Entrepreneurship Theories

What is a Corporate Spin-off? Definition, Strategy, and Examples Corporate Spin-offs: Definition and Strategy A corporate spin-off is a strategic decision by an organization's managers to form a new, independent organization for a specific unit of the company. Physically, the unit might move to a new location or stay in the same building, but operationally, it begins to function under a different corporate entity. How it Works: Compensation and Shares In a standard spin-off, the owners of the parent firm typically receive shares in the new spin-off company. This serves as compensation for allowing the unit to leave the parent's portfolio. For public companies , the spin-off receives a new ticker symbol and trades independently from the parent company's stock. This allows the market to value each entity separately, deciding if the split was a good idea for one, both, or neither. Why do Companies Spin-off? (Strate...

Information Asymmetry in Entrepreneurship: Definition & Risks Information asymmetry refers to a condition where two parties in a market or organizational relationship have access to different levels of information about an exchange. It acts as the alternative to the classical economic assumption of "perfect information." In the real world, one side usually knows more than the other, leading to power imbalances and market inefficiencies. 1. Regulatory Context: The "Insider" Problem Information asymmetries are the primary reason laws exist to forbid insider trading . Company insiders (CEOs, executives) possess a "high-definition" picture of the company's financial health, while the public sees a "low-resolution" version. As Aboody and Lev (2000) note, this gives insiders an unfair advantage when buying or selling stock. To counter this, executives have fiduciary responsibilities requiring them to be truthf...

Real Options Theory: Why Flexibility Adds Value to Startups How do you value a startup that has no revenue, massive uncertainty, but huge potential? Traditional accounting fails here. Instead, savvy investors use Real Options Theory . Originally derived from financial markets (Bowman & Hurry, 1993), this theory treats investments in "real" assets (like a factory, a startup team, or a patent) similarly to financial stock options. Call Options: Allowing investors to bet on the upside without committing full capital immediately (e.g., a Seed round). Put Options: Allowing investors to limit downside losses (e.g., liquidation preferences). Real Options vs. Net Present Value (NPV) According to McGrath (1999) , Real Options Theory is superior to traditional Net Present Value (NPV) analysis under conditions of high uncertainty. NPV assumes a linear path: you invest $X today to get $Y tomorrow. But startups aren't linear. Real Options logic argues that...

Liquidity Constraints Theory: Does Money Buy Entrepreneurship? There is an old saying: "It takes money to make money." In academic terms, this is known as Liquidity Constraints Theory . The theory posits a simple but powerful relationship: founding a new venture is significantly more common among individuals with greater access to financial capital. Because borrowing money for a high-risk startup is difficult and expensive, personal wealth becomes the primary gateway to entrepreneurship. The Wealth Advantage Evans and Jovanovic (1989) provided the foundational research for this theory. They found that wealthier individuals are more likely to enter entrepreneurship simply because they can risk their own capital without relying on skeptical banks or investors. This creates a barrier to entry: talented but poor individuals are "constrained" from starting businesses, while perhaps less talented but wealthy individuals are free to try. Liquidity Events as ...

Signaling theory has been used to explain how firms communicate their quality and intentions to investors. It addresses a fundamental problem: Information Asymmetry . [Image of signaling theory diagram economics] Entrepreneurs have private (insider) information about their venture's prospects that outsiders do not have. For example, entrepreneurs may know early R&D results, sales data, or human capital details. They may also know about impending lawsuits or union troubles before the public does. Because investors know they lack this information, they look for signals to determine which startups to fund. What Makes a "Good" Signal? The best signals are costly and observable . Observable: The investor must be able to see it easily. Costly: It must be difficult to fake. If a signal is cheap, low-quality firms will mimic it. If it is expensive (like ISO9000 certification or a high degree of founder equity), only high-quality firms can afford to send...

The Pecking Order Theory was developed in the 1980s by finance scholars (Myers and Majluf) seeking to understand the financing preferences of firms. The theory suggests that there is a specific hierarchy (a "pecking order") that entrepreneurs follow when deciding how to fund their business. They do not choose randomly; they choose based on the path of least resistance and lowest cost. The Hierarchy of Preferences Entrepreneurs typically prefer funding sources in this specific order: Internal Funds (Bootstrapping): Personal savings and retained earnings (profits reinvested). This is the preferred choice because it requires no disclosure to outsiders. Debt (Loans): If internal funds run out, entrepreneurs prefer debt. Banks are less intrusive than equity partners. New Equity (Investors): Selling shares to outside investors is the last resort. It is the most expensive (you lose ownership) and requires the most disclosure. The Cause: Information Asymmetr...

Agency Theory: The Battle Between Owners and Managers Why do investors insist on vesting schedules? Why do Boards of Directors exist? The answer lies in Agency Theory . Developed in the 1970s and 80s by economists like Michael C. Jensen at Harvard Business School, this theory provides the framework for understanding the often contentious relationship between those who own a company and those who run it. The Core Players: Principals vs. Agents Agency theory distinguishes between two parties with distinct roles: The Principal (The Owner): The party that delegates responsibility (e.g., the Investor or Shareholder). The Agent (The Doer): The party that performs actions on behalf of the principal (e.g., the Founder or CEO). [Image of principal agent theory diagram] The theory’s underlying assumption is cynical but realistic: Humans are self-interested. Therefore, the interests of the Principal and the Agent will inevitably diverge. If left unchecked, the Age...