Business at a Crossroads: The Crisis of Corporate Leadership

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Business at a Crossroads

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Business at a Crossroads The Crisis of Corporate Leadership

Tom Lloyd

© Tom Lloyd 2010 All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No portion of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, Saffron House, 6–10 Kirby Street, London EC1N 8TS. Any person who does any unauthorized act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The author has asserted his right to be identified as the author of this work in accordance with the Copyright, Designs and Patents Act 1988. First published 2010 by PALGRAVE MACMILLAN Palgrave Macmillan in the UK is an imprint of Macmillan Publishers Limited, registered in England, company number 785998, of Houndmills, Basingstoke, Hampshire RG21 6XS. Palgrave Macmillan in the US is a division of St Martin’s Press LLC, 175 Fifth Avenue, New York, NY 10010. Palgrave Macmillan is the global academic imprint of the above companies and has companies and representatives throughout the world. Palgrave® and Macmillan® are registered trademarks in the United States, the United Kingdom, Europe and other countries. ISBN-13: 978–0–230–23094–1 This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. Logging, pulping and manufacturing processes are expected to conform to the environmental regulations of the country of origin. A catalogue record for this book is available from the British Library. A catalog record for this book is available from the Library of Congress. 0 9 8 7 6 5 4 3 2 1 1 19 18 17 16 15 14 13 12 11 10 Printed and bound in Great Britain by CPI Antony Rowe, Chippenham and Eastbourne

This book is dedicated to the memories of my mother Maggie, my sister Judy, and two great friends, Peter Bielby and Ray Heath


Contents

xi

Acknowledgements Introduction Reference

1 11

PART I What ails big business

13

1

What people want Self-respect is a primary good Free Fair Reasonable Decent Power and powerlessness Good work The argument so far References

15 17 19 20 21 24 26 29 30 30

2

A feudal heritage A cat ponders a king Business is natural Early trade The precursors of companies

31 31 32 34 35 37 39 41 42 43 45 47 48 48 50

The English East India Company

From mercantilism to capitalism The Industrial Revolution An accidental birth The birth environment Medieval tournaments The evolutionary puzzle The argument so far Box: Hudson’s Bay Company References

vii

viii

contents

3

The steam-age corporation Why the MuBE emerged Why the MuBE thrived Chandler’s contribution The argument so far Box: Vickers-Armstrongs References

51 52 56 66 67 67 68

4

The decadent corporation Justice as fairness Growing inequality More than fair shares TARP restrictions on executive pay The gathering storm Barriers to reform A dangerous decadence The argument so far References

69 69 72 78 79 82 83 85 86 87

5

Not so much greed Greed Asset-skimming An unwholesome alliance An unhappy coincidence The cult of leadership The buck and the bucks stop here The argument so far References

88 88 92 93 95 98 102 102 103

6

The myth of leadership The CEO system The management ideas market The CEO as principal and conductor Systemic risks Fortunes from good fortune The CEO as ambassador Leaders and leadership Progress report The argument so far References

104 105 107 109 111 114 115 116 119 119 120

contents

ix

PART II Reforming big business

121

7

123 124 127 128 130 132 135 135 139 142 143 143

Leaderless competitors Roads not taken A fractured landscape Box: Patches on landscapes Phase transition The poverty of strategy New roads Linux Wikipedia

Stewards, seeders, guardians The argument so far References 8

The adaptive challenge The question of purpose Soul and community Too few women Feminine management The arrow and the spiral The female advantage

The promise of women The argument so far References

145 145 148 150 153 156 157 157 158 158 158 159 159 160 160 161

Size and shape Real business Small and local Power with Box: From an Acorn The parasite’s strategy Partnership problems Yielding power

162 163 164 165 167 169 170 174

Talent Moderating macho Risk Ethics

Box: Ethics and gender Pay

9

x

contents

Creative conversation Partnership enterprise The argument so far References 10 Corporate reformation The Individualized Corporation The regents committee Corporate democracy Numbers that nudge Open-book management Measuring CEO performance

Redeeming the corporation Box: Semco’s steps to democracy References Index

175 176 177 177 178 178 182 185 187 188 190 191 193 193 194

Acknowledgements

This book has been germinating for several years during which time the way I see business has been influenced by many people. They include two “turnips,” as my wife calls them (they’re Swedes), my friends and ex-colleagues, Karl-Erik Sveiby and Ronald Fagerfjall, John Curtis, Andrew Bull, Anne Murphy, Jon May, Anne Deering, Tony Rowland, Danny Barr, James Ramsden, Mike Hainsworth, Adrian Pryce, Richard Miller, Peter McAllum, Peter Robinson, and David Hurst. Thanks to all of you for the stimulating conversations that have led me to conclusions some of you will, no doubt, disagree with. A number of other people have helped me to put what I have learned into the words that follow by contributing ideas and reviewing and criticizing drafts. They include Peter Duffy, Rich Foggio, Vince Darley, John McNulty, John Stansell, and Neil Marshman. Very special thanks go to my two most diligent and helpful reviewers, James Page and Antonie Reichling. Thanks also to Palgrave Macmillan’s Stephen Rutt, for taking a chance with the book, and his colleague Eleanor Davey Corrigan, for her helpful comments and guidance. I would also like to thank Rose Lewis for her light and accurate editing.

xi


Introduction

The evolution of the liberal capitalist system ground to a halt in 2007– 08. The default of the apocryphal subprime mortgage borrower in America’s mid-west, a mere flutter of butterfly wings, caused a hurricane of fear to rage through the securitized debt markets and sent the world’s banking system into cardiac arrest. With the help of blood transfusions from central banks, the system regained a semblance of life, but emerged from the trauma a pale shadow of its former self. The hunger for ever riskier lending was transformed into extreme risk aversion. Banks, fearing their peers were even more exposed than themselves to the subprime securities market, stopped lending to each other and lenders dependent on the interbank market collapsed. When the troubles spread to Main Street a bonfire of all Wall Street’s vanities engulfed “the Masters of the Universe,” as novelist Tom Wolfe had dubbed investment bankers and securities dealers at the time of a less dramatic crash two decades earlier. What were they thinking? That “securitizing” loans to people on welfare made them less risky? That making a market in risk and moving it about would reduce its virulence? That the magic wand of economic growth would transform sows’ ears of subprime debt into prime silk purses? In the firestorm of recrimination and accusation that followed the crash, the trust ordinary people had in the powers that be – those who had been running the liberal capitalist system, company chief executive officers (CEOs) and their Wall Street allies – and their tolerance of their astronomical pay packets, were consumed. The system was broken. Its fragility was exposed. There was a flaw in the complicated array of risk management devices and securities those erstwhile masters of the universe had designed to juggle the gravely mis-measured risks of their lending binge. Perhaps there was a flaw in liberal capitalism itself. It was up to governments and central banks, which were held partly to blame for what, with hindsight, was seen as their reckless deregulation of financial markets before the crash, to deliver first aid. It is up to 1

2


us, the ultimate architects of political-economic systems, to decide the kind of society we want to live in, and the kinds of organization we want to work for. A vote, whether cast with hands or feet, is no small thing, and at a time like the present, when long-held beliefs and previously unquestioned assumptions can no longer be taken for granted, a vote becomes a very large thing. In choosing political parties, by ticking boxes, and choosing the kinds of organization we work for, by walking away from some and toward others, we can reshape our society and its institutions. Let us choose reform and restoration. The alternative is too awful to contemplate. I fear Yeats’s Second Coming; the second coming of socialism. The return, to the political debate, of Marx’s “blank and pitiless” slogan: “From each according to his ability, to each according to his need.” It would be a rational choice in many ways. The system that failed was manifestly unfair. It was producing gross and rapidly growing inequalities. Ordinary people were already bemused and angered by the huge sums paid to hedge fund managers, investment bankers and CEOs before the crash. They were incensed by the enormous “golden parachutes” paid to the ex-CEOs whose strategies had contributed to the meltdown. They became apoplectic when, faute de mieux, their money had to be used to rescue the banks that had precipitated the crisis. The financial crisis also exposed a profoundly unfair asymmetry in the system. In a rising market, bank lending magnifies gains which enrich a few hedge fund managers, investment bankers and top level executives. But in a falling market, it magnifies losses which are carried by everyone when banks are bailed out by the taxpayer. In this way, boom and bust act like an inequality ratchet. Gains during the boom are captured by the privileged few, losses during the bust are paid for by everyone and, cycle after cycle, inequality grows. For voters made aware by the bailout that they have been played as mugs in a classic “heads I win, tails you lose” game, it would be folly to allow the game to continue, and rational to substitute neo-socialism for the liberal capitalism that had, supposedly, led to the unfairness. Rational, but not reasonable. Something must clearly be done about this unfairness, but to blame liberal capitalism for the inequality and financial crisis, and to vote in a socialist government would be to throw the baby out with the bathwater; to shut Pandora’s box before hope emerges. Liberal capitalism has proved its worth. Few now dispute that free markets protected by vigilant antitrust and other forms of regulation are the best system for a society that places a high value on economic well-being.

introduction

3

Vigilant regulation is vital, because there are worms at the cores of free markets. Sir Karl Popper’s “paradox of democracy” was that when democracy is too free, tyranny can emerge. When markets are too free, monopolies, inequality and financial instability can and do emerge. Political, economic, biological and other complex systems all have fundamental flaws of this kind; seeds of their own destruction, in subsystems, tendencies and propensities, which, like cancers, can grow out of control and suborn, take over or otherwise jeopardize the survival of their host systems. That’s why liberal democracies need constitutions and markets need regulation. Recent events and developments suggest liberal capitalism harbors two dangerous seeds of self-destruction; growing inequality, which undermines the political consensus that sustains the system, and a tendency for markets to spiral out of control. The economist, John Maynard Keynes, suggested that economic activity was partly driven by alternating waves of irrational optimism and pessimism. Some 70 years before the 2007 subprime crisis Keynes said, in The General Theory of Employment, Interest and Money, most of our decisions “to do something positive … can only be taken as the result of animal spirits – a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.” Some suggest it’s these animal spirits, their effects magnified by positive feedback from self-fulfilling prophesies, that drive business cycles. It’s up to us to ensure these seeds of self-destruction in liberal capitalism are brought under control. My prescription is reculer pour mieux sauter; to step back to jump forward more strongly. We need to turn liberal capitalism’s clock back to a time before its seeds of self-destruction began to take over. Evolution in nature sometimes works this way in a process known as “neoteny” (“holding youth”). We are the creatures of neoteny. Our rounded, bulbous cranium containing our large brain resembles that of a foetal ape. Subsequent ape brain growth is slower than ours, so the cranial vault is smaller and lower in an adult. We acquired our large brains by retaining rapid foetal growth rates. The human face – distinguished from the faces of other primates by its straight profile, small jaws and teeth, and weak brow ridges – resembles the face of a juvenile ape. The resemblance fades as the ape’s jaw grows, relative to the rest of the skull, to produce the adult ape’s muzzle. The foramen magnum, the hole in the mammalian skull from which the spinal cord issues, is underneath our skull, pointing downwards, as in

4


the embryos of other mammals. This means we look forwards, when we stand upright. As other mammals mature, the foramen magnum rotates and ends up pointing backwards, so that the animal looks forwards when standing on all fours. The Microsoft Windows operating system incorporates a reculer pour mieux sauter option. If your computer keeps crashing, or begins to run agonizingly slowly, because it has acquired viruses, worms or other internet pathogens, System Restore allows you to restore the machine to a previous known working state. Files and data, such as wordprocessing documents, spreadsheets, music and images, remain intact, but the operating system itself reverts to its state at an earlier time, before things began to go wrong. We must do a System Restore on liberal capitalism. Something of the kind has already occurred in the new regulations for banks and capital markets following the 2008 financial crisis. In a sense, they have restored liberal capitalism’s financial subsystem to its mid-1980s state, before the deregulation and subsequent globalization of the financial services industry. This book advocates the reformation of another creature of liberal capitalism, the large, limited liability joint stock company, some of the features, practices and appetites of which I believe lie at the heart of liberal capitalism’s malaise. In their new “global” guise these institutions appear to exemplify liberal capitalism. They are the overwhelmingly dominant business organizations, and most of us are directly or indirectly employed by them. They seem to be integral to liberal capitalism, or at any rate capitalism. The system seems inconceivable without them. So prominent and powerful are they that it is easy to forget their relatively recent origins. The company as we know it, only assumed its modern form in the mid-19th century and remained a minor player in business until the early 20th century. But since then, this form of enterprise, cobbled together with a structure borrowed from the military, practices and habits inherited from mercantilist trading companies, and hungers derived from the entrepreneurial businesses and partnerships that drove the Industrial Revolution, has been astonishingly successful. The modern world is in many respects its creature. But it has begun to show clear signs of decadence. Enron, WorldCom, Tyco and Parmalat are a few of the names that had tainted the reputation of “big business” with a whiff of fraud and corruption long before the big crash. These scandals led to the SarbanesOxley Act in the U.S., and similar laws and codes of practice elsewhere.

introduction

5

That such regulations were deemed necessary in nations wedded to laissez-faire economics reflected a concern that, when left to their own devices, big companies tend to behave badly and it was, therefore, necessary to curtail their liberty. The generally more critical view of business has also been evident recently in the accusations by governments, fiscal authorities and commentators that companies that engage in aggressive tax planning (tax avoidance, the opportunities for which have been increased by globalization and tax competition between national governments for foreign investment) are behaving unethically, and not paying their dues to the societies in which they operate. But much the clearest and, in my view, the most worrying sign that the large, publicly listed, limited liability, joint stock company has entered a decadent stage where its behaviour is diverging from commonly accepted standards, is the executive pay explosion. Let us be clear about this issue from the outset. There is no remotely conceivable justification, economic or otherwise, for the CEOs of our largest companies to be paid several hundred times the average pay of their employees. I imagine readers gasping in disbelief. Surely this is a typing error? But no. At the top of the bull market in 2000, the CEOs of the 500 largest U.S. companies were paid (“earned” is entirely the wrong word) on average over $500,000 for every $1,000 paid on average to the rest of their employees. The subsequent market crash (a minor blip, compared to what was to come later), and new reporting rules requiring companies to account for stock options as expenses, led to a brief reduction in the multiple subsequently, but the average multiple for Fortune 500 companies was 350 in 2005, and rising. There’s a furtiveness about executive pay. Like a spider caught in the light, it freezes and sometimes even retreats, when it becomes a focus of attention, but creeps up again when no one is looking. It froze and retreated after the 2008 crash, in response to public outrage at the huge severance packages and pensions paid to former CEOs of banks who had bet the farm on subprime debt. CEOs are not stupid. They can’t possibly believe they are actually worth what they’re paid. They know there’s no link between CEO pay and corporate performance. So why do they demand such enormous pay packages and, more importantly, why do their shareholders accede to their demands? These questions lead directly to the rottenness at the core of the modern corporation. But greed isn’t the answer. To explain the CEO pay explosion as a consequence of insatiable human greed is to miss the point entirely.

