Formal and real boundaries in entrepreneurial ventures: An incentive perspective

    Firm boundaries are ‘fuzzy’, and the paper distinguishes between formal and real boundaries. For the property rights theory (Grossman and Hart 1986; Hart and Moore, 1990) firms’ formal boundaries are determined by the distribution of asset ownership for the purpose of maximizing the agents’ incentives. However, ownership can be viewed as a bundle of access and veto rights (Bel, 2013) that can be granted independently. In reality, boundaries are ‘fuzzy’ and granting access or use rights (Rajan and Zingales, 1998), or veto or exclusivity rights (Segal and Whinston, 2000) naturally leads to intermediate – hybrid – forms of organizations, between market and hierarchy, that preserve ownership autonomy and elicit strong incentives while allowing some level of control and coordination (Williamson, 1991).

    We consider an entrepreneur who requires a complementary asset to transform her idea into a practical product. The complementary asset could be a tangible asset such as a distribution channel or a manufacturing plant, or an intangible asset such as a complementary technology or know-how. In a context of incomplete contracts, we draw from the resource-based view (Wernerfelt, 1984; Barney, 1991; Peteraf, 1993), transaction costs economics (Williamson, 1985) and the property rights theory to propose a formal framework where optimal boundaries are chosen to maximize the entrepreneur and the partner’s incentives, and hence welfare. The entrepreneur can make the strategic choice to get contractual access or exclusivity to the complementary assets, or to buy them, or she can just enter in arm-length relationship with the partner. However, she must also consider the choice of the strategic partner. Alternatively, the entrepreneur may sell the idea to the partner or grant him contractual access or exclusivity. In the end, the boundaries of the entrepreneur’s firm will be determined by the interplay between the rights of the two agents. The paper rationalizes the boundary choices of the entrepreneur, given the characteristics of the potential partner, and highlights its determinants: the degree of innovativeness of the entrepreneur’s idea, the tangible or intangible nature of the partner’s asset and its degree of specificity, and the relatedness between the entrepreneur and the partner’s assets. In passing, we provide a typology of possible organizational forms involving the entrepreneur and the partner, and their consequences for the boundaries of the entrepreneur’s firm. The framework brings about an actionable theory of organizations that may provide a guide to the entrepreneur’s choice of optimal organizational forms.