Frank H. Knight's magnum opus Risk, Uncertainty, and Profit, published in 1921, is widely recognized for introducing and establishing the distinction between risk and uncertainty. It is also known for developing a novel theory of the firm and business profit based on entrepreneurial judgment. However, the work's relevance for institutionalism has only rarely been addressed or even acknowledged. This introduction to the special issue organized to celebrate the centenary of Knight's tome briefly summarizes the work's institutionalist implications and the articles that comprise the special issue.
This paper evaluates the contribution of Risk, Uncertainty, and Profit to the development of economic theory in the 20th century. Our argument in this paper is twofold. First, we contend that this book embodied what had been the common knowledge of early neoclassical economics prior to World War II (WWII). Second, we also argue that embryonic to Knight's account of economics were two divergent approaches to economic thought that emerged after WWII. The first approach, what has come to be known as microeconomics, is characterized by utility maximization under fixed price, income, and institutional parameters that approximate equilibrium. This first approach is distinct from a second approach, referred to as price theory, in which prices are not sufficient statistics, as in microeconomics, but operate as guides to consumption and production decisions under alternative institutional arrangements. This second approach not only represented the continuation of the mainline1 of economic thought from its classical and early neoclassical roots. It also embodies the basis for Knight's understanding of uncertainty, profit and entrepreneurship, as well as its implications for economic organization and social progress.
knight 1921 risk uncertainty and profit pdf download
The second set of hypotheses regards the effect of risk and uncertainty on R&D returns. The hypothesis concerning the impact of risk on the returns to R&D follows the risk-bearing rationale (Chambers et al. 2002; Chan et al. 2001), i.e., the presence of risk yields to positive R&D returns. Additionally, using a proxy of ambiguity, we advocate the work of Chen and Epstein (2002) that shows how asset returns can be expressed as a sum of a risk premium and an ambiguity premium, i.e. the presence of both risk and ambiguity may lead to higher R&D returns than when ambiguity is not taken into account. Furthermore, similarly to Ghosal and Ye (2014), we verify whether the impact of risk varies across firm size.
In what follows, we test these assumptions and present evidence on the relation between R&D investment, risk and the uncertainty of future benefits from those investments. In the next Section, we discuss the difference between risk and uncertainty and briefly review both theoretical and empirical literatures that have dealt with the relationship between uncertainty and R&D. Section 3 describes the data and the empirical methodology. Section 4 presents and discusses the results. Section 5 concludes.
In addition to R&D, data on net sales, operating profit, capital expenditure, number of employees and market capitalisation are reported. The EU R&D Scoreboard economic data are nominal and expressed in Euros with all foreign currencies converted at the exchange rate of the year-end closing date (31 December). The country attributed to a given company refers to the country where the headquarter is located. Although headquarters are concentrated in a relatively small set of countries, the subsidiaries of top corporate R&D investors are located in more than 200 economies, where the levels of risk and uncertainty may be different. However, corporate R&D performers seemingly concentrate the majority of their subsidiaries in the very same area where the headquarters are located (see Dernis et al. 2015; Tübke et al. 2015 for a focus on European based companies), where most of the R&D decisions are typically taken.
Among the approaches to deal with risk, we advocate that of Markowitz (1952) who used variance of losses as a risk measure. Similarly, in this paper, to obtain an idiosyncratic deviation risk measure, we take the standard deviation of operating profits
where we control for both indirect effect of R&D mediated by ambiguity and for the direct impact of the change in ambiguity on operating profits. In fact, the vector x contains the measures of firm-level and industry-level risk, the first difference in firm-level ambiguity, \(\Delta \text amb_it\), and the intermediate variable that measures the indirect contribution of ambiguity in explaining the impact of R&D on operating profits. The remainder term, \(\delta _t+\eta _j+\zeta ^c+\epsilon _it\), accounts for yearly, sectoral, country effects, and a measurement error, respectively. Despite Sect. 2 identified a number of channels through which ambiguity and risk may increase or reduce the profitability of R&D, the presented empirical set up has the ability to derive only their net effects.