6


CEOs aren’t abnormally greedy. They simply accept the good fortune that has brought them to a place where huge rewards are there for the taking, ignore protests in the popular press about troughing and fat cats and try to ensure that their pay remains competitive. As one German CEO, relatively lowly paid by Anglo-Saxon standards, is said to have put it: “I know I am overpaid, but the benchmarks say I’m not overpaid enough.” It is an institutional greed; a product, not of human avarice, but of the way hierarchical corporate organizations concentrate power in the hands of individuals and create a “CEO class” isolated from market disciplines, where remuneration is decoupled from work and economic value added, and CEO pay packets chase each other upwards in a never-ending spiral. Let us be clear about another thing from the outset. Pay and power are inextricably linked. It would make no sense for shareholders to pay their CEOs huge amounts of money if they didn’t also assign to them huge amounts of power. Only omnipotence can justify modern CEO rewards and omnipotent CEOs can’t pass the buck when things go wrong. The consequent emergence of what are in modern times unprecedented inequalities of power, income and wealth, marks the beginning of a new and alarming chapter in the evolution of liberal capitalism. I will argue that, fortunately for liberal capitalism, the explosion in executive pay is not a natural outcome of the system. It is an aberration that can be corrected. It must be corrected, because it is the Achilles heel of modern capitalism. It is so obviously and so offensively unfair that, if it continues, the sense of fairness and justice that sustains the liberal democratic consensus will be undermined. Growing inequalities within liberal capitalist societies and their business organizations undermine not only the general consensus on which these societies rest, but also the countless contracts of employment and association that comprise that consensus. Partly because of the executive pay explosion, modern companies are seen by their employees and prospective employees as profoundly unfair organizations that do not recognize or reward ability and diligence proportionately. Why this should be so is something of a puzzle. Institutions that compete with each other in a free market should realize the vital importance of paying fair rates for goods and services rendered, and the market itself should penalize those that don’t. But disparities in pay – between men and women, ethnic groups and, most conspicuously, between middle and senior managers and “C-level” executives (CEO, CFO, COO, and so on) – persist. Whatever the reasons for them, these huge disparities in income are seen as unfair and hang like

introduction

7

dark clouds over company cultures, breeding resentment in those who have to get by on a tiny fraction of their leaders’ incomes. It is not the fact of differences in pay that is controversial; it is the extravagance. It is simply impossible for reasonable people to believe that their CEOs, several of whom are sacked with multi-million-dollar severance packages each year for incompetence and who, as a breed, are notorious for destroying shareholder value by paying too much for acquisitions and – in their pursuit of targets linked to their incentive plans – for taking too many risks, could be worth such huge rewards. The second problem, related to the first, that people have with large companies, is the deterioration in the so-called “work–life balance.” Working for large, complex organizations has always been demeaning, since Henry Ford turned his employees into cogs in a machine. More recently it has also become intolerably demanding. In today’s intensely competitive business world CEOs have to crack the whip harder and harder to get their numbers to the point where their incentive plans kick in. The result is that it is becoming difficult, if not impossible, for ambitious managers to maintain a full and fulfilling family and social life. It is here, in the unfairness of large companies and the excessive demands they make on employees, that the System Restore, reculer pour mieux sauter possibility lies. People voting with their feet, moving from one kind of organization to another, is the engine of the evolution of the corporate form. For lack of anything better, we have put up with the unfair and demanding organizations most of us work for, but we are unlikely to do so for much longer. People, particularly those exceptionally able people large companies fight tooth and nail with each other to employ in the so-called “war for talent,” are now realizing that recent technological, economic and social changes give them more options. Nowadays, they can leave organizations in which they feel uncomfortable with less fear of becoming destitute and they can form, join or become associated with smaller, looser organizations that offer them work and types of association that suit them better. Once their economic needs have been met people will seek the kinds of work and types of association that appear, to them, most likely to satisfy their emotional needs and particularly their hunger for selfrespect. I believe it is this human hunger for self-respect, rather than globalization or technological change, that is driving corporate evolution. Like natural forms, corporate forms co-evolve with the environment in which they compete for resources. Now that able, hard-working people, the most important business resources, realize they have choices, they will leave organizations that deny them self-respect.

8


This book explains why capitalism’s main economic agent, the large CEO-led, limited liability joint stock company, is in dire need of fundamental reform and suggests some steps companies could take to improve their adaptation to today’s environment. It focuses on the U.S. and the U.K., because it is in these countries that the problems are most acute, and the decadence of companies is most advanced. There are three protagonists in my story. The first is the company that wants to hire able people who respect themselves, because it knows they are more self-confident and creative than wage slaves. The second is the individual who, as a voter, wants a society that is fair as well as free and, as a worker, yearns for a career that is fulfilling and rewarding without demanding so much commitment that she or he feels inadequate as a partner, parent, friend and human being. The third is less easy to describe. It is the modern company’s as yet inchoate nemesis – the new breed of enterprise that will challenge and possibly replace the company if it fails to reform itself. The first step in a System Restore process is to choose an earlier date to which to return the system or institution. This is no easy task because, although the problems themselves (the unfairness and excessive demands) are clear enough, their causes are shrouded in the mists of the past. We must go right back to the origins of the institution itself to understand what corporations are and why and in what ways they became decadent. There is no mystery about why trade and business developed. It was because there are synergies in exchanges of goods and services, and economies in specialization. Business organizations were developed to conduct business and trade, because there are economies in the coordination of business activities and synergies in cooperation between specialists. But there is no ideal business form or model of association. Forms and types of association emerge in response to new challenges and will fall into disuse when changes in their environment make them less “fit”; when their initial virtues become, or are replaced by, vices. Each form has what evolutionists call a unique “environment of evolutionary adaptedness” (EEA) and tends to become less fit as its current environment diverges from its EEA. Today’s dominant form of business organization emerged in response to the environment of the late 19th century, so it’s no surprise it has run into trouble in the environment of the early 21st century. Much has changed over the past 150 years. Markets have become more efficient, a global economy has emerged and new technologies have changed the nature and intensity of competition, and created space for new enterprise experiments and business models.

introduction

9

Most important, the attitudes, outlooks, aspirations and emotional needs of able individuals have been changed profoundly in the past two decades or so by important social and economic developments. These include the unilateral repudiation by most employers of the old “loyalty for security” psychological contract (keep your nose clean and close to the grindstone, and you have a job for life); the re-emergence of the market rather than the organization as the mechanism for valuing human worth and allocating human resources; the opportunities for self-employment created by the internet and the disaggregation of business through outsourcing and other kinds of association; and more recently, the sea change in the perceived cost–benefit profiles of employment, versus self-employment caused by the recession. (Recessions always eject large numbers of people from companies and not all of them return when growth resumes.) The importance of these changes lies not so much in themselves, as in the options they offer able people to satisfy their hunger for selfrespect. Just as slaves and serfs had to resign themselves to their status when there was no prospect of freedom, so wage slaves raised no objections to their economic serfdom when there was no obvious alternative. People are beginning to realize that there is an alternative now. Economic serfdom has become voluntary. The human hunger for self-respect has led to the gradual diffusion throughout the world of a system of government we call liberal democracy. It has been a slow process and, even now, liberal democracy is not universal. But the trend is clear and it seems for the most part to be irreversible. Self-respect is a “primary good,” as John Rawls1 called it, and history suggests that, in the political arena at any rate, it’s maximized for the mass of ordinary people within a liberal democracy. This same hunger for self-respect requires changes in the forms of organization and the types of association in which, and with which, people will come together in future to combine their talents and abilities in concerted efforts to create wealth. This book has two parts. The first six chapters focus on what ails big business. The final four chapters focus on what can be done to reform it. Part I, “What ails big business,” begins in Chapter 1 with an invitation to readers to redesign work; to ask themselves how, in an ideal world, they think work should be managed or organized and how, in an ideal world, they think that the rewards for work ought to be distributed. Armed with the model extracted from this thought experiment of the working arrangements most people want, I shall explain, in Chapter 2, why they have so far been denied such arrangements. My approach is

10


evolutionary. To understand how we have got to where we are, we must return to the origins of business and its organizations, and retrace our steps back to the present. Such an exploration of the antecedents of the modern corporation leads us, I will suggest, to the conclusion that one reason why today’s dominant corporate form differs from the form most people want is because it is adapted to an older environment. In Chapter 3, the adaptive pressures on the corporation created by the differences between its EEA in the mid-19th century and today’s environment are examined in more detail. I will suggest that many of the corporation’s original advantages are either less valuable now or have become disadvantages, and the conventional company has thus become vulnerable, in principle, to the invasion of its niche by other, better adapted variants. The conventional corporation has become vulnerable, because it has not changed; has not adapted adequately to changes in the business environment. It has also become vulnerable in another way, because it has changed – changed for the worse. Chapter 4 explains how the decadence of the corporation, exemplified by the seriously bizarre sums of money paid to executives, threatens the liberal capitalist system that sustains it by undermining the consensus that sustains liberal capitalism. Chapter 5 investigates the causes of this decadence and attributes it not so much to the standard explanation, greed, as to a serious inefficiency in the market for senior executives caused largely by the pyramidal shape of modern corporations. I will argue that this shape is so deeply embedded in modern business culture that no one questions its implicit presumption that, to be successful, a large company requires an exceptionally able and charismatic leader. The consequence of this standard, hierarchical model is that power and pay are invariably drawn, as if by a siphon, to a CEO space at the top insulated from normal market disciplines. Some will argue that there’s another, more prosaic reason for very high levels of CEO pay; namely that CEO work is very difficult and demanding, those who can do it well are as rare as hen’s teeth and their pay simply reflects the market clearing rate for these “rare skills.” Chapter 6 challenges the assertion that the CEOs of large corporations are really worth their weight in gold every year. The role of luck in business success is discussed, various CEO “agency costs” are examined, and the extent to which others, including the company’s workforce as a whole and outside consultants, contribute to the successes for which only the CEO is rewarded, is explored. Part II, “Reforming big business,” begins in Chapter 7 with a discussion of some roads not taken in the evolution of enterprise, which

introduction

11

could have led to a different place. These discarded threads of possibility are developed, with the help of complexity theory, into an examination of the prospects for leaderless enterprise, of the kind exemplified by the Linux software system and Wikipedia. This is my third protagonist – the multi-agent business enterprise; the challenger – the nemesis of the conventional CEO-led company if it fails to adapt. Chapters 8 and 9 each focus on a particular adaptation open to the CEO-led company; appointing more women to senior positions, and so moderating the masculine corporate persona which has become such a liability recently, and reducing CEO omnipotence, by entering into more business partnerships. Finally, in Chapter 10 I sketch out the elements of a “System Restore” procedure for the large company. My main argument is that corporations should become more sensitive to their environment; to the hunger of their employees for self-respect; to the demands of those who shape their political environment for fairness, openness (or “transparency” as modern parlance has it), decency and an acknowledgement of social and environmental responsibilities. I am a great believer in the power of simple rules (for compensation in capital markets, for instance) to steer, channel or nudge people and companies in desirable directions. By adjusting, tuning and thoughtfully tinkering in this way we can create new background conditions that will encourage companies and their leaders, if leaders there must be, always to behave in ways that maintain economic and financial stability, and the essential political consensus that sustains the system of liberal capitalism from which companies derive their licences to operate. Liberal democracy and its economic system, capitalism, is the best system for creating and maintaining free and prosperous societies so far devised. It would be a tragedy if the decadence of its main business institution led us, as voters, to abandon it and exchange some of our freedoms for the promise of a fairer society. The large CEO-led joint stock company can and must be reformed.

Reference 1

A Theory of Justice, Harvard University Press, 1971.


PART I What ails big business


1 What people want

The most challenging long-term problem facing companies is not the speed of change, although that’s relentless; it is not the growing complexity of business and finance, although that is becoming more convoluted by the month; nor is it the risks that complexity brings with it, although, as the crash showed, they are horrendous. It is not disruptive new technology, although that is coming thick and fast; nor the capriciousness of customers, although they’re becoming less and less predictable; neither is it competition, although that’s intensifying all the time. All these certainly add to the difficulty of the modern management problematique, but all pale into insignificance beside the problem modern businesses have with people; or rather, to put it the right way round, the problems people have with modern businesses. Work can be enjoyable, fascinating, satisfying, and enriching, both intellectually and materially. At the best of times, it’s a source of peak experiences, firm friendships, and illuminating insights into how the human psyche, including your own, and the world work. It can give meaning and purpose to life. It can bring out the best in people. It can be a rich source of self-respect. But there’s also the frustration when you are told to do something you think is wrong or prevented from doing what you feel is right; the humiliation when less able people are promoted and you’re not. There is the unfairness; the bureaucracy; the regimentation; the excessive demands; the shame when your company behaves unethically or unkindly; the sense of powerlessness when the leader reassigns roles and tasks without consulting the people affected, or, on the advice of a few smart “here today, gone tomorrow” consultants who don’t seem to know their arses from their elbows, implements a new strategy any fool can see will be disastrous. Because large companies need specialists, people tend to get stuck in departments or roles that seemed interesting and challenging to begin with, but turn out to be backwaters. Others languish in the ghettos of “non core” or “pink collar” support functions, far from the mainstream. Many feel they are paid less than they’re worth or that they are going 15

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nowhere, because the powers that be appear to value political skill more highly than business competence. How many middle managers can honestly say they do not occasionally resent the fact that their so-called leaders, who often seem to be reckless or breathtakingly incompetent, are paid hundreds of times more than they are, or have not thought to themselves, “I’m outta here!”, but have buttoned their lips in the interests of those who depend on them? Companies are made by, but not for people. There is always tension and often open conflict between the interests of the organization, and the interests of its employees. If you are the Chief Executive Officer (CEO), things are different, because you have “powers of sovereignty” that your employees lack. But even you may feel the demands of the market and of your investors are unreasonable, and that you have been treated or judged unfairly. Some companies are better places to work than others, but there is no denying that many are seen by their employees these days as being illiberal, unfair, callous, irresponsible, and presumptuous in the demands they make on the time of those who work for them. This may help to explain why there’s so much talk now about an epidemic of workrelated stress. A 2000 European Working Conditions Survey found that workrelated stress was the second most common work-related health problem in the European Union (EU), after back pain. It has been linked to cardiovascular diseases, musculoskeletal disorders, particularly back pain, and the so-called RSIs (repetitive strain injuries), as well as to absenteeism. It occurs when workers are presented with work demands that exceed their knowledge, skills or abilities, such as time pressure or the amount of work, the difficulty of the work or an inability to show one’s emotions at work. Time pressures at work have been growing. According to a report by the European Foundation for the Improvement of Living and Working Conditions, the percentage of employees working at very high speed rose from 48 percent in 1990, to 56 percent in 2000. The report also found that, of those working continuously at very high speed, 40 percent suffered stress, compared to only 21 percent of those who never worked at very high speed.1 Causes are linked to the work itself: such as work demands and the lack of freedom to control one’s work (autonomy); combinations of high demands and low autonomy; and combinations of high efforts and

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low rewards; and the individual’s characteristics, such as an inability to cope with pressure. Stress is particularly strong when an employee’s autonomy is threatened. Fear of underperforming and of its consequences causes anxiety, anger, and irritability. Stress is more likely in people who tend to be over committed to their work, and lack self-confidence. Stress is less likely if the employee has a high degree of control over his or her work, and if the work requires a variety of skills. OK, so work-related stress is one of those ailments that tend to become more common when they are named. But there is no doubt work became more stressful after the unilateral repudiations during the downsizings in the early 1990s of the old “loyalty, for security” psychological contract, that the 24/7 rhythm of today’s companies and intensifying global competition have increased work pressures, and that the lack of a work–life balance puts hapless employees between the rock of insatiable work demands, and the hard place of family responsibilities. It is not so much hard work itself that causes stress, as the lack of autonomy, and the inability of the employees of large, CEO-led companies to set their own work rhythms and pace. This may go some way toward explaining why, according to U.S. Census Bureau figures, the number of non-employers (mostly self-employed people and small unincorporated businesses) rose by over 35 percent to 21 million between 1997 and 2006, compared to an increase of less than 14 percent to 120 million in the numbers of company employees. The contract between employer and employee increasingly favors the former, and is thus becoming less acceptable to the latter. A new contract is needed, which acknowledges the hunger of employees for self-respect both at home and in the workplace.

