Organizing transactions between entrepreneurs and human capital resources under Knightian uncertainty

Abstract

This paper develops theory to explore when it is most efficient for entrepreneurs operating under Knightian uncertainty to contract with human capital resource providers through market governance as independent contractors or through firm governance as employees or holders of residual rights of control (i.e., co-ownership stakes in the entrepreneurial firm). We identify and develop the notion of unintentional adverse skill selection which can occur if skill requirements change as entrepreneurs experiment with the production of new resource combinations of uncertain future value. We explore the comparative efficiency of the cooperative flexibility of firm governance and the autonomous flexibility of market governance when unintentional adverse skill selection is salient. We develop a typology of human capital resources based on the breadth and depth of the skills they possess. We propose that skill breadth is positively associated with the expected efficiency of firm governance and that skill depth is positively associated with the expected efficiency of market governance. We then utilize this typology to theorize about which governance mechanisms are most efficient for transacting with four types of human capital resources: polymaths (high skill breadth, high skill depth), novices (low skill breadth, low skill depth), specialists (low skill breadth, high skill depth), and Jacks/Jills-of-all-trades (high skill breadth, low skill depth).