Entrepreneurists and Firmists: Knight vs. The Modern Theory of the Firm

Frank Knight was a “grand theorist.” Like other grand theorists from Adam Smith to Friedrich A. Hayek, his interests extended beyond economics. In economics, his major writings focused on the most general problems of the discipline, his goal being to show the merits and limitations of the free enterprise system. He took a special interest in intersubjective uncertainty and the accompanying problem of agency. To benefit from an economic transaction an individual must rely on others (agents, broadly speaking) to perform actions even though he or she cannot be certain that the others will decide to perform the actions. Agency, in the broadest sense, is present in all relationships that are properly defined as economic. Knight apparently recognized that both the classical liberal's trust in free enterprise and the interventionist's distrust stem from their different views of the agency problem and of how best to solve it. Accordingly, he made the problem a centerpiece of his investigation of free enterprise in his celebrated Risk, Uncertainty and Profit (1921). The agency problem also plays an important role in the modern, or new institutionalist, theory of the firm. The new institutionalists aim to show that some observable economic relationship, rule or procedure in an organization, most notably a Coasean firm, is a result of the efforts of individuals to deal with the agency problem.