Self-respect is a primary good Francis Fukuyama suggested, in his book The End of History and the Last Man,2 that the prime movers in the human journey to what he argued was the political end-state of liberal democracy, were the superiority of liberal economics and the human desire for what he called “recognition.” Our desire for recognition was identified by Plato in the Republic where he argued the human soul incorporated a “desiring” part, a “reasoning” part and thymos (“spiritedness”). “Desire induces men to seek things outside themselves,” Fukuyama explained, “reason … shows

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them the best way to get them. But in addition human beings seek recognition of their own worth, or of the people, things or principles that they invest with worth.” Fukuyama sees thymos as a desire for selfesteem and as an innate sense of justice: People believe that they have a certain worth and when other people treat them as though they are worth less than that, they experience the emotion of anger … when people fail to live up to their own sense of worth, they feel shame, and when they are evaluated correctly … they feel pride. The desire for recognition and the … emotions of anger, shame and pride are parts of the human personality. Hegel saw history as man’s “struggle for recognition.” Machiavelli wrote of man’s desire for glory. Hobbes recognized the importance of pride. Rousseau originated the term amour propre. Nietzsche noted physiological evidence of our need for self-respect, by describing man as a “beast with red cheeks.” You do not have to subscribe to Fukuyama’s “end of history” theory to recognize the existence within yourself of thymos; a hunger for recognition and self-respect. John Rawls said self-respect was the most important “primary good.” He defined it as follows:

First of all … it includes a person’s sense of his own value, his … conviction that his … plan of life is worth carrying out; … second, self-respect implies confidence in one’s ability to fulfill one’s intentions. When we feel that our plans are of little value, we cannot pursue them with pleasure, or take delight in their execution. Nor, plagued by failure and self-doubt, can we continue in our endeavors. It is clear then why self-respect is a primary good. Without it nothing may seem worth doing, or if some things have value for us we lack the will to strive for them. All desire and activity becomes empty and vain, and we sink into apathy and cynicism.3 Rawls built his philosophy of “justice as fairness” on the primary good of self-respect; Hegel saw the struggle for recognition as the engine of history. Fukuyama saw the hunger for self-respect as one of the drivers of the evolution of human societies toward the political end state of liberal democracy. But although the human hunger for self-respect has been a powerful stimulus of social and political developments, it is too general a hunger on which to build, as I will try to do, a new framework for business organization. We need to unpack it a little, to derive a list of workplace

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qualities, the presence or absence of which will increase or reduce the chances that those who occupy it will learn to respect themselves. Let us start with a thought experiment. Readers are invited to put themselves in a workplace version of Rawls’s “original situation,” behind a “veil of ignorance,” where they know nothing of their own characters, abilities and attitudes to risk, and nothing about the world of work they’re about to enter, apart from knowing that work they must, to provide for themselves and their families. What workplace qualities would you regard as desirable? Forget how things are, and how it seems they must be, and try to imagine, in general terms, which among all conceivable workplace qualities and arrangements you, given the choice, would choose for yourself. If John Rawls had been asked this question he might have concluded that, behind the veil of ignorance, most of us would say we wanted our workplaces to be “free,” “fair,” “reasonable” and “decent.”

Free We are constrained by the organizations that employ us, and by our need for the money they pay us. We have to sacrifice and suppress parts of ourselves for the sake of our employing organizations and our careers. We are compromised by our employment, because it can prevent us from realizing our potential, by obliging us to follow only those paths our employers lay out for us, and take only those opportunities they make available to us. We may suspect that, in different circumstances, we could have developed in very different ways and discovered in ourselves different talents and abilities, the development of which might have satisfied us more, and made us feel more fulfilled. But we are trapped by our situations, and the passage of time. We might be proud of our achievements so far and excited by the opportunities open to us, but we can never be sure that the person we have become, and can become, is the best of the persons we could have been, or could become. We can never be sure of that of course, but we know our chances of realizing our potential and maximizing our self-esteem depend, to a large extent, on how open our circumstances are; on how free we are to change our situations. We value freedom highly, because the freer we are, the greater the chance we will find places where we can shine and become fulfilled. We know luck plays a large part in determining where we end up, and how we feel about ourselves, but, more and more nowadays, we are attracted to open situations in the middle, rather than on the banks of the river of fortune.

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In other words, we are attracted to situations where our fates are not set in stone and, thus, to relatively “liberal” organizations, that seem less likely to trap us in narrow specialties, or typecast us, on the basis of what we are, or have been, at the expense of what we will or could be. We want to work in organizations that offer us a wide range of opportunities; that see us as developing individuals; that don’t try to brainwash us into believing in them more than in ourselves; and that respect our need for self-respect, and the freedom to experiment, and to test ourselves in various roles and working arrangements.

Fair Fairness is a sine qua non of a just society. Although what’s fair in a particular situation is sometimes hard to divine, most of us recognize with our emotions situations in which issues of fairness arise. We may feel anger, outrage or indignation, depending on the circumstances, when it seems to us that we or others we care about are treated unfairly and most of us abhor favoritism, nepotism and cronyism. The sense of what is fair and unfair is deeply rooted in us. Young children become aware of the concept of fairness at an early age. They may not understand its full social implications until later, but their tantrums and frustrations, even when ignited by selfish hungers, are expressed with a stamp of the foot and the cry: “It’s not fair!” Fairness is as vital in our psychological development as oxygen is in our physiological development, and it’s an essential background condition for a peaceful and harmonious society. This human hunger for fairness has led to the rise of liberal democracy and to its current position as the world’s dominant, though not yet universal, system of government. The modern workplace is not a fair place and the company is an odd kind of institution to have survived for so long in a world where liberal democracy is, or, at any rate, is becoming, the standard political system. In political terms an institution in which power is vested in a single individual is a living fossil – a throwback to feudal times. Some say the company would not work as a liberal democracy, and it would be absurd if CEOs were elected by employees, or were obliged to put their strategies and policies to employee votes. But if, as history suggests, human beings have this innate hunger for liberal democracy in their political lives, they’re unlikely to settle, in the long term, for anything less than its equivalent in their work lives. I’m talking here of the long-term evolutionary trend, not imminent upheaval. The “democratization” of companies is inevitable, but it will

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come about, not suddenly, through employee coups d’état, but gradually, through the migration of able people from tyrannical to more democratic organizations. We are the agents of the evolution of working arrangements. Things will change because we have needs, and will take our talents, and the competitive edges associated with those talents, to workplaces and organizations that can best satisfy those needs. Others say the constituents of a company are its shareholders, not its employees. In a legal, formal sense, of course, they are quite right. But to deny political rights to employees, because they are not shareholders, is to behave like the Athenians when they denied political rights to slaves, because they were not citizens. One does not have to subscribe to the “stakeholder” concept of the company to acknowledge that, although a company’s employees cannot hold its executives to account in the same way as shareholders, a company will get into trouble if its executives fail to take into account their employee’s political needs and desires, particularly their desire for self-respect. It seems highly unlikely that employees will continue indefinitely to allow workplaces to be controlled by external shareholders. The political equivalent would be heterarchy (rule by an alien). Once again, the transfer of power from external shareholders (who have, in any case, delegated most of their power to their CEO) will come about, not through the reform of existing corporate constitutions, but through the gradual migration of talented and competent people from conventional companies, controlled by the agents of external owners, to companies majority owned by their employees or companies with more employeeorientated constitutions.

Reasonable The recognition that, in addition to formal constitutional matters such as who owns the company and has rights to its free cash flow, there are practical constitutional matters, such as the likelihood that good people will leave if they believe they are being treated unfairly, has led to an interest in constitutional issues, such as just and fair procedures. It has been suggested, for example, that employees will only comply with decisions that are disadvantageous to them, when they feel those decisions were reached in a just way after full consultation with those affected. Procedural justice is necessary, but not sufficient. Other aspects of justice, including fair rewards for work (of which much more in Chapter 4)

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also influence the extent to which employees regard the company’s procedures, processes, assignments and distributions (of power, status and reward) as fair. To minimize the risk that their good people will leave, because they find the company’s political atmosphere obnoxious, frustrating or uncomfortable, managers would be well advised to look beyond the management debate, to the wider discourse of political and moral philosophy. In The Law of Peoples 4 John Rawls applied the two “principles of justice” he had set out 28 years earlier in A Theory of Justice to international relations. The later book, which includes a restatement of his idea of public reason, has nothing directly to do with management, but includes two related ideas of interest to managers who want to create and maintain a fair political climate. The first is the distinction between “peoples” and “states.” Rawls defines a “people” as being united by a common outlook on life. This differs from a “state,” in that it lacks a state’s “powers of sovereignty,” including rights to wage war and govern its people. The same distinction can be drawn between the people employed by a business and the person who leads it. The fact that a company is a people, as well as a state, is important, because a people may not always see eye to eye with the state it comprises. The company, as a people, cannot bid for or form an alliance with another company, for instance, open or close plants or branches, downsize, raise new capital, or devise and implement a strategy. These are “powers of sovereignty,” and are the prerogatives of the leadership, which embodies the company as a state. But although mergers, acquisitions and alliances, for example, are brought about by the leadership, whether or not they create value for shareholders depends partly on whether the “peoples” involved find a value-creating modus vivendi. Unlike shareholders, employees cannot fire leaders who make bad acquisitions, but they can quit, refuse to cooperate or actively obstruct post-merger integration, and so help determine whether or not the acquisition creates value for the acquirer’s shareholders. The other idea in The Law of Peoples that should be of interest to companies is the distinction between “rational” and “reasonable.” According to Rawls, the difference between a state and its people: rests on how rationality, the concern with power, and a state’s basic interests are filled in. If rationality excludes the reasonable (… if the state is moved by the aims it has and ignores the criterion of reciprocity in dealing with other societies); if a state’s concern with

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power is predominant and if its interests include such things as converting other societies to the state’s religion, enlarging its empire and winning territory, gaining … prestige and glory, and increasing its relative economic strength – then the difference between states and peoples is enormous. Such interests as these tend to put a state at odds with other states and peoples, and to threaten their safety and security, whether they are expansionist or not. Suppose a company has to move its offices. The “rational” approach would be to instruct a relocation consultant to find the cheapest premises that fulfill certain criteria for quality, facilities, logistics and so on. A more “reasonable” approach would be to move to an area that minimizes the travel times of employees. In a company where the second, reasonable approach seems natural, there may not be much difference between the company as a state, and the company as a people. In a company where the first approach is preferred by the leader (embodying the company as a state), where the leader’s “rationality” excludes the “reasonable,” ignores the interests of employees (embodying the company as a people), and other companies and their employees, and is driven by the leader’s interests, such as a desire for enlargement, prestige and wealth – the differences between the company as a “state” and the company as a “people” may be enormous. Interests such as these tend to put a company at odds with its own employees, and with other companies and their “peoples.” They lead to rational, but unreasonable behavior, such as predatory pricing and buying, late payment of suppliers’ invoices and other abuses of market power, and threaten the solvency of other companies, and thus the livelihoods of their employees. In other words, a decision by a company to acquire another company or to pay its invoices late, as a matter of routine, in an effort to appropriate more than its fair share of trade credit, could be “rational,” in respect of the firm’s own, basic interests, but is “unreasonable” in respect of the interests of its people and other companies and their peoples. Peoples have basic interests, such as security, safety, fair rewards and the freedom of their members to pursue their ambitions and realize their full potential, but these interests are confined to those that are “reasonable.” The implications of the difference between reasonable and rational behavior go far beyond fair processes. One implication is that the company’s political climate will be determined, in part at least, by whether employees (embodying the company as a “people”) regard the behavior of the leader (embodying the company as a “state”) as reasonable.

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Some will argue that employees cannot be expected to understand or be moved by the need to buy market share, or downsize; that they are not privy to the relevant information, or capable of grasping the thinking that makes such actions “rational”; and that it’s not their place to judge the ways in which their leaders wield their powers of sovereignty. But whether or not they can grasp the rationale for their leader’s course of action, and whether or not it is their place to question it, question it they do, according to what they view as reasonable in respect of their own, basic interests. And they will be hard to lead if they believe their leader is behaving unreasonably. The political climate that helps to determine employee loyalty and thus the Key Performance Indicator of labor turnover, can also be affected by high levels of top executive pay. In an allegedly very competitive market for executive talent, it may be “rational” (or not, see Chapter 5) to pay the CEO 300 times more than the average middle manager, but it is unlikely to appear “reasonable” to the average middle manager, particularly if the reward for a CEO’s failure is a multi-million-dollar “golden parachute.” I will return to the issue of fair rewards later. My point here is that a political climate cannot be just if it denies the right of employees to selfrespect. An average middle manager is willing to accept that a talented executive should be paid considerably more than him or her, but it’s hard for anyone to accept that he or she is worth barely 0.3 percent of another manager, however talented. It is not, or not only, a matter of envy. Most people admire successful entrepreneurs and many seek to emulate them. It is more a question of perceived justice and the effect a perceived injustice has on the self-respect of its victims. It’s true that progressive income tax rates reduce the disparities in net income and, therefore, contribute to distributive justice. But it is the gross income of the CEO which is so often seen to be “gross,” and which thus exerts the most influence on the political climate of the company she or he leads. It is hard to quantify the effect of a company’s political climate on the loyalty of its employees, but it is also hard to believe it is negligible and when there is a “war for talent,” all dimensions of attraction are important.

Decent A broader definition of reasonable behavior includes behavior that abides by normal ethical standards and accepts responsibilities to society at large. Rawls called such behavior “decent.”

