PROBLEM SOLVING AND THE ENTREPRENEURIAL THEORY OF THE FIRM

Should attempts at opportunity discovery be governed through markets or firms? We argue that many opportunities boil down to valuable problem-solution pairings, and that opportunity discovery relates to deliberate search or indeliberate recognition over this solution space. As problem complexity increases, directional search via trial-and-error provides fewer benefits, and heuristic search via theorizing becomes more useful. Heuristic search, however, requires knowledge sharing that is plagued by a knowledge appropriation hazard and a strategic knowledge accumulation hazard. Given the complexity of the associated problem, markets, authority-based hierarchy, and consensus-based hierarchy have differential effects on the efficiency of opportunity discovery. EXECUTIVE SUMMARY When should an entrepreneur employ a market to help discover and exploit opportunities, and when should the entrepreneur create a firm to help discover them? If the firm is created, how should it be organized? We argue that opportunities boil down to valuable problem-solution pairings, where, entrepreneurs select problems to solve, and then organize a search for high- valued solutions. Problem complexity, or the degree to which required knowledge sets are interdependent, determines the efficacy of two different modes of search, one mode of which is ineffective when problems are complex because of excessive costs while the other is ineffective as problems become still more complex. This latter failure is due to knowledge formation hazards. Following Nickerson and Zenger (2004), we describe three prototypical yet alternative governance structures at the entrepreneur's disposal. When problem complexity is low, the entrepreneur can best contract with others in markets to search for solutions related to the problem he selects. When problem complexity is intermediate, the entrepreneur best orders trials in search of a valuable solution and directs others to undertake various aspects of the trials. Therefore, valuable solutions are discovered within a specific type of entrepreneurial firm, the authority-based hierarchy. When problem complexity is high, the entrepreneur creates a firm by investing in a consensus-based hierarchy, where a team is formed and socialized towards a common goal with common communication codes and channels. Doing so facilitates the collective ordering of trials to discover valuable solutions. Additionally, we argue that Kirzner's notion of entrepreneurial recognition, unique to the entrepreneurship literature, improves the efficiency of both trial-and-error and knowledge sharing but only for authority-based hierarchy, thus increasing that governance form's range of problems for which it has comparative cost advantages in seeking a solution.