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Theoretical Background

Our main argument is that by lumping together different types of firm disappearance, such as closures and failures, the failure rates for entrepreneurial ventures have been grossly overstated, and that there are various categories of firm disappearance, of which outright failure is only one. Other categories of disappearance would be better defined as closures and would include, for example, the retirement of the owner without a successor, the accomplishment of the owner’s original purpose, the pursuit of more profitable uses of capital in another enterprise, and the pursuit of a more stable, wage earning position at a larger organization. For the purposes of this study, we will define closures as those firms that have left the business for reasons other than financial exigency, and failures as those firms that have stopped operations because of financial burdens.

In order to examine a theoretical grounding to the examination of the differences between failures and closures, we rely on three main theories: strategic choice theory, organizational equilibrium theory, and efficiencywage theory. From diverse sources, each offers a distinct lens through which the phenomenon of closure can be viewed, and each indicates that there are multiple categories of firm closure beyond business failure.

First, strategic choice theory (Child, 1972; Hambrick & Mason, 1984), suggests that organizational outcomes are the result of managerial intention and choice. We believe that this can be quite easily extended to the outcome of closure. While a failure might be defined as a closure that was not the intent of the firm’s owner, as we have stated above there are numerous intentions for which the closure of the firm is the most direct way to successfully achieve them. This leads us directly to the proposition that categories of closure can be based on the owner’s intentions.

Second, organizational equilibrium theory (Barnard, 1938; Simon, 1945), proposes that the contributions of an organization’s suppliers, customers, workforce, and other environmental actors will be instrumental to the organization’s continuance. When those contributions provide insufficient inducement, the theory suggests that the firm will cease operations and close. This seems particularly salient to the distinction between business failures and other types of closure. Two instances may serve as examples. When the organization provides unsatisfactory net inducements, the owner may search for other opportunities for the investment of effort and/or capital. Second, "better" opportunities may present themselves and serve as the impetus for redirected effort in another business or in returning to the workforce. In either case, the organization may be financially sound when the owner decides to pursue these other opportunities. The work of Barnard and of Simon is behavioral in its approach and, of course, we agree with Herron & Sapienza that "the entrepreneurial process is [not] strictly rational or linear . . . [and that] an opportunity may be thrust upon someone without his/her undertaking a conscious search process" (1992: 53). Even when faced with an identical set of opportunities and constraints, two individual entrepreneurs could respond differently, each acting in accord with his or her individual choices and intentions.

Third, and finally, efficiencywage theory is instrumental in explaining some of the alternatives which are faced by workers in LDCs (EzealaHarrison, 1988). Firms tend not to offer any wage less than the reservation wage, that is, the lowest wage for which a worker will be productive. The firm’s employment and wage decision is not affected by the unemployment rate because, as hypothesized by the efficiency wage theory, lower wages will yield lower productivity. In essence what is happening is that the firm believes that it is inefficient to employ workers a rate below the reservation wage. The firm believes that it should keep the reservation wage at an optimal, efficient level and employ fewer workers. Even if there were firms large enough to hire all unemployed workers at a very low wage, it would not be productive or efficient.

Therefore in LDCs, where there is excess unemployment (excess workers) EzealaHarrison (1988: 86) found that there are three options available to the unemployed: (1)To seek lower–paying, casual employment, (2) to search for jobs with MNC’s or local large sized companies, or (3) enter into self–employment. But, these options are not equally attractive or available. A succession of casual jobs may be unattractive due to its low wages and lack of growth potential. A barrier to more attractive employment with an MNC may be created by particular worker’s lack of skills. McPherson (1996) suggests that appropriate skill levels may be acquired by the experience of owning one’s own business. This is consistent with Maier’s (1965) hypothesis that "skills are at least partially determined by the interaction of aptitudes with training … includ[ing] experience" (Herron & Sapienza, 1992: 50). If the micro or small enterprise provides training which will allow the owner to pursue a better paying job with a larger organization, the owner may close the small enterprise to accomplish his or her ultimate objective. Though the business has been discontinued, it is not a failure. Indeed, from the point of view of the individual’s intentions, it is a clear success.

Thus, we hypothesize that:

H1: A significant number of firm disappearances, that would normally be classified as failures, should be classified as closures.

H2: The likelihood of a firm disappearance being a closure or a failure, can be explained by: (a)Age of the firm, (b) size, defined by number of employees, (c) presence of external sources of funding,(d) whether it is a home based business or located outside the home, (e)gender of the proprietor, and (f) post–venture job prospects of the owner.

Consistent with prior research in entrepreneurship, which has argued that factors such as size and age are negatively related to firm failure, we expect that (a) younger firms would be more likely to fail whereas older firms would be more likely to close, that (b)firms with higher numbers of employees would be more likely to close, whereas those with less employees would be more likely to fail, that (c) firms with external sources of funding would be more likely to close, whereas those without would be more likely to fail, that (d)firms based outside the home would be more likely to close , while those that are home based would be more likely to fail, that In a patriarchal society such as the ones in Latin countries, (e) women owned businesses would be more likely to fail, and finally, and following efficiency wage theory, those firms in which the owners had better post–venture prospects would be more likely to close, while those in which the owners did not have good post–venture job prospects would be more likely to fail.

To test our hypothesis, we suggest a definition of failure that expands on that of Duncan & Handler (1994) and believe that a firm should be classified as a failure when it has ceased operations due to outright insolvency, and/or when it has ceased operations in order to stop continued losses. Firm failure then, is but one possible classification of the broader category of firm closure, which includes all reasons for discontinuing a business. Consistent with Haswell & Holmes (1989) we also propose that there should be a clear distinction between closures (including failures) and the reasons for those closures, so that a finer grained understanding may be achieved.

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