In Chapter 2 of The Capitalist and the Entrepreneur, Peter Klein addresses an important deficiency in much of the literature concerning the theory of the firm: its tendency to confuse upper-level management with entrepreneurship.
To understand the distinction between the two, it is useful to understand the Misesian concept of “functional distribution”.
The underlying notion of functional distribution goes back to Aristotle:
“a man who is a doctor might cure himself. Nevertheless it is not in so far as he is a patient that he possesses the art of medicine: it merely has happened that the same man is doctor and patient”
-Aristotle, Physics, Book II
In other words a doctor who obeys the call to “heal thyself”, cures qua doctor, and is cured qua patient.
Ludwig von Mises describes the distribution of specifically catallactic functions:
Living and acting man by necessity combines various functions. He is never merely a consumer. He is in addition either an entrepreneur, landowner, capitalist, or worker, or a person supported by the intake earned by such people. Moreover, the functions of the entrepreneur, the landowner, the capitalist, and the worker are very often combined in the same persons. [...] Economics… is intent upon discerning categories and functions. [...]
In the context of economic theory the meaning of the terms concerned is this: Entrepreneur means acting man in regard to the changes occurring in the data of the market. Capitalist and landowner mean acting man in regard to the changes in value and price which, even with all the market data remaining equal, are brought about by the mere passing of time as a consequence of the different valuation of present goods and of future goods. Worker means man in regard to the employment of the factor of production human labor. Thus every function is nicely integrated: the entrepreneur earns profit or suffers loss; the owners of means of production (capital goods or land) earn originary interest; the workers earn wages. In this sense we elaborate the imaginary construction of functional distribution as different from the actual historical distribution.
-Human Action, Chapter XIV, THE SCOPE AND METHOD OF CATALLACTICS
Klein points out that, in the Misesian framework, the manager, qua manager, is not an entrepreneur. According to Mises,
The term entrepreneur as used by catallactic theory means: acting man exclusively seen from the aspect of the uncertainty inherent in every action. (Ibid.)
In other words, the entrepreneur in any given situation is the “uncertainty-bearer” with regard to the capital investment in question. He is the one whose assets are on the line: who earns a profit if his speculations were spot-on, and suffers loss if things go south. In contrast, a manager qua manager, by definition, has no skin in the game. To the extent a person who happens to be a manager does have skin in the game, he is also an entrepreneur. For example, most small businessmen are entrepreneurs who “hire themselves” to manage their own businesses.
Much economic literature treats the manager as the principle helmsman of the firm, and depict shareholders as basically passive figures. But according to Mises, the manager is merely a “junior partner” to the owner-entrepreneur. And Klein explains the various means by which owners of capital manage to keep their hands on the helm, and limit self-serving “discretionary behavior” in management:
- “performance-based compensation to motivate managers to act in the owners’ interest (for instance, giving managers stock options instead of cash bonuses).”
- “a particular organizational form, such as the “M-form” structure, in which managerial discretion is more easily kept in check”
- “competition within the firm for top-level management positions”
- “Competition in the product market [which assures] that firms whose managers engage in too much discretionary behavior will fail, costing the managers their jobs.”
According to Mises, the most important instrument through which the capitalist-entrepreneur steers capital is what Klein calls the “market for corporate control.”
[T]he changes in the prices of common and preferred stock and of corporate bonds are the means applied by the capitalists for the supreme control of the flow of capital. The price structure as determined by the speculations on the capital and money markets and on the big commodity exchanges not only decides how much capital is available for the conduct of each corporation’s business; it creates a state of affairs to which the managers must adjust their operations in detail.
-Human Action, Chapter XV, THE MARKET: Promoters, Managers, Technicians, and Bureaucrats
(I would also note as an aside that, according to Mises’s nautical analogy, while the capitalist-entrepreneur is the helmsman of the economy, it the consumer who is captain.)
Now this post contains only a sampling of the profound syntheses and insights Klein has packed into this chapter. After distinguishing the Austrian approach to considering the entrepreneur and the manager from that of the mainstream, Klein pushes on to draw the outline of a fully Austrian theory of corporate governance, which is the endeavor to solve “agency problems” (managerial conflicts of interest). This theory is to be founded on the bases of thinking of firms as investments and financiers as entrepreneurs.
For a thorough introduction to the fascinating world of the entrepreneur, enroll in Professor Klein’s summer 2010 offering Entrepreneurship in the Capitalist Economy, an all-online course at the Mises Academy, starting June 7.
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I am not sure what is meant by an Austrian theory of corporate governance. Two things come to mind regarding corporate governance. First, a corporation is a type of bureaucracy and so those are the challenges that have to be overcome. Second, the limited liability of the owners may very well lead to violations of property rights that can only be remedied by taking away that limited liability which is the hallmark of corporations.
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