Most of the literature in innovation economics focused on the relationship between firm performance and R&D adopting either a knowledge capital production function à la Griliches (1979) (Doraszelski and Jaumandreu 2013), or an accounting approach, where the focus is on the relationship between accounting-based performance measures and R&D investments (Lev 2000). Our paper adopts this latter approach, as we estimate Eq. (3) to quantify the impact of investment in intangible and tangible assets, risk and ambiguity on firm future profits, using financial data on the top world R&D investors contained in the EU R&D Scoreboard.
This results somehow complement those of Ghosal and Ye (2014). Larger companies are not only better equipped to resist the negative impact of uncertainty on employment growth, but they also get higher returns in presence of risk. Furthermore, Montresor and Vezzani (2015) show that smaller companies get higher returns to R&D, because they benefit from more innovative R&D projects with high technical specialisation (Acs and Audretsch 1987). This suggests that further investigation on the interplay between R&D and size-premium (Reinganum 1981) is crucial for a better understanding of the entrepreneurial process.
American economist Frank Knight was best known for his theoretical work on the profits earned by entrepreneurs. Knight was the eldest of 11 children born to deeply religious parents in southern Illinois. As an adult, he was known for challenging prevailing economic doctrines. This penchant for questioning the existing order, however, was revealed much earlier. While attending church at age 14 or 15, Knight and his siblings were required to sign pledges binding them to attend church services for the rest of their lives. As soon as they returned home, Knight built a fire behind the barn and demanded that everyone burn these pledges on the grounds that, since they were made under duress, they could not be binding. Knight received his education at Milligan College, the University of Tennessee, and Cornell University. He taught at Cornell, the University of Iowa, and the University of Chicago, where he remained from 1927 until 1958. Knight's most famous book is Risk, Uncertainty and Profit (1921). In it, he attempted to explain why a firm could earn profits under conditions of perfect competition, even though accepted theory argued that equilibrium was incompatible with the existence of profits. To address this problem, he introduced the distinction between risk and uncertainty. Risk involves situations in which the probability of an outcome can be estimated (such as the chance of dying at a certain age, of a labor force going on strike, and so on). If the probability of an outcome could be estimated, then the firm could protect itself in a number of ways, such as by acquiring insurance. Uncertainty, however, involves situations in which the outcome cannot possibly be predicted (such as the introduction of a new and vastly superior product by a close competitor). Since rapid economic change involves uncertainty, Knight reasoned that the profits earned by competitive firms must be a reward for uncertainty, rather than risk. This was, and still is, regarded as a superior explanation of profit, and it marks Knight's most important contribution to the field of economics. Another important contribution involved Knight's attack on the concept of a production period in the theory of capital formation. The concept is somewhat esoteric and mostly of interest to theoretical economists, but it should be noted that Knight's criticism was sufficiently powerful to remove the concept from the literature. Knight viewed economics as part of a larger whole that involved consensus and rational discussion, and resulted in a liberal society based on individual freedoms. Because of this, his interests extended to morality, ethics, and philosophy. In 1950 Knight was honored with the presidency of the American Economics Association, and in 1957 he received the Walker Medal, the association's highest award.
Events and crises that may come in the future and that remain uncertain, such as those created by pandemics and by other major catastrophes, remain anomalies, or Acts of God. Little attention is paid to them. They do not and have not changed the economic behaviour of governments or enterprises, in the democratic countries with market economies, during the normal times. They have not entered in the routine policy decisions of governments, or in the planning of private enterprises. Future random events are impossible to predict statistically, and the same is the case with some risky events such as aging in the Frank Knight (1921) definition, in both their timing and their severity. Therefore, they do not force governments and private enterprises to make preparations, to better deal with them, when they finally come. The timing of pandemics cannot be predicted, and neither can their severity. 2ff7e9595c
Comments