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I have written elsewhere about the value of a company’s reputation for behaving ethically and being seen as a good employer, customer and corporate citizen.5 But my prediction that most companies would recognize the value of reputational assets and try to create and preserve them has not been realized. Big companies are “nicer” than they were in some ways, but partly because their leaders have become obsessed in recent years with the quintessentially rational logic of finance, many are still behaving “rationally” rather than “reasonably” and incurring reputational liabilities as a result. One day in spring 2001, big business had a particularly rough ride in the press. Chocolate manufacturers were taken to task for not using their influence on suppliers to eradicate child slavery in cocoa plan tations, pharmaceutical giants had to abandon a lawsuit they had begun in South Africa, to protect their patents on anti-Aids drugs and a leading oil company faced criticism at its annual meeting for alleged exploitation in Sudan. The pressure groups that find fault with global companies and urge them to behave more “ethically” are not always articulate or well informed. In the case of the drug companies, however, it was clear that the rational insistence of the companies’ leaders that their intellectual property rights must be protected in the courts, had prevented the companies from doing what most people, including, no doubt, many of their own people, saw as the “decent” thing; namely making their Aids drugs available at a cost poor African countries battling with an alarming Aids epidemic could afford. If the drug companies’ CEOs had realized that, although vigorously protecting patent rights was rational, it was, and would be widely seen to be, unreasonable to deny millions of poor people access to medicines they desperately needed, and ignored the advice of their lawyers, their reputations would have been greatly enhanced rather than gravely damaged. They did the right thing in the end, but you get no credit for behaving decently under duress. How a company behaves affects its reputations with all its various constituencies; suppliers, customers, partners and the communities in which it operates. But we are interested here in its reputation with current and prospective employees. Well-publicized attacks on a company by pressure groups are sure to affect how the company is perceived by employees, because employees are associated by others with their employers’ reputations. They will feel ashamed if their company is accused of behaving badly, and angry when they believe the accusation is justified. People want to be thought well of by others.

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When others lose respect for the company you work for your own selfrespect is diminished. People are attracted to companies that seem likely to enhance their reputations and self-respect and will leave companies that damage their reputations. Whether or not employees understand the reasons for their company’s actions, they will judge them, according to what they regard as “reasonable” and “decent.” Companies are not moral creatures, but people are, and companies will find it hard to recruit and keep good people if they behave in ways that seem to violate common standards of decency. This is one of the dilemmas faced by company leaders. They have a duty to shareholders to exercise their “powers of sovereignty” rationally, but their need to retain talented staff obliges them always to act “reasonably.”

Power and powerlessness Because talented people in business aspire to become leaders, they are fascinated by the idea of “leadership” and enormous numbers of books about leadership were, until recently, published every year. It is probably no exaggeration to say the management discourse was little more than an extended examination of the qualities, skills and tricks of the trade of great business leaders, who, for want of better definitions, are those who lead conspicuously successful companies. Books that purport to reveal the secrets of great business leaders are compulsive reading for ambitious middle managers, but there is a sameness about them; the same heroes, the same qualities, the same explanations, the same secrets and the same conclusions: if you want to be a great leader, model yourself on Jack Welch, Bill Gates, Sir Richard Branson, John Chambers (or whoever’s the latest leader role model). Michael Brimm, a Francophile American who is Emeritus Professor of Organization and Management at INSEAD, broke with this big company leader tradition when he decided to study great French chefs. To most English speakers the French word “chef” means cook, but it translates literally as “chief.” “Great chefs don’t cook anything themselves” Brimm told me. “They direct organizations of up to 100 people dedicated to achieving excellent performance, meal after meal. Their job is leadership.” At first sight, chefs seem to be very bad role models for aspiring leaders. “When you walk into a kitchen” said Brimm, “you walk into an environment that appears to violate practically every modern management precept. The chef is a dictator, barking out orders and maintaining a rigid discipline. There’s very little participation. And talk

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of ‘empowerment’ would be greeted with howls of derisive laughter by the staff.” Most books on leadership urge managers to avoid criticizing people, and to try to find something positive to say. Chefs rarely praise anyone explicitly. Why are people willing to work long hours in slave conditions, for up to two years for next to no money under dictatorial leaders who never praise them? “I have asked many kitchen staff that question” said Brimm. “They say they would even pay money to work with such chefs. They say they are learning so much that the ‘investment’ is certain to help their careers.” In other words, ambitious young people can work for a pittance, in terrible conditions under tyrannical leaders, and yet retain their selfrespect, because they see the servitude as a rite of passage; an apprenticeship; a necessary step toward realizing their dreams of opening their own restaurants. Brimm says this dream is part of the kitchen culture. “Most chefs are very interested in developing people. Because of the hours they work they rarely meet, but when they do the talk invariably turns to the people they’ve developed. ‘Have you heard’ one may say with pride, ‘François, who started in my kitchen, has just got his first Michelin star?’” Brimm’s study of chefs highlights the danger of generalizing about “best practice” in leadership. Most leadership books urge aspiring leaders to praise generously and emphasize the positive. The chefs of top French restaurants do neither. It is partly a reflection of the French culture, in which “pas mal” (“not bad”) is high praise, but there is a little more to it than that. It is also a matter of expectation and interpretation in the particular situation. On one occasion, Brimm watched the chef walk up to an apprentice who had just spent 15 minutes completing a complicated garnish. “The chef tasted the dish, and emptied the plate into the garbage can saying ‘too salty.’ I went up to the apprentice afterwards and asked him: ‘doesn’t it ever get to you that you never get praise?’ He looked at me in astonishment. ‘But I do! Didn’t you see those times when chef walked by, tasted and walked on without saying anything. That was great praise. He was telling me that I had got it right.’” Brimm says chefs deal in “successive approximations.” Because they design the dishes, only they can judge whether the presentation is appropriate and the taste has just enough salt or spice. “The dish is their creation, and they know when it is just right. It is like the Japanese master who teaches students, by asking them to copy a character he has drawn. Because it’s hard to describe exactly what is desired, the learning

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comes from approaching perfection through trials and adjustments. The chef has a vision and a style, and it is the job of kitchen staff to learn to achieve it. ‘Quality’ lies in the fidelity of replication. This is an environment of constant teaching.” The chef says to his apprentices “here’s the taste” and keeps telling them it is too salty or too sweet until they get it right. Each sauce will be tasted by the chef and by the person who prepared it, so that there is always a “meeting of tongues,” so to speak. When apprentices have learned to do it the chef’s way, they start to develop their own styles. Staff accept the dictatorial styles of great French chefs, because they respect the chef’s artistry. The chef is a master to a team of apprentices who aspire to be masters. It’s rather like the English pupilage system for young barristers. The skills and insights you acquire working for outstanding professionals seem a fair exchange for your surrender of power, and thus there is no threat to your self-respect. The chef’s “style” resembles that of entrepreneur leaders of small firms much more than that of leaders of large firms and, according to Brimm, it’s characteristic of “the arts.” “Chefs are similar to orchestra leaders and film directors or ‘artist–leaders,’ as Edgar Schein called them.” They take pride in the achievements of their apprentices and pupils, in the same way that parents take pride in the accomplishments of their children. The reason why student chefs don’t find their masters’ power (even when exercised callously) demeaning, is that their relationship is based on a learning contract. Both parties to the relationship are united in their wish for the led to become a leader in his or her own right. The same isn’t true of the relationship between the leaders and employees of large firms. Much was written a few years ago about “learning organizations,” and the role of the leader as teacher or coach. But you can’t learn the way an apprentice learns from a master if you never see your master, and you can’t respect yourself when you are powerless if you cannot respect those with power over you. Nothing is more demeaning than being bossed around by someone you have no regard for. Self-respect is a primary good, but it’s very hard for individuals to earn it in large, hierarchical organizations where they are the subor dinates of leaders they rarely see, for whom they have had no opportunity to develop regard, and with whom they have no learning contracts. Powerlessness is only tolerable if you believe you are getting something in return. Security and a good salary were once regarded as a fair exchange. Now that security is no longer on offer and what is a good salary (one that, all things considered, seems fair) is determined more

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by markets than by HR departments, people will tend to leave work situations in which their self-respect is in the hands of others and seek out work situations in which it is in their own hands. The emigration of people from large CEO-led companies is likely to accelerate over the next few years as a consequence of the current recession. U.S. Census Bureau figures show that in 2002, during the recession following the bursting of the dot.com bubble, employment in companies with more than 500 employees fell by 3 percent while selfemployment rose by 4 percent. Power, in large companies, is what Fred Hirsch called a positional good 6 that can only be enjoyed by a few, when it is denied to many. Everyone wants power, but since not everyone can have it, we have to settle for being equally powerless. Most of us have agreed in the past four centuries or so that liberal democracy satisfies this compromise better than other political systems that have been tried. But we have yet to find a comparable compromise for working arrangements.

Good work I have argued that the evolution of working arrangements, and thus of the company and the forms of association between working people and companies, are being driven these days by the human hunger for selfrespect. This wasn’t always so. Until recently other hungers, for security and a minimum level of income, took precedence over self-respect and allowed the emergence of working arrangements and forms of organization where self-respect was hard to come by. Now that people know security is no longer available, and markets for abilities and talent have become much more efficient, their demand for self-respect will not be denied. On the basis of what has already been said, we can begin to sketch out the qualities the human hunger for self-respect will encourage people to look for in their work situations: ■■ Freedom to change. People will tend to move to companies that do

offer, and from companies that don’t offer, the freedom to change course and experiment with other roles and specialisms as their interests and understanding of their own talents and aptitudes change and develop. ■■ Fairness. People will tend to move to companies where they’ve reason to believe they will be treated (and rewarded) fairly and they are unlikely to be victims of the arbitrary exercise of power.

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These desires for fairness and freedom to change roles amount to a desire for “open” working arrangements – “open,” in the sense that people have freedom to change their circumstances, and “open” in the sense Sir Karl Popper meant in his idea of “The Open Society” – a society in which, because of its constitution, a bad ruler can be prevented from doing too much damage. ■■ Reasonable. People will tend to leave companies where “powers of

sovereignty” are exercised in ways that, though rational, appear to them, given their own basic interests and the basic interests of others, to be unreasonable. ■■ Decent. People will tend to leave companies where the “powers of sovereignty” are exercised in ways that seem unethical, or violate common standards of decency. ■■ Balanced power. The hunger for self-respect requires power to be distributed equally. The only unequal power distributions that are acceptable are those that are of benefit, in one way or another, to the relatively powerless. (The 2007–08 credit crunch and the subsequent recession made it harder to believe the omnipotence of CEOs is of any benefit to their relatively powerless employees.)

The argument so far The human hunger for self-respect has led to the spread of liberal democracies all over the political world, but has not so far had a similar impact on the world of work. The workplace qualities most people would agree to behind John Rawls’s veil of ignorance remain conspicuous by their absence in today’s large companies. Why? If our hunger for self-respect has shaped our political institutions, why have the workplace qualities it demands not yet been provided by our main economic institutions? This is the question to which we turn in Chapter 2.

References 1 2 3 4 5 6

Ten Years of Working Conditions in the European Union, 2007. Free Press, 1992. A Theory of Justice, Harvard University Press, 1971. Harvard University Press, 1999. The ‘nice’ company, Bloomsbury, 1990. Social Limits to Growth, Routledge & Kegan Paul, 1977.

2 A feudal heritage

The question posed at the end of Chapter 1 was why the company, as we know it, is so different from the company most of us would like it to be. Given its dominance of modern business and the very large numbers of people it employs, why does it not bear the mark, in the same way as our political system, of the hunger of ordinary people for self-respect? The evolutionist’s answer is that adaptation is never perfect – it is work in progress. A species is as it is largely because of its history, and only partly because what its history has made it is a sufficiently good fit with the environment for it to survive. The question then becomes, what is it about its evolutionary history that has made the large limited liability joint company the way it is? To answer this question we will begin with an account of a meeting between a 21st century monarch and a serf, from the serf ’s point of view.

A cat ponders a king Your project has gone well. Everybody says so. It has been quite a struggle. You haven’t seen much of your children for the past six months, but you feel OK – pretty good, in fact. You and your team have developed a new e-channel for your company’s products and the pilots that have been running over the past two weeks suggest that it could generate an extra $25 million of revenue a year. The CEO is pleased and has summoned you for one of his famous pats on the back. It is the first time you’ve talked to him one-to-one. He is friendly, charming and very complimentary. He was two hours late for your meeting – bad weather delayed the executive jet from America – but his apology is as handsome as his praise is fulsome. As you watch his personal assistant shepherd him into the big limo that will whisk them back to the airport, you think idly about how different his life is from yours. The limo, the executive jet and the two hours you spent waiting for him, tell you that his time is infinitely 31

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more precious than yours. His salary and emoluments, as stated in the annual accounts, tell you that he is worth 80 times more to your company than you are. His performance bonuses and the options he has recently exercised make his net worth two orders of magnitude greater than yours. He’s from a different planet. Wealthy beyond dreams of avarice, he lives a life of luxury, pampered by personal flunkies, surrounded by courtiers and counselors, and casually running up expenses each month that would keep you in clover for a whole year. The company he keeps, in the rarified CEO atmosphere, also sets him apart. He spends as little time with his company colleagues, as he does with his family. His intimates (the people he talks CEO talk with) are wealthy, external professionals (investment bankers and analysts, lawyers, consultants and so on) dressed in the same tailored suits and handmade shoes, and wearing the mandatory Swiss watches costing as much as a small car. His social life consists of hobnobbing with politicians and journalists at sporting events and playing host to royalty at concerts and charity galas. He is a few years older than you and has a similar background, but his life is as different from yours as the life of a medieval king was different from that of a villein. He seems, somehow, to have found the door to another world where the worth of its inhabitants is measured by different standards. We will explore the justification for and the implications of this striking economic “class system” within large companies later. In this chapter, I will explain why I think it emerged, and why it is (or has been until now) generally accepted as the “natural order.” My explanation is evolutionary. It takes us on a journey back in time to the origins of enterprise, long before the company, as we know it, made its first appearance.

Business is natural Business, trade and industry are manifestations of what Adam Smith and the French physiocrats saw as “natural economic laws” embedded in the logic of the human situation; of the need for shelter and sustenance, of the wish for warmth and convenience, of the ability to manipulate and craft, and of differences in skills, aptitudes, experience and environments. They have very little to do with “the company” as we know it today, and for most of human history, they generated economic activity without it.

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Smith argued that, while animals fend for themselves: Among men … the most dissimilar geniuses are of use to one another; the different products of their respective talents, by the general disposition to truck, barter, and exchange, being brought, as it were, into a common stock, where every man may purchase whatever part of the produce of other men’s talents he has occasion for.1 Animals are not as self-sufficient as Smith supposed – we know now that cooperation is quite common in the animal kingdom. But that simply means his economic laws were more profoundly “natural” than Smith knew. The hunger for wealth is more distinctively human, but Max Weber believed it to be just as natural: The impulse to acquisition, pursuit of gain, of money … has in itself nothing to do with capitalism. This impulse exists and has existed among waiters, physicians, coachmen, artists, prostitutes, dishonest officials, soldiers, nobles, crusaders, gamblers and beggars … it has been common to all sorts … of men, at all times and in all countries of the earth, wherever the … possibility of it is or has been given.2 How these “impulses” were first expressed is shrouded in the mists of pre-history, but business is probably as old as society itself, because it is very hard to imagine how mankind could have emerged from the caves without specialization, and the barter of goods and services. (The first providers of professional services might have been the artists who painted pictures of animals on cave walls and were given shares in the kill in exchange). Trade – exchanges of goods or services between, rather than within tribal societies – came later. But it, too, was the consequence of innate human dispositions, and the potential for win–win exchanges between social individuals. Matt Ridley tells the story of the Yir Yoront aboriginals who live at the mouth of the Coleman river, on the York Peninsula, in north Australia.3 Until the 19th century, they were still Stone Age huntergatherers with no crops, no writing, no money, no science and no systems of government or law. (Or so it seemed to the white colonists who first encountered them. As Karl-Erik Sveiby and Tex Skuthorpe showed in their book, Treading Lightly – The Hidden Wisdom of the World’s Oldest People,4 Australian aboriginals developed very sophisticated systems of government, law and leadership 60,000 or so years

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ago. They have not been recognized as such, because they are very different from their Western counterparts but, as we shall see later, they may have much to teach us.) The Yir Yoront used axes, with stone heads and wooden handles, for cutting wood, digging, hunting and fishing, but lived 400 miles or so from the nearest quarries. They could have walked south for the stone, but there was no need. Plenty of axe heads reached them from the tribes that lived near the quarries, through a line of trading partners who passed them north, in exchange for spears tipped with stingray barbs passed south through the same hands. The trade developed, not because of a plan to make spears and swap them for axes, but because of differences in price. A Yir Yoront could exchange y axe heads from a neighboring southern tribe for x spears, and sell y axe heads to a northern neighbor for more than x spears. Because there was profit in the arbitrage, the axe heads moved north and the spears moved south automatically. The trade emerged spontaneously from the “natural economic law” named, by the 19th century economist David Ricardo, the “Law of Comparative Advantage.” No human gene codes for trade. The potential for trade exists when different people value tradable goods differently, have different abilities, and command different resources. The potential will be realized when beings smart enough to see profit in the differences begin experimenting. When mutually profitable trades were seen to have occurred, the trade “meme” (a term coined by the evolutionist Richard Dawkins to denote a unit of memory5) spread all over the world.

Early trade6 Salt and stone may have been the first “traded” goods. The Chinese are thought to have boiled brine in small pans of saline soil from desert basins more than 4,000 years ago. Obsidian (a dark volcanic glass formed when molten rock reaches the surface and hardens too quickly to crystallize) is a unique indicator of trade, because it was widely used by early peoples for weapons and cutting tools and contains trace elements that identify its origins. Recent studies have shown it was being traded by huntergatherers during the late glacial period 15,000 years ago. The Mayas were still using it in the 16th century. David Landes says that when the Spanish invaders first encountered them in the Yucatán the Mayas “did not know hard metal … but they had weapons – slings, poison darts, clubs set with razor-sharp pieces of obsidian.”7

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By 3000 bc the Euphrates river was a busy trade route transporting semi-precious stones, baskets and carpets between Iraq and Egypt. Sargon of Akkad, conqueror of the Sumerian city-states, spoke of ships laden with goods moored outside his capital in 2370 bc. The Canaanites, the indigenous people of the Levant, were trading with Egypt in the early Bronze Age, using donkey caravans. As the civilizations of Sumer, Assur, Nineveh and Babylon rose and fell, new markets in slaves, food, wine, wool, livestock, metal and wood developed in Iraqi ports, the organization of donkey caravans improved and trading ships steadily increased in size.

The precursors of companies As a legal form, the company can be traced back to Roman times and company-like bodies were often used to organize monasteries, craft guilds and universities in the Middle Ages. But, as R. H. Tawney noted, “pecuniary transactions were a fringe on a world of natural economy” in medieval times, and “there was very little large-scale organization.” The typical craftsman was a “master,” employing two or three journeymen and apprentices.8 The craft guilds, the immediate precursors of companies, were not much admired, either then or later. “They were first and foremost, monopolists,” according to Tawney, “and the cases in which their vested interests came into collision with the consumer were not a few.” John Wyclif, the 14th century religious reformer, did not mince his words: “all new fraternities and guilds made of men seem openly” to conspire “to bear up each other … and oppress other men in their right by their wit and power.” Wyclif’s invective against corporations and guilds had a religious and an economic rationale. He claimed associations for mutual aid were in the first place unnecessary, because people were already obliged by God’s commandments to help each other, and in the second place were a conspiracy against the public. Such criticism has haunted the company ever since. It was used in the 16th century as an argument for state control of industry and commerce and, with the market’s “invisible hand” substituting for “God’s commandment,” by Adam Smith and others as an argument for free competition. Trade declined after the Roman Empire fell, but resumed its growth in the Middle Ages. It was further stimulated by the appearance of much larger ocean-going ships in the 15th and 16th centuries. New sea

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routes between Europe and the East reduced the prices of Asian imports and merchantmen gradually replaced caravans. The discovery of the Americas led to trade in tobacco and wood and Spain’s imports of gold, silver and precious stones from Mexico and Peru stimulated trade in the other direction, by giving Europe commodities in demand in the Far East. As long-distance trade grew, merchants began to experiment with new forms of organization. In Holland it became common after 1500 for “shareholders,” rather than captains to own ships, because owning “shares” in several ships allowed them to divide their goods among vessels bound for different ports. But it was not until the great voyages of discovery in the 16th and 17th centuries that an obviously corporate organizational form made its appearance, and even then these proto-companies were barely recognizable as the forerunners of modern companies. They were profitseeking, to be sure, but they were also the creatures and servants of states, and states would later become their executioners. They emerged from a new kind of commercial rivalry between nations that developed in the 15th and 16th centuries, known as mercantilism, in which competing states assumed such sovereign rights over trade as they could secure through diplomacy and force. But such rights were worthless until attempts were made to exploit them. In the early 17th century European states privatized them by dividing the globe into areas and selling exploitation rights, or “charters,” to companies of merchants. The new chartered companies took their original form from the medieval fraternities and guilds Wyclif had railed against. There were two main types. In regulated companies, the members had their own stock and traded at their own risk. In joint stock companies, the members held a joint stock and earned profits (or incurred losses) in proportion to their shares. The regulated company became extinct as a corporate form, although one can see a remnant in the highly regulated utility companies of the present day. The joint stock company, however, was eventually to evolve into the most dominant form of business organization the world has ever seen. The trade of a joint stock company was managed by “directors,” who were subject to the control of a general court of proprietors (the modern general meeting). But as Adam Smith pointed out: the greater part of those proprietors seldom pretend to understand anything of the business of the company; and when the spirit of

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faction happens not to prevail among them, give themselves no trouble about it, but receive contentedly such … dividends as the directors think proper to make them. This … exemption from trouble and from risk, beyond a limited sum, encourages many people to become adventurers in joint stock companies, who would, upon no account, hazard their fortunes in a private co-partnery. Such companies, therefore, commonly draw to themselves much greater stocks [capital] than any private co-partnery can boast of. (This quality of the joint stock company would be characterized by Berle and Means 200 years after Smith described it, and after the institution had become ubiquitous and dominant, as the “divorce of ownership and control” – see Note 12, Chapter 3.) Smith conceded that the joint stock company had a role to play in trades such as banking, insurance and water engineering, where the operations can be “reduced to what is called a routine, or to such a uniformity of method as admits of little or no variation.” It didn’t seem to occur to him that the “division of labor” he advocated would greatly extend the variety of trades in which the operations could be “reduced” in this way. But that was much later. It would take another three centuries for the joint stock company to achieve the dominant position it enjoys today and it would acquire, during this long apprenticeship, some characteristics that have become liabilities in our own time.

The English East India Company

In December 1600 England’s Queen Elizabeth I granted a charter to “The Governor and Company of Merchants of London Trading into the East Indies,” conferring a trading monopoly in Asia, Africa and America, the only restriction on which was that the company should not contest the existing trading rights of “any Christian prince.” The new company was managed by a governor and 24 directors, chosen from its wealthy, aristocratic stockholders. In its early voyages it ventured as far as Japan, but established its first “factories” (trading posts, run by “factors”) in Madras and Bombay in 1610 and 1611. Having absorbed several rivals and acquired more rights from the crown, the English East India Company (EEIC) established itself as a major power in India at the end of the 17th century.

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After the victories of EEIC officer Robert Clive, over the French at Arcot in 1751, and Bengali prince Suraj-ud-Dowlah (perpetrator of the Black Hole of Calcutta massacre), at Plassey in 1757, the EEIC became the dominant power in India. All European challenge to its rule ended with Clive’s defeat of the French at Pondicherry in 1761. But military prowess was no defense against the consequence of the EEIC’s position as the chartered holder of sovereign rights. Its charter was renewed several times during the 18th century, but each time it was obliged to make financial concessions to the crown. In 1773 the government appointed Warren Hastings the governor-general of India and greatly reduced the company’s administrative role. An India Department of the British government was created by the 1784 India Act, to assume political, military and financial control of the EEIC’s affairs, and the company’s monopolies of the Indian and Chinese trades were removed in 1813 and 1833 respectively. The company continued to play a significant administrative role in India until the Sepoy Mutiny of 1857–58, but the Act for the Better Government of India of 1858 transferred its governmental duties to the Crown and absorbed its 24,000 troops into the British army. On January 1 1874 the company was finally dissolved by the East India Stock Dividend Redemption Act. It’s not known whether EEIC shareholders resented the government’s withdrawal of powers from and dissolution of their company, but it seems unlikely that senior EEIC “officers” raised objections. Many became so fabulously rich, during their tours of Indian duty, that they acquired the nickname “nabobs” (the English version of the Indian nawab). Robert (later Lord) Clive, victor of Plassey, had amassed a personal fortune by his 35th birthday probably unmatched by an individual until our own time. His share of reparations for the Black Hole of Calcutta massacre extracted after the battle of Plassey, was some £90 million in today’s money and that wasn’t the half of his wealth. The “nabobs” exemplified a weakness of these early companies which survives until this day – too much of the value they created ended up in the pockets of the officers. Clive only became a significant shareholder in the EEIC after he had amassed a huge fortune as its employee. In modern parlance, EEIC officers imposed heavy “agency costs” on shareholders, partly because the company was operating too far away for shareholders to control its managers, and partly because there was and there remains to this day a conflict between the interests of the shareholders of a joint stock company and the interests of its managers.

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The Abbé Morellet, a contemporary of Smith, counted 55 joint stock companies for foreign trade formed in Europe since 1600, which had failed, due to mismanagement, despite monopoly privileges. Smith, the most perceptive economic observer of his age, regarded the new species as a pernicious evil; a creature of the dark side of human nature; a system for indulging in the sin of avarice by distorting the free interplay of market activity in ways that benefited the incorporators, at the expense of potential competitors and society at large.

From mercantilism to capitalism The early companies were the agents of mercantilist states, rather than independent businesses, and most failed because politics too often compromised their economics. But, although mismanagement and nationalization took a heavy toll of the early joint stock trading companies in the 17th and 18th centuries, there were some survivors; the Hudson’s Bay Company, for instance, and the joint stock system itself. A brief history of the impressively adaptable Hudson’s Bay Company (now owned by a U.S. private equity firm) will be found at the end of this chapter. Adam Smith would have been astonished by its longevity, but he was aware that it was different from the general breed of joint stock trading companies that he so heartily despised. He approved of its small size and modest ambitions: a joint stock company, consisting of a small number of proprietors with a moderate capital approaches very nearly to the nature of a private co-partnery, and may be capable of nearly the same degree of vigilance and attention. He was referring to his famous and still relevant criticism of the joint stock company, namely that its directors: being the managers … of other people’s money … it cannot well be expected that they should watch over it with the same anxious vigilance with which the partners in a private co-partnery frequently watch over their own. These remnants of mercantilism lived to see the emergence of a new economic order in which the joint stock company would eventually, long after the Industrial Revolution was complete and, as we shall see, more because of good luck than any inherent merit, find a new role.

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Although not named by its arch-enemy, Karl Marx, until the mid19th century, the origins of modern capitalism date back to long before Adam Smith’s description of its main principles in An Inquiry into the Nature and Causes of the Wealth of Nations (1776). Defined as a self-regulating system in which both land and capital are privately owned, economic activity is coordinated through the interactions between buyers and sellers (markets), and the owners of land and capital and suppliers of labor (workers) are all free to pursue their own interests, “capitalism” existed in a primitive form in a number of ancient societies. It is, in a real sense, the natural system. Full-blooded, industrial capitalism, which in our time has all but vanquished its only serious challenger, communism, as a system for coordinating economic activity is of European and particularly of English origin. It was an adaptation of the mercantile capitalism (mercantilism), which flourished between the 15th and 18th centuries, to the opportunities and problems presented by industrialization. Mercantilism embraced the principles of private property, and used markets to coordinate economic activity, but, unlike capitalism, its focus was the interests of the sovereign or state, rather than the individual owners of economic resources. The concern of states in the mercantilist era was to accumulate wealth in the form of gold and silver and, since most nations lacked a natural abundance of such metals, the only way to acquire them was through trade. State governments controlled production and exchange and favored low wages to discourage imports, encourage exports and so generate trade surpluses with other states that would be paid for in gold. Trade was fundamental to mercantilism and ships, from the “stately Spanish galleon” of the second verse of Masefield’s poem, right up to their final, mercantilist incarnation in the speedy and elegant tea clippers of the late 19th century, were mercantilism’s primary instruments. Under capitalism, ships assumed a humbler role as the servants of industry. States abandoned mercantilism and embraced the new capitalism when they realized that the real wealth of any nation was not its hoard of gold, but its ability to produce goods and services. The relationship between wealth and production, rather than wealth and trade, was first explored by the physiocrats in France. In his Tableau Économique (1758), François Quesnay traced a natural flow of money and goods through an economy consisting of three classes: a productive class (engaged in agriculture, fishing and mining), a proprietorial class (landowners and their dependants) and what he regarded as a sterile artisan class, who merely “transformed” and circulated the output of the productive class.

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Quesnay and the other physiocrats, including Pierre Samuel du Pont de Nemours and Victor Riqueti, also argued that there were natural economic laws with which the state should not interfere. The physiocrats’ attacks on the state interference associated with mercantilism were later developed by Adam Smith into a rout of the entire mercantilist system. Smith explained how the combination of self-interest, private property and competition leads “as if by an invisible hand” to an unintended end; the well-being of society. He shared the physiocrats’ belief in a natural economic order that works best when the state does not interfere, but took issue with them on their assertion that only agriculture, fishing and mining created wealth. Au contraire, he saw, in the transforming activity of Quesnay’s “artisan” class, the division of their labor and the coordinating power of free markets, infinite potential for wealth creation. Thomas de Quincey, a friend of Wordsworth and Coleridge and author of Confessions of an English Opium-Eater, identified two kinds of literature: the “literature of knowledge” and the “literature of power.”9 “The function of the first is to teach; the function of the second is to move: the first is a rudder, the second an oar or a sail.” An Inquiry into the Nature and Causes of the Wealth of Nations was an example, perhaps even the exemplar, of the literature of power. Its illumination of the inherent dynamics of industry and commerce began to influence government policy throughout Europe as soon as it was published. Apart from what seem in retrospect to have been brief, 20th century flirtations with modified forms of mercantilism (communism and socialism) advocated by Karl Marx who gave capitalism its name, Smith’s descriptions of natural economic forces have remained unchallenged and his policy prescriptions have been generally heeded by Western governments ever since. Smith had no time for the joint stock company, and would have been amazed by the role it has come to play in the system he described. But he, more than any other writer, established the philosophical rationale the company needed if it was to transcend its origins as the instrument of mercantilism and become the dominant institution of industrial capitalism.

The Industrial Revolution At the start of the Industrial Revolution the company was equipped with two valuable and distinctive qualities – the ability to trade on joint stock, and the beginnings of bureaucratic organization.

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But it also had other qualities less suited to the very different circumstances of the Industrial Revolution. Because of their close links with the crown, and their dependence on monopoly privileges in the crown’s gift, the trading companies were owned and directed by aristocrats and courtiers, rather than entrepreneurs. They did not need entrepreneurs to farm their monopolies. And, because they were all “armed businesses,” with many more military than civilian personnel, they inherited the military class system that separated commissioned officers from other ranks. It was their possession of this power of officers in an ostensibly wealth-creating enterprise that allowed Clive and the other nabobs to indulge their impulse of acquisition so extravagantly. This was the origin of an economic feudalism that survives to this day. The joint stock company’s defects offset its advantages and denied it more than a negligible role in the dramatic surge of industrial development that exploded in the mid-18th century. The prime movers of the Industrial Revolution were entrepreneurs and their families – the Darbys, Huntsmans, Bessemers, Cadburys and others. Many were Quakers. The family businesses and partnerships, such as the steam engine partnership of Watt and Boulton, or the pottery partnership of Bentley and Wedgwood, were not what we would recognize today as companies. The fact that some of these businesses assumed the form of, or were absorbed by, companies subsequently doesn’t alter the fact that the modern, industrialized world was created not by companies but by entrepreneurs. By most accounts, the English Industrial Revolution was complete by the time the modern company made its appearance.

An accidental birth The large, limited liability, publicly listed joint stock company is so firmly established that we take its dominance of the business world for granted and rarely question the reasons for it. When we do, we tell ourselves that it is natural, and was thus inevitable. Big is best in business, so big companies achieved dominance. But the use of the joint stock company for industry, as opposed to commerce, is a recent innovation; much more recent than the use of the unlimited liability partnership in law and accountancy. And the circumstances of the birth of this “industrial” version of the company do not suggest the inexorable working out of some natural economic law. On the contrary, the birth of the modern company was an accident, literally.

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The accident in question occurred in October, 1841, on the Western Railroad in America, between Worcester and Albany. Some scheduler had blundered and two passenger trains collided. A conductor and a passenger were killed, and 17 others were injured. Although hardly a disaster by modern standards, news of these first fatalities for the young railroad industry caused great alarm. The Massachusetts legislature launched an investigation and the Western appointed an internal committee of inquiry. In its “Report on Avoiding Collisions and Governing Employees” the Western committee proposed, according to the company’s historian, “the assignment of definite responsibilities for each phase of the company’s business, drawing … lines of authority and communication for the railroad’s administration, maintenance and operation.” The distinguished business historian, Alfred Chandler, argued that the implementation of the committee recommendations created “the first modern, carefully defined, internal organizational structure used by an American business enterprise,” and in the process “the first [company] … to operate through a formal administrative structure, manned by full-time salaried managers.”10 According to Chandler, the reformed Western Railroad was the first example of the “multi-unit business enterprise” (MuBE); the modern company. But suppose there had been no accident. It would probably not have occurred, if the telegraph had been introduced a few years earlier than it was. What then? Was the emergence of the MuBE inevitable, or might the evolution of business organization have taken quite a different path, had the Western scheduler been more alert, or been warned of the danger by the ring of a telegraph? We will return to this question in Chapter 7.

The birth environment When explaining why a particular life form came to be how it is, evolution theorists talk of its “environment of evolutionary adaptedness” (EEA) – the combination of time and circumstances for which it appears to have been “designed.” There is no designer, of course, apart from chance and time, but adaptation often gives the illusion of design. Since no biological or organizational form can be adapted (except by chance) to the present or future, the EEA of the modern company

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has to lie in the past. It is, therefore, “unfit” for the present insofar as its EEA differs in significant respects from the modern environment. Adaptation is never perfect. Although we humans adopted an upright stance five million years ago, we still endure the back problems and hernias that afflict four-footed animals when they walk on the toes of their hind feet. As the eloquent evolutionist Stephen Jay Gould put it: Our world is not an optimal place fine tuned by omnipotent forces of selection. [Each life-form] is a quirky mass of imperfections, working well enough (often admirably); a jury-rigged set of adap tations, built of curious parts, made available by past histories in different contexts.11 Each new species, biological and social, is a creature of its time invoked into being by a particular set of circumstances that will never be repeated. The company is a “jury-rig,” and the scale and nature of the changes in its environment in recent years are such as to make one doubt whether its “quirky mass of imperfections” will continue to work well enough to maintain its dominance. Chandler effectively described the company’s EEA when he explained the MuBE’s emergence in eight propositions, which he summarized as follows: The visible hand of management replaced the invisible hand of market forces where and when new technology and expanded markets permitted a historically unprecedented high volume and speed of materials through the processes of production and distribution. Modern business enterprise was thus the institutional response to the rapid pace of technological innovation and increasing consumer demand in the United States during the second half of the nineteenth century. But it was a response that carried a lot of baggage; a “quirky mass of imperfections” accumulated over three centuries. Its bureaucracy was designed for monopoly-farming, rather than for innovation. Its structure was a hierarchy based on the military class system where power was concentrated at the top. Its distribution of value added bore the marks of a feudal world, where fabulous wealth co-existed with grinding poverty.

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Medieval tournaments We can now help the executive with whose musing on her own and her CEO’s wealth and status we began this chapter. We can help her to understand why, for example, a February 2008 study of 45 randomly selected, publicly listed U.S. companies by The Wall Street Journal and the Economic Research Institute found that executive pay rose by over 20 percent in 2007, revenues grew less than 3 percent, the median pay of U.S. workers rose 3.5 percent to $36,140 (according to the U.S. Bureau of Labor Statistics), and CEOs of the 45 companies studied were paid, on average, $18.8 million. Do the math – the average CEO was paid 520 times the median pay of U.S. workers. It’s because of the peculiar nature of the modern company; because of “agency costs” imposed on owners by its over-mighty “officers”; but most of all because its hierarchical structure, inherited from its military precursors, leads to “winner-takes-all” competition. Roger Federer, Lewis Hamilton and Tiger Woods are not rewarded for their abilities as a tennis player, racing driver and golfer. They are rewarded for winning. Winner-takes-all competitions shaped the social and economic environment into which the company was born. Doughty and skillful medieval warriors willing to risk their lives in their sovereign’s service in wars, were rewarded with land and titles. In peacetime the crown’s patronage was also determined by physical prowess – by a man’s willingness to risk his life tilting with a lance in jousting tournaments. The distribution of land and power in medieval Europe was assigned, not by ability in a general sense, but by the strength, aggression and reckless courage of men who hungered for wealth and status. In economic theory, the rewards for work are based on more prosaic criteria. They’re supposed to reflect the economic value employees add for their employers. But there is a problem. You can measure the value added by machine-tool operators objectively, by counting the pieces they make, and you can pay them on piece rate. But the value added by executives who don’t make things is hard to measure objectively. Rewards in hierarchical organizations, therefore, are based, faute de mieux, on “relative” rather than “absolute” worth, and their currency is not pay rises, but promotions. The pay rises come later, as consequences of the promotions. Promotion is a winner-takes-all competition. The absolute worth of the loser, if it could be measured, may be virtually identical to the worth of the winner, but the winner will take all the enhanced status and pay

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increase associated with the promotion. (It is also a competition open to abuse, because it’s as much in the interests of competitors to sabotage the candidacies of their rivals, as to promote their own. This is one reason why there is so much of the back-stabbing, turf wars and politics in large companies that many people find so distressing.) But why should the winner’s reward be so enormous? It is not as if executives take their lives in their hands when they compete for a CEO job. The answer offered by Edward Lazear (former chair of ex-president George W. Bush’s Council of Economic Advisors) and the late Sherwin Rosen is that the purpose of the huge rewards of high corporate office is to motivate people to seek them, and that this motivation will only be effective if the rewards on offer are very substantial.12 This is known as “tournament theory.” Managers cannot be motivated by piece rate pay, because their pieces cannot be valued objectively, but they can be motivated to work very hard if the prize for the promotion that is the reward for hard work is large enough. Or as Lazear himself put it, “The salary of the vice president acts not so much as motivation for the vice president as it does as motivation for the assistant vice presidents.”13 Tournament theory means, therefore, that the remuneration packages of senior executives (salaries, share options, bonuses, pensions and so on) are rewards, not for the work they do in their jobs, but for the work they have done to get the jobs. This helps to explain why the distribution of rewards in large companies is so compressed at the bottom and extended at the top. Those who are already enjoying substantial improvements in living standards, as a result of their latest promotions, will need prospects of even greater rewards for subsequent promotions if they are to remain motivated. The idea of the diminishing marginal utility of money in classical economics supports this expectation. The more money you have, the less you value an additional dollar. In other words, the higher an executive’s current rewards, the less eager he or she will be to compete for a $10,000 raise. Make that next raise $100,000 and you might get some action. This also helps explain why already wide differentials are getting even wider. All executives are getting richer, so they all value an additional dollar less and all require promises of even more at their next promotions to remain motivated. Simple versions of such winner-takes-all tournaments take place in professional firms, when associates are put up for partnership. This is the crucial career step for young accountants and lawyers, because, once they are partners, their remuneration switches from salaries to profitsharing and large professional firms tend to be very profitable.

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a feudal heritage

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This helps to explain the trend toward oligopoly (when the market is dominated by a few large players) in professional services. The firms have been getting larger over the past two decades or so, not just because their corporate clients have been getting larger and more global, as the professions themselves claim, but also because size generates rich rewards for partners. The rewards of partners rise as the ratio of partners to associates (professionals who are not yet partners) falls. Partners favour growth, because it allows them to reduce their partner/associate ratios, and so increase the proportion of value added they share out among themselves. As a prescription for motivating employees, “tournament theory” is not compelling for several reasons. It encourages back-stabbing and other kinds of destructive “system-gaming” behavior; it takes no account of and so penalizes people who are not or not primarily motivated by money; it leads to distributions of income and wealth that are perceived by those inside and outside the organization to be unfair. As a description of how value added is actually allocated in large hierarchical organizations, however, it is much more persuasive.

The evolutionary puzzle Why has it turned out like this? Why have companies retained these medieval qualities, which impel ambitious people to devote most of their energies and talent to fighting their way to the top (or as close to the top as they can get) of company hierarchies? It’s not on the face of it an efficient use of energy and talent. Evolutionists will argue that it’s in our nature, or at any rate in the nature of men, to be obsessed with status and power, in the same way male chimpanzees compete aggressively with each other for the position of alpha male. “It’s natural selection” they will say. Although it might seem cruel and wasteful, it serves a vital evolutionary purpose; the elevation of the best individuals [which is to say the “strongest” in the cases of chimpanzees and medieval knights] to positions of dominance, where they improve the stock by monopolizing females and maximizing the dissemination of their superior genetic heritage. Company hierarchy-climbing does indeed select a “best” and it is undeniably a better “best” for business than physically strongest. But is the best at climbing company hierarchies the best “best” for business? Companies don’t serve the same evolutionary purposes as chimpanzee hierarchies and medieval jousting tournaments. Their purpose is to

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create wealth for their shareholders, not to elevate strong males to positions of dominance, where they can disseminate their superior genetic heritage by claiming droit de seigneur. Engaging in business is a creative, not a procreative activity. It is competitive to be sure, but its competition selects, or should select (in the Darwinian sense) those organizational forms able to create wealth. If the fittest companies are the most creative, why do today’s dominant business institutions concentrate power in the hands of people who have proved most adept at climbing corporate hierarchies? Why have other forms, that do not concentrate power in one person and in which exceptionally creative people (engineers, scientists, designers, artists, philosophers and so on) are accorded a higher status and given a freer rein, so far failed to demonstrate their superior fitness and rendered this medieval, military model of organization obsolete? I have suggested, in this chapter, that part of the answer to this question is time. The model survives, despite its denial of self-respect to employees and its relative lack of creativity, because, although its origins are very old, it is itself still young in an evolutionary sense. It’s still colonizing business space liberated by the spread of liberal democracy and is still consolidating its power locally, through privatizations, demutualizations and other forms of incorporation. Fitter business models have not had time to emerge and challenge its dominance.

The argument so far The modern company is not as we would like it to be, but nor is it a creature of natural economic laws. It is a jury-rig, consisting of remnants inherited from mercantilist institutions and military organization. It cannot, therefore, be expected to be well adapted to the modern environment. Seen in this way, the large company or, as Alfred Chandler called it, the multi-unit business enterprise (MuBE), loses its appearance of permanence, because a jury-rig can be re-rigged for a changed environment. How the MuBE’s environment has changed is the subject of the next chapter.

Hudson’s Bay Company Hudson’s Bay Company (HBC) was created in 1670, when Charles II of England granted a charter to his Bohemian cousin and ally, Prince Rupert, and 17 others, giving them a monopoly over trade in the regions watered by streams flowing into

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Hudson’s Bay. In this vast territory, known as Rupert’s Land, the HBC was given the power to pass laws, exact penalties for their violation, erect forts, build warships and make war on, or peace with, the natives. Although HBC’s monopoly went unchallenged for over a century, Adam Smith recorded that, by 1776, the company only employed 120 people in “habitations which they have honored with the name of forts.” There was no need for any more, because the trade, although highly profitable, involved no more than the barter of three or four shiploads of British goods per year for a roughly equal weight of furs and skins. The company’s formation provoked a conflict with the French, which escalated into open war, eventually resolved by Britain’s conquest of Canada in 1763. This made Rupert’s Land accessible by land, as well as sea, and trade increased dramatically. The company was hit by another outbreak of war with the French, but was strong enough by then to carry the losses. A more serious threat was the private trappers, who coveted HBC’s fulsome profits. In 1783, a group of speculators formed the North West Fur Company of Montréal, and began to compete. The companies merged in 1821 and their combined territories were extended to the Arctic in the north and the Pacific in the west. The enlarged HBC acquired the sole rights to the trade in this area for 21 years in 1838. At the expiry of the license in 1859, the trade monopoly was abolished and in 1869 Rupert’s Land was bought by the Dominion of Canada for £300,000 and a land grant of seven million acres. Part of the remnant of this once vast land empire was sold and the proceeds were invested in other areas. During World War I, HBC operated a steamship line with over 300 vessels, shipping food and munitions to France and Belgium. Earlier, in a fine example of a Stephen Jay Gould jury-rigged adaptation “of curious parts, made available by past histories in different contexts,” HBC turned its Hudson’s Bay Company Stores, a network of trading posts throughout northern Canada originally serving the fur trade, into the Bay department stores chain. Some downtown Hudson’s Bay Company stores were later transformed into boutiques. The first department store opened in Winnipeg, Manitoba in 1881 and it was to Winnipeg that the company’s head office moved from London, in 1970, on the company’s 300th birthday. Later, when HBC expanded eastwards, head office functions were moved to Toronto in Ontario. There are now four retail brands – The Bay, Zellers, Home Outfitters, and Fields. The company’s London warehouse, Beaver House, became the center of the international fur trade and the fur trading business expanded outside Canada to Russia. The Canadian fur auction business was sold in 1987, however, and in 1991 The Bay stopped selling fur in response to pressure from animal rights groups. But demand for fur persisted and The Bay fur salons were re-opened in 1997. In recent years, HBC has diversified, through joint ventures, into credit cards, mortgages and personal insurance. After a prolonged battle, HBC’s board agreed to recommend acceptance of a bid for the whole company from minority shareholder, Jerry Zucker, a South Carolina

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billionaire, in 2006. Zucker was appointed “Governor” and CEO, but was succeeded as Governor by his widow, Anita, after his death in April 2008. Two months later NRDC Equity Partners, owner of two American department store chains, announced its purchase of the company. From an English fur trapping company owned by a Bohemian prince in the late 17th century, to a subsidiary of a U.S. private equity firm in the early 21st century, shows evidence of impressive adaptability.

References 1 2 3 4 5 6 7 8 9 10 11 12 13

An Inquiry into the Nature and Causes of the Wealth of Nations, Adam Smith, Ward, Lock, 1776. The Protestant Ethic and the Spirit of Capitalism, Allen & Unwin, 1930. The Origins of Virtue, Viking, 1996. Karl-Erik Sveiby and Tex Skuthorpe, Allen & Unwin, 2006. The Selfish Gene, Oxford University Press, 1976. The next sections draw on An Unfinished History of the World, by Hugh Thomas (Hamish Hamilton, 1979) and The Wealth of Nations. The Wealth and Poverty of Nations, Little, Brown, 1998. Religion and the Rise of Capitalism, John Murray, 1926. “The Poetry of Pope,” North British Review, August, 1848. The Visible Hand: The Managerial Revolution in American Business, Harvard University Press, 1977. The Flamingo’s Smile, W. W. Norton, 1985. “Rank-Order Tournaments as Optimum Labor Contracts,” Edward Lazear, Sherwin Rosen, Journal of Political Economy, October, 1981. Personnel Economics for Managers, John Wiley, 1998.

3 The steam-age corporation

We have seen how the idea of trade and the dynamics of comparative advantage emerged from the economic logic of the human situation. Trade was a fire that, once lit, was sure to spread. Moreover, the trade idea brought with it other ideas, such as “price,” “exchange rate,” “profit” and “arbitrage.” Although not named as such until much later, all of these ideas were understood and probably widely discussed in the Stone Age. We have seen how the company evolved from the medieval guilds, and took its place in the world of commerce alongside and sometimes in competition with private adventurers and co-partneries. For a long time it was less successful than either, despite its possession of monopoly privileges granted by charter in its role as the agent of mercantilist states. In his Pulitzer-prize-winning book,1 Alfred Chandler suggested that a new kind of company emerged in the U.S. railroad industry in the mid-19th century when a military-style bureaucracy was added to the joint stock limited liability model. The 1841 collision on the Western Railroad and the recommendations for reform that followed led to a period of organizational innovation in the U.S. railroads, from which the “divisional line-and-staff” organization emerged as the standard. The line-and-staff organization adds to the simple line management system a staff department that supports and advises line managers. In theory it has two separate hierarchies: departments in the line hierarchy (manufacturing, selling and so on) generate revenue, and are responsible for achieving the organization’s goals, while those in the staff hierarchy (accounts, maintenance, HR, IT and so on) consume revenue and support line functions. In practice, modern management jobs usually have elements of both. Chandler suggested that, by the outbreak of the American Civil War in 1861, the “modern American business enterprise” had been born: The needs of safety and then efficiency had led to the creation of a managerial hierarchy, whose duties were carefully defined in organi51

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zational manuals and charts. Middle and top managers supervised, coordinated, and evaluated the work of lower level managers who were directly responsible for the day-to-day operations. Chandler called the new organizational form a “multi-unit business enterprise” (MuBE) and explained its rise to dominance in the late 19th and early 20th centuries with eight “propositions.” They amount to a description of the large modern company’s EEA (environment of evolutionary adaptedness). This chapter uses Chandler’s propositions, with a modern commentary on each, to examine the extent to which the environment of today’s large company differs from its EEA, and thus describes the adaptive challenges it currently faces. The modern commentaries should on no account be interpreted as a criticism of Chandler’s book. In my view, The Visible Hand is one of the best books about business (it is not strictly a “business book”) ever written.

Why the MuBE emerged Chandler’s first three propositions explained the emergence of the MuBE – why it appeared when it did, and where it did. Insofar as they no longer prevail, it is reasonable to question whether MuBEs would have emerged in response to today’s business challenges.

Proposition 1 Chandler’s MuBE replaced small traditional enterprises whenever and wherever: ■■ T he routinizing of transactions reduced transaction costs. ■■ The linking of the administration of producing, buying and distrib-

uting units reduced information costs. ■■ The internalization of many units permitted the administrative

coordination of flows of goods between units, leading to more effective scheduling, more intensive use of facilities and personnel, increased productivity, lower costs, more certain cash flow and faster payment. Chandler believed savings from reduced information and transaction costs were not nearly as significant as those from “administrative coordination,” which he saw as “the central function of modern business enterprise.” In this he took issue with Ronald Coase, who had suggested

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40 years before The Visible Hand was published that the reason why integrated organizations had evolved was that, by suppressing the internal price system, they saved the “transaction costs” that arose when markets balanced supply and demand.2 Coase’s ideas were later developed into a broad theory of the firm by his student, Oliver Williamson. He suggested that: “The modern corporation is mainly to be understood as the product of a series of organizational innovations that have had the purpose and effect of economizing on transaction costs.”3 Williamson argued that transaction costs can be large, because people are opportunistic, but not omniscient, and act in a “boundedly rational,” rather than a purely rational way.4 Williamson acknowledged that the reduction in transaction costs in an integrated organization must be set against the growing “agency costs” of management – the imperfect matching of supply and demand and the tendency of managers to pursue their own ends (as did the English East India Company’s nabobs – see Chapter 2) at the expense of shareholders – as the organization grows. He saw the multi-unit company as a solution to this problem, because its scale captured transaction cost economies, and the independence of profit centers controlled agency costs.

Modern commentary Whether you are persuaded by Chandler’s view, that it was the cost savings produced by administrative coordination, or the Coase and Williamson view, that it was transaction cost economies, that gave the MuBE its crucial competitive advantage over small, traditional enterprises, it’s hard to deny that the relative competitiveness of the MuBE has been eroded in the past 30 years. Advances in information technology (IT) have reduced transaction and information costs in general, and greatly increased the efficiency of markets, and thus the potential efficiency of inter-firm coordination. That many large, modern companies acknowledge this is demonstrated by the growth of outsourcing in recent years. Moreover, although pending the appearance of all-knowing consumers and employees, rationality will always be “bounded” to some extent, the impact of the internet on the availability of information must have dramatically reduced transaction costs generated by imperfect information.

Proposition 2 MuBEs required managers to assume the market’s resource allocation role, if they were to capture the cost savings from internalizing the

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activities of multi-units. According to Chandler, this means a managerial hierarchy is a “defining characteristic” of the MuBE. This is simply using the assertion about costs in Proposition 1 to describe an MuBE. Administrative coordination is less costly than market coordination, but to capture such savings, an organization needs a management hierarchy, and if it has a management hierarchy it is an MuBE.

Modern commentary Once again the issue here is the respective efficiencies of market and managerial coordination. Let’s agree for the sake of argument that managerial coordination, after taking full account of agency costs, was more efficient than market coordination at the time of the MuBE’s EEA in the late-19th century. The question that needs to be answered is whether that remains the case today. It is hard to be sure, but there is reason to believe it does not. The growth of outsourcing, for example, which is a competitive and thus a market coordinated business, suggests outsourcers at any rate believe it to be cheaper than insourcing. Other things being equal, the “experience curve” suggests that a company that does nothing but payroll management, for example, will do it more efficiently than the payroll department of an MuBE. The growth of joint ventures, strategic alliances, and other kinds of business partnership, which has been such a feature of the so-called “globalization” of business, also suggests that, thanks in no small part to reductions in information and communication costs stemming from advances in IT, the cost of coordinating activities between companies is falling relative to the cost of coordination within companies. Moreover, globalization has also added to intra-firm coordination costs, by encouraging national tax regimes throughout the world to introduce transfer pricing rules. These require cross-border (and sometimes within border) intra-firm prices to be arm’s length (as set by markets) and so deny global MuBEs opportunities to optimize commercial relationships between units for tax and other purposes. Although here too, precise measurement is difficult, it also seems likely that the agency costs associated with the MuBE’s managerial hierarchies have increased substantially since the MuBE’s EEA and since Chandler was writing in the 1970s, witness the executive pay explosion, the poor record of large companies for extracting value for acquirers’ shareholders from mergers and acquisitions and, not least, the dire consequences for shareholders of the reckless and recklessly financed pursuit of growth that precipitated the 2008–09 global recession.

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If it was the superiority of managerial coordination over market coordination that “selected” (in a Darwinian sense) the MuBE, with its species-defining managerial hierarchy, the evidence suggests that it might not have “speciated” (emerged as a new species) today, because the balance of advantage between managerial and market coordination has shifted too far since the MuBE’s EEA toward the latter. There is another question, of course. Do the differences between today’s business environment and that of the mid-19th century require us to regard the MuBE, and its “defining characteristic” of a managerial hierarchy, as an endangered species?

Proposition 3 The MuBE made its appearance on the business stage when the volume of economic activities reached the level where administrative coordination became more efficient, and more profitable, than market coordination. Chandler saw technology, and particularly the steam engine (on railroads and in factories), as a vital catalyst in the MuBE’s evolution. “New technology made possible an unprecedented output and movement of goods” and larger markets were required “to absorb such output.” That’s why the MuBE “first appeared, grew and continued to flourish in those industries characterized by new and advancing technology, and by expanding markets.”

Modern commentary This is my favorite – a beautiful idea, similar to Stuart Kauffman’s conjecture about how life on earth began: When the number of catalyzed reactions is about equal to the number of chemical dots, a giant catalyzed reaction web forms, and a collectively autocatalytic system snaps into existence. A living metabolism crystallizes. Life emerges as a phase transition.5 Kauffman’s idea is that life emerged when chemistry in the ancient world passed a critical level of complexity. Chandler suggests the MuBE emerged when the volume of business in the 19th century passed a critical level. The MuBE was invoked. Circumstances demanded it. It didn’t emerge gradually step by step; it snapped into existence when James Watt’s invention “made possible an unprecedented output and movement of goods.” The appearance of the MuBE was caused by a phase transition in America’s economic development.

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This proposition expands the first two. It says in effect that the efficiency of market coordination on the one hand and managerial coordination on the other is volume-sensitive. You don’t need the latter while the volume of activity remains below a certain level, but once it exceeds that level, a phase transition occurs and you can’t manage without it. The MuBE was a solution to the production and distribution challenges created by technology-driven growth in the size and complexity of firms. We do not see technology in the same way nowadays. It appears more generally capable to us. By reducing costs and prices, and thereby stimulating demand, it can create new management problems, but it can also solve them. As Chandler acknowledged, if the U.S. railroads had recognized the potential of the electric telegraph a few years earlier, as their counterparts in England had done, the collision on the Western Railroad in 1841 might have been prevented. Charles Wheatstone and William Cooke patented the electric telegraph as an alarm system in May 1837, and demonstrated the technology in July of that year, between Euston and Camden stations, in London. Their invention entered commercial use on the Great Western Railway over the 13 miles from Paddington to West Drayton in April 1839. It was not until 1843 that Samuel Morse’s Magnetic Telegraph Company was given permission to build an experimental line along the Baltimore & Ohio Railroad’s right-of-way between Baltimore and Washington. In our own time, the internet, e-mail and broadband communication have enormously increased the efficiency of market coordination and the volume of activity small firms can handle efficiently. The digitization of information transmitted across broadband networks has transformed the economics of scale in many industries, ranging from banking to travel. The internet has made possible new forms of self-organizing association between individuals and small firms that have already created large and sophisticated products, such as the Linux operating system and Wikipedia (see Chapter 7), which previously only large, integrated MuBEs could have developed. What technology brought together yesterday, it can rend asunder today.

Why the MuBE thrived Propositions four to eight explain the MuBE’s growth – how and why it survived, spread and became dominant. The extent to which these propositions seem at odds with today’s environment, begs questions about whether the MuBe can continue to thrive in its current form.

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Proposition 4 Traditional partnerships were reformed or disbanded when a partner left, but once a managerial hierarchy had been created, it became a source of “permanence, power and continued growth,” and the MuBE acquired “a life of its own.” The managerial hierarchy transcends individuals. When managers depart, they’re replaced. “Men came and went. The institution and its offices remained.”

Modern commentary This proposition is obviously true. An MuBE does acquire “a life of its own” and a much more substantial life than that of the broom the caretaker used for 20 years, during which time he replaced the handle twice and the brush head six times. While managers come and go, the MuBE accumulates its own substance in the form of tangible assets (plant, buildings, cash, inventories, and so on), and intangible assets (intellectual property – patents, brands, logos – and what Karl-Erik Sveiby called “customer capital” [customer loyalty], and “structural capital” [processes, accounting systems, and so on]).6 In its early years the MuBE did not just accumulate substance; its managers hungered for it, and transformed business from a project- to a process-based activity. Production processes, for making iron and steel, for instance, had played a vital role in the Industrial Revolution, but it wasn’t until the age of mass production and the adoption of F. W. Taylor’s “scientific management” approach in the early 20th century that business itself became a continuous process rather than a set of discrete projects. The managerial hierarchy’s hunger for permanent substance led to a gathering together of business activity; a great integration. Most commentators have seen this as necessary and inevitable. Business was at a crossroads, according to Sir John Clapham. As it became more complex and companies became concerned with many technologies a choice had to be made: either there must be an elaborate fitting together of the products of many specialised firms or single many-sided firms must do most of the essential work themselves, as government dockyards had always done.7 The widespread adoption of the MuBE as the solution to the problem of complexity added more substance to the new species by

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requiring new systems and processes to replace market coordination. It was the emergence of the MuBE, and the consequent need for infor mation about transactions within organizations, that led, for example, to the development of management accounting. Before then, according to Thomas Johnson and Robert Kaplan, almost all business transactions were “between an owner–entrepreneur and individuals who were not part of the organization; raw material suppliers, labor paid by piecework, and customers.” There was no need to establish “costs” when everything was priced by the market.8 When managers hungry for more substance brought previously subcontracted processes “in house,” costs ceased to be adequately revealed by prices, and had to be identified and managed. The task of management was created by vertical integration; the replacement of outworkers and subcontractors by employees. It occurred initially in only a few industries like textiles, iron and steel making, railroads, shipbuilding and retailing. Elsewhere firms adapted to the growing complexity by modifying rather than abandoning the subcontracting system. Johnson and Kaplan refer to John Buttrick’s account of the “inside contracting” system used in the mid19th century by the Winchester Repeating Arms Company: the management of a firm provided floor space and machinery, supplied raw material and working capital, and arranged for the sale of the finished product. The gap between raw material and finished product, however, was filled not by paid employees arranged in the descending hierarchy so dear to the hearts of personnel experts but by contractors, to whom the production job was delegated. They hired their own employees, supervised the work process, and received a piece rate from the company for completed goods. The income of a contractor consisted of the difference between his wage bill and his sales to the company, plus the day pay he earned as an employee himself. The company’s largest single expense was the amount paid to the contractors for finished goods.9 It was the appearance of vertically integrated MuBEs at the end of the 19th century that turned managerial hierarchies into sources of “permanence, power and continued growth.” These days, the case for vertical integration is much less self-evident. There was always a risk that, in substituting Chandler’s “visible hand” of management for Smith’s “invisible hand” of markets, and switching management attention from price to cost, managers would come to rely too much on their cost accounting systems, lose touch with markets and make pricing

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mistakes. This is why the activity-based costing reform of management accounting, advocated by Robert Kaplan and Robin Cooper10 in the late 1980s, caused such a stir and why today’s conventional wisdom is that firms should focus on their “core competencies” and subcontract or outsource all other functions to specialists. It is generally accepted these days that in normal times no amount of substance will guarantee the “permanence, power and continued growth” of firms making the wrong products at the wrong price. The “in normal times” qualification is necessary, because, as recent events have shown, substance in the form of large numbers of jobs can induce governments struggling to combat recession to shore up failing MuBEs with taxpayers’ money.

