristics)zi encompassing the sophistication of contracting (governance and transactional arrangements)Xi vector of control variablesη and φ represent year and industry sector dummies ρ>0, θ > 0, or  > 0; Complementarity> 0?First large scale, cross-industry, noncase empirical test of these contrasting theories of the firm to determine which better matches reality.

19Results: firm performanceN=800; Controls: Number of cofounders, founder age, firm age, industry and year. ***, **, and * indicate statistical significance at the 1%, 5%, and 10% levels, respectively. P-values represent one-tailed tests. All regressions include industry sector dummies, though the coefficients are not shown.

20Results: Resource AccumulationN=800; Controls: num. cofounders, founder age, industry and year. ***, **, and * indicate statistical significance at the 1%, 5%, and 10% levels, respectively. P-values represent one-tailed tests. All regressions include industry sector dummies, though the coefficients are not shown.

Misleading Results When Other Theory Neglected21N=650

Revenues by Idea Source22

Misleading Results When Other Theory Neglected23N=400; Controls & main effects not shown. Main effects for Research Idea and Work Idea are pos. and significant for IPO also.

Matching / Endogeneity ConcernsIn a world of efficient matching, endogenous screening occurs, the best human capital at commercializing pairs up with the best ideas (regardless of source)In a regression of performance on idea sources and teams, if only one is actually important, then both will appear to be significantly associated with firm performance. Would never see a good idea paired with mediocre people or vice versa, a mediocre idea paired with high human capital individuals. Attempt to condition on inefficient matches24

25Team and Idea Sources

26Results: Conditioning on “inefficient matching”

Idea and Team Sources27

ConclusionsH1a: Human assets specialized in idea screening/developmentH1b: Human assets with experience in structuring contracts (transactional or governance) will be associated with higher performing firms.H2: Controlling for contracting experience, capabilities will still explain part of the variation in firm performance.H3: Human assets providing experience in structuring internal contractual relationships (transactional/governance) will complement the development of capabilities, leading to higher performance.Empirical tests of organizational economics alone with yield spurious results Tests of organizational capabilities in terms of resources alone will provide confusing results at best. Some firms identify and develop more valuable resources than others, yet in accordance with organizational economics, firms with experience in the founding team in structuring transactional and governance arrangements outperform Firms must both identify valuable ideas and also find the human capital with expertise in structuring the organizational arrangements to commercialize those ideas and resources.

Empirical tests of organizational economics alone with yield spurious results

Tests of organizational capabilities in terms of resources alone will provide confusing results at best.

Some firms identify and develop more valuable resources than others, yet in accordance with organizational economics, firms with experience in the founding team in structuring transactional and governance arrangements outperform

Firms must both identify valuable ideas and also find the human capital with expertise in structuring the organizational arrangements to commercialize those ideas and resources.

Robustness Checks / LimitationsMultiple resource accumulation and performance measuresInefficient matching subsampleAlternative measuresBroader set of controlsLimitationsomitted variable bias Δxi, changes in the internal and external conditions from founding to the time performance is measuredpartially absorbed by the year and industry fixed effects Representativeness, response rates, self-reportingDirect measurements of contracting concepts / idea qualityAsset specificity29management of innovation between a research unit and a customer/financiers concludes with the insight that the research unit will be integrated if capital inputs are substantial relative to intellectual inputs and R&D will be non-integrated when intellectual inputs dominate (Aghion, Tirole 1994).

30ResultsN=500; Controls: idea/team source, education, external funding, age, firm age, num. cofounders, industry, year. ***, **, and * indicate statistical significance at the 1%, 5%, and 10% levels, respectively. P-values represent one-tailed tests. All regressions include industry sector dummies, though the coefficients are not shown.

ImplicationsProcess embedding new resources into web of firm activity/economyCapabilities-based/Strategic Theory of the Firm Capabilities-based logics with org. economics-based theory of the firm Reductive approach to resources too simplistic Initial New Firm or New Business Line Formation are Under-Theorized Complicating picture – capability sources and how resource value is unlocked/realizedInnovation Literature Team Formation - demography/experience, less on context of team formation, theoretical mechanism Sources of ideas/innovationsLiability of Newness – firm structures/hierarchiesEffects of Managers on PerformanceOrganizational Economics Tension as to “core” of the firm, firm heterogeneityinnovation

Capabilities-based logics with org. economics-based theory of the firm

Reductive approach to resources too simplistic

Initial New Firm or New Business Line Formation are Under-Theorized

Complicating picture – capability sources and how resource value is unlocked/realized

Team Formation - demography/experience, less on context of team formation, theoretical mechanism

Sources of ideas/innovations

Tension as to “core” of the firm, firm heterogeneity

Relationship to Broader Research StreamDirection of Commercialization of InnovationCutting Your Teeth (with Edward B. Roberts – MIT)Prior work experience  cognitive representations The Right StuffRole of institutional environment in selection of high human capital entrepreneursWhat Drives an Innovation Strategy?Role of Institutional Env./funding of S&T in search for ideasVisionaries vs. OperatorsNothing to the Idea vs. Idea to Growth/ExpansionConstrained more by the latter than the formerEntrepreneurs from Technology-Based Universities (with David Hsu – Wharton and Ed Roberts – MIT)32

Thank you!Chuck EesleyStanford UniversityManagement Science & Engineering (MS&E)cee@stanford.edu