Bringing Ideas to Life : Integrating Organizational Economics and Organizational Capabilities

Using unique data on firm origins, early composition and multiple stages of performance measures, we provide evidence that if there are significant differences in the organizational capability to find valuable resources, then empirical tests of organizational economics alone with yield spurious results. Similarly, if determining the optimal arrangements for governance and transactions significantly drives heterogeneity in firm performance, then tests of organizational capabilities in terms of resources alone will provide confusing results at best. Our results demonstrate that as organizational capabilities literatures suggest, 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 as well outperform those who do not. Advancing a more integrated perspective, we show that 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. * corresponding author, Stanford University, [email protected] ** The Wharton School U. Penn. [email protected] *** MIT Sloan School of Management. [email protected] 2 According to the resource-based view (RBV) of the firm, which underlies much of the organizational capabilities-based literature, differences between firms in the resources and capabilities they have gathered through superior information or luck generate differences in firm performance (Peteraf 1993, Barney 1991, Wernerfelt 1984). Yet our current understanding of the beginning stage of how those initial strategies and resource positions are developed is limited. Only recently has the field begun to develop theory about dynamic processes that allow some firms to produce more valuable combinations of resources (Teece, Pisano, Shuen 1997, Porter 1991). Overall, the capabilities-based literature asks why firms differ and tells us that some firms through luck or better information develop more valuable resources. Yet it is left unclear how? For instance, is it through finding good intellectual property or good people? Is it through pure luck or by creating governance structures that lead to capability development? We suggest that a source of this lack of clarity is the failure to integrate theories of the firm from organizational economics into capabilities-based theories of resource identification and development. Capabilities-based theory suggests that firms that identify and gather more valuable resources will outperform other firms if these resources meet certain criteria such as being unique and difficult to imitate. Organizational economics theories of firm, particularly those focused more on internal firm dynamics, tell us how to structure firms and allocate ownership of assets to get efficient effort (Hart, Moore 1990, Holmstrom 1999) or how to formulate hierarchies to incentivize specialized human capital investments (Rajan, Zingales 2001). These theories are concerned with governance and transactions and have little to say about firm heterogeneity, but could be read to suggest that even firms with identical resources will differ in performance if certain firms are better able than others to determine and implement 1 Competitive advantage is sustained to the extent that competitors can be prohibited from replicating valuable resources (Rumelt 1991, Hatch, Dyer 2004, Lippman, Rumelt 1982). 3 the optional organizational forms and transactional arrangements for those resources. Organizational economics on the whole does not tell us about how some firms develop more valuable resources or why some get these decisions right and others do not. They are asking related but different questions and as such, there is a need to approach a similar question to integrate them. Scholars are already moving toward recognizing these complementarities and integrating the two views, particularly regarding transaction costs and the boundaries of the firm (Barney 1999, Argyres 1996, Jacobides, Hitt 2005, Jacobides, M. and Winter, S. 2005). However, less work has focused on integrating more recent theories of the firm that look less at boundary or make vs. buy decisions and more internally at firm organization and how firms originate and grow. A way to integrate these theories is to understand this common question core to both of from where initial differences in firm productivity and performance arise. Using a theory that integrates both capabilities and organizational economics effects, we show that when resources are more likely to be valuable and the team holding them has expertise in governance and transactional arrangements for commercializing those resources, then the two theoretical approaches are difficult to empirically disentangle. Furthermore, tests of either theory that do not control for the other may yield spurious or noisy results, providing motivation for their integration. By asking questions such as whether the idea or human capital is a source of value we can understand what is the “glue” that holds firm together and what type of capabilities identify and best extract the value from resources. We emphasize the incompleteness of theories relying on capabilities to explain variation in outcomes and show that the incompleteness arises because the origins of firms have been under-theorized. We also provide one of the first empirical tests of a more integrated theory across industries, in a large number of observations,