Proposition 5 As the tasks of salaried managers in management hierarchies became more technical and professional, the criteria for their selection and promotion came to be based on training, experience and ability rather than on kinship or money, and managers could conceive of “a lifetime career involving a climb up the hierarchical ladder.”

Modern commentary One of the most striking developments in corporate employment over the past two decades or so has been the disappearance of “the job for life.” Following the downsizings and de-layering of the early 1990s, and the new wave of job losses during the 2009 recession, very few managers now see climbing the same company hierarchy as a lifetime career. Hierarchy-climbing, these days, is more diagonal than vertical; more a matter of leaving one hierarchy and joining another at a higher level, with a better pay package. The manager has become a mercenary moving from company to company and industry to industry, in a constant search for better pay and more status. The mobility of the modern manager is partly a consequence of more active “head-hunting” by the executive search consultants, hired to help their clients win the so-called “war for talent.” But the seeds of managerial disloyalty were sown long ago. When management became a profession, its various sub-professions, such as finance, manufacturing, HR and marketing, became portable and dedicated to the service of MuBEs general, rather than particular MuBEs. As Harvard Business School professor John Kotter pointed out, the then new MuBEs were complaining about shortages of qualified staff to run their organizations as early as the 1860s.11

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The University of Pennsylvania responded to the new skill shortage in 1881, by founding the Wharton School of Finance and Commerce to offer an undergraduate management degree. Similar schools were set up in California, Chicago, and elsewhere before the end of the 19th century and in 1908 the Harvard Business School (HBS) was founded to offer a masters degree in business administration (MBA). George Baker, head of what would become Citicorp, was impressed by the Harvard school and in 1925 gave it the money to construct an eight-building campus. The following year, 58,000 students taught by 2,500 faculty at 132 American schools majored in business. Most of them joined large MuBEs. It was inevitable, given the inspiration for the schools and the destinations of their graduates, that intimate relationships would develop between “B-schools” and large firms. This was particularly true at Harvard. The library is named after George Baker, the MBA classrooms are Aldrich and Rockefeller (Standard Oil), the dining hall is Kresge (K-Mart), executive programs are taught in Cumnock (J. P. Stevens) and the faculty office building is Morgan (Morgans Guaranty and Stanley). As Kotter explained: Harvard received donations from big corporations to support its programs and research. It also obtained access to study interesting business problems and to write teaching cases. The first major piece of social science research conducted by professors at HBS was possible only with the cooperation of a Western Electric (AT&T) factory in the Chicago area. In return, the School trained people to assume managerial careers in big companies and helped those businesses to gain access to students through an on-campus lecture series and a job placement program. The American business schools played a vital role in the evolution of managerial capitalism, by providing the skills Chandler’s MuBEs needed to perfect the new system of administrative coordination. They were and they remain the officers’ training colleges for large companies. Harvard Business School was and remains to big business what West Point is to the U.S. Army. Two regrettable consequences followed from the close relationships between big business and the B-schools. The first is that standard management principles, philosophies and strategies prevail throughout big business and all large companies tend to become enamored with new management fashions, such as the focus

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on shareholder value and financial engineering that some say was partly responsible for the credit crisis, at the same time. If all large companies follow the advice of an academic in a Harvard Business Review article, and use derivatives to manage risks, for example, the entire industrial system becomes more vulnerable than it would otherwise be to the kind of shock it endured in 2007–08. Philip Delves Broughton, holder of a Harvard Business School MBA, excoriated his alma mater in an article in the Sunday Times in March 2009. He pointed out that HBS alumni had been involved in several pre-crash scandals, including Enron, and recalled that one HBS case study being used while he was there was on the Royal Bank of Scotland, a prominent U.K. casualty of the banking crisis. “Every trendy business school idea was being implemented, it seemed, while what really mattered – the bank’s risk assessment, cash flow and capital structure – was going to hell.”12 The second regrettable consequence of a close relationship between large companies and the B-schools is that the management discourse became dominated by the concerns of big business, and very little attention was paid to the corporate undergrowth, from where tomorrow’s industries, companies and business models are likely to emerge. As Kotter put it: Small businesses were mostly left out of this relationship. They were not in the job market for young managers every year. They had little money to donate to HBS. Besides, they wanted street-smart generalists more than the analytical specialists who tend to be the product of universities. By training the troops MuBEs needed to operate their new system of managerial coordination, the business schools also contributed to the MuBE’s “permanence, power and continued growth.” They became a vital part of what I call the “CEO system” (see Chapter 6).

Proposition 6 As the MuBEs grew in size and diversity, and their managers became more professional, management became separated from ownership. The traditional, capitalist firm was very much a personal enterprise. From the start the company required more managers than a family or its associates could provide. When a company raised new capital to finance growth, it was common in the early 19th century for investors to put representatives on the board and share major decisions with managers. Chandler called

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this system “financial capitalism,” and saw it as a transitional stage between “family” and true “managerial” capitalism consisting of two symbiotic components – a characteristic institution, in the MuBE, and a characteristic profession, in the salaried manager.

Modern commentary Chandler’s conjecture that what he calls “financial capitalism” is an intermediate stage does not specifically preclude coexistence, but it does imply some sort of progression from a primitive to a more sophisticated capitalist system, an important consequence of which is the separation of ownership from control. Control remains with owners in “family/entrepreneurial capitalism,” is shared with investors in “financial capitalism” and is surrendered to managers in “managerial capitalism.” An example of this development process is provided by the story of the British company, Vickers-Armstrongs, at the end of this chapter. Increasing scale is the impetus behind the progression. The larger the business and the higher the volume of transactions, the more salaried managers were required to administer and coordinate, and the thicker the wedge driven between ownership and control. Adolf Berle and Gardiner Means had identified what they called the “divorce of ownership and control”13 44 years before Chandler introduced his concept of “managerial capitalism.” As Berle put it later: stockholders, though still politely called “owners,” are passive. They have the right to receive only. The condition of their being is that they do not interfere in management.14 But there was nothing new about this. As we saw in Chapter 2, Adam Smith noted (in 1776) that owners of joint stock companies “seldom pretend to understand anything of the business of the company … [and] receive contentedly such half-yearly or yearly dividends as the directors think proper to make them.” The divorce of ownership and control should be seen, not as an important development in the early 20th century, but as an intrinsic quality of the joint stock company, which only became evident and worthy of comment after the joint stock company became the dominant corporate form. In Smith’s time the Berle and Means observation would not have been worthy of comment, because the joint stock company played only a small part in economic life. It was an insight of the first importance in the 1930s, however, because by the end of that decade the joint stock company accounted for over 50 percent of U.S. business, and over 90 percent of manufacturing output.

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Chandler implied that the MuBE, with its characteristic managerial hierarchy, was a culmination of some kind. New companies are still being created by entrepreneurs, but those that survive and prosper are destined to develop into MuBEs. As evolutionists say: ontogeny (the development of the individual) recapitulates phylogeny (the evolution of the species). The corporate population of a modern economy always includes firms at all stages of development, but those at the “entrepreneurial,” “family” and “financial” stages are, if they survive, just passing through, Chandler appears to suggest, on their way to the ultimate “managerial” stage. The idea that Chandler’s MuBE is an ontogenetic and a phylogenetic culmination (“the end of corporate history,” to adapt Fukuyama’s title – see Note 2, Chapter 1) was probably more plausible when Chandler was writing than it seems today. Some of today’s largest companies, such as Rupert Murdoch’s News Corporation and Sir Richard Branson’s Virgin Group, seem to combine aspects of entrepreneurial and family capitalism with those of managerial capitalism. Others that have been, or may be acquired by private equity groups, seem to exemplify Chandler’s financial capitalism. The enormous growth of debt financing during the past two decades suggests financial capitalism was not, or is no longer, as transitional as Chandler supposed, although Harvard Business School professor, Rakesh Khurana, sees this neo-financial variant as a new, post-managerial stage, which he calls “investor capitalism”(see Chapter 6). The practice of paying executives with stock options, which remains widespread despite rules that require them to be treated as expenses in company accounts, seems like and is intended to simulate a return to “entrepreneurial capitalism.” This is not to suggest that Chandler’s “managerial capitalism” was a misconception, or to deny that there is a tendency for companies to acquire managerial hierarchies as they grow and thus to develop into MuBEs. It’s simply to say that this pattern of development is neither inevitable nor irreversible. Moreover, if the thickness of the wedge driven between ownership and control is measured by the extent to which stock ownership is dispersed – such that no single shareholder owns enough equity to exercise effective control over managers – managerial capitalism is only truly dominant even today in the U.S. and the U.K. The belief, in the 1970s, that a corporate form that only began to play a significant role in industry after 1860 and still accounted for less than a quarter of American output in 1900 was the “end of corporate history” may have had something to do with the role that governments played in business over the subsequent five decades.

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Chandler acknowledges that Western governments contributed to “the spread and continued growth of modern business enterprise” through their commitment to maintaining full employment and their adoption of Keynesian demand-management economic policies before and after World War II. This created the economic stability the MuBEs needed to keep their factories busy and their supply chains full. But he dismisses the idea that government played an important role in the two world wars as customers of MuBEs: The suggestion that the rise [Chandler’s emphasis] of big business has any relation to government and military expenditures (or for that matter to monetary and fiscal policies) has no historical substance. Perhaps so, but the story of Vickers-Armstrongs; the role the idea of “national champion” firms has played, and still plays in continental Europe, in national industrial policies since World War II; and recent job-preserving rescues of America’s “big three” automakers, demonstrate that governments have felt obliged to ensure the survival of some big businesses that might otherwise have failed. Although the partial nationalizations of big banks during the 2008 crash were inspired by the need to relieve pressure on the banking system as a whole rather than to rescue particular banking groups, they too have had the effect of preserving large businesses at the expense of small businesses that might otherwise have occupied the niches big bank failures would have left vacant.

Proposition 7 When making decisions, career managers prefer policies that promote the long-term stability and growth of their enterprises to those that maximize current profits. For salaried managers, the survival of the enterprise was essential. Because their goal was to assure the continuing use of, and the flow of material to, their production facilities, they protected sources of supply and outlets, took on new products and services to make better use of existing resources and preferred to reinvest profits rather than pay dividends. “In this way the desire of the managers to keep the organization fully employed became a continuing force for its further growth.”

Modern commentary A modern MuBE, the managers of which preferred growth and stability to creating shareholder value, would become a prime candidate for

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acquisition and possible dismemberment. Although, in practice, the corporate takeover system has been a notorious destroyer of value for acquirers’ shareholders, the constant threat of takeover is, in theory and also in practice, a potent curb on managers inclined to impose agency costs on shareholders, by indulging their desires for growth and stability at the expense of value creation. But the takeover is a double-edged sword. Although the increase in mergers and acquisitions (M&A) activity since Chandler wrote has reduced agency costs at target companies, it has also allowed CEOs to pursue acquisition-led growth strategies that have usually been at the expense of their own shareholders. Encouraged by the tacit assumption that the bigger the company, the more the CEO should be paid; by their own egos; and by the urgings of transactions-driven investment bankers peddling seductive but nonsensical maxims, such as “eat or be eaten,” “dare to be great,” and “you can’t overpay for a strategic acquisition,” CEOs frequently squander shareholder value on unprofitable acquisitions, financed by what in retrospect often appear to be dangerously high levels of debt. Managers are still imposing agency costs on shareholders, but of a different kind. They stem not so much from the desire of managers for “organic” growth, as from the desire of CEOs to engage in the more glamorous and exciting, but ultimately less creative, pursuit of acquisitionled growth. The focus of CEO attention has switched from enhancing the profit and loss account through the hard graft of innovation, product development and efficiency improvements, to manipulating the balance sheet and orchestrating the new financial engineering techniques associated with M&A activity.

Proposition 8 As Chandler’s MuBEs grew and came to dominate major sectors of the economy, “they altered the basic structure of these sectors and of the economy as a whole.” They did not replace the market, because their decisions were still based on estimates of demand, but they took over the coordination of flows of goods and services. By the mid-20th century, the salaried managers of a few large enterprises coordinated flows of goods and resources through the processes of production and distribution in every major U.S. industry. “By then,” Chandler concluded “the managerial revolution in American business had been carried out.”

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Modern commentary Chandler’s characterization of the transition from entrepreneurial to managerial capitalism as a “revolution” implies that he saw it as a development equivalent, in its significance and permanence, to the Industrial Revolution that preceded it. Revolution implies more radical change than evolution; a discontinuity rather than an adaptation. With the benefit of hindsight, it doesn’t seem that way today. The emergence of the MuBE and managerial capitalism seems more like an adaptation to the circumstances of the steam age than a permanent, irreversible revolution. It was a phase transition of a kind, but not of the same kind or permanence as the phase transitions from no life to life, or from pre-industrial to industrial economies. It seems more like the transition from water to ice, which can be reversed by the injection of heat. As we will see in the next chapter the equivalent of more heat, in the form of a politically significant increase in inequality, has been injected in recent years into the system of which managerial capitalism is part, even as the MuBE has extended its writ from its Anglo-Saxon birthplace to the global economy.

Chandler’s contribution That some of its conclusions have not in my view stood the test of time does not alter the fact that The Visible Hand is a wonderful and important book, and a worthy winner of both the Pulitzer and Bancroft prizes. It was the first to address the questions of why the institution that dominates the global economy emerged when it did, what qualities have sustained it, and what advantages over the “invisible hand” of the market, to which Adam Smith assigned the prime coordinating role, have enabled MuBEs and their managers to achieve the dominance they enjoy today. Chandler saw the institution he called the MuBE as far more than a mere abstraction around and within which the invisible hand of the market allocated resources and coordinated activity in the ways envisaged in classical microeconomics. He saw the MuBE as a potent economic agent, with its own beliefs, desires and intentions, and he understood that, like elephant herds that have turned woodlands into savannah by stripping the bark from trees, it has changed the business environment. This is the way we need to look at companies now, as real economic agents, rather than abstractions whose actions, practices, habits and hungers change, for good or ill, the business environment and the wider societies in which they operate.

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The argument so far Large modern companies aren’t as we would like them to be, because they are the creatures of the business environment of the late 19th and early 20th centuries. They are under pressure to adapt, because some of the qualities that were their original strengths and led to their dominance of business, are either less valuable today or have become weaknesses. The next chapter examines the greatest and most obvious of these weaknesses – the omnipotence and enormous pay packets of Chief Executive Officers (CEOs).

Vickers-Armstrongs The history of U.K. shipbuilder, armaments and aircraft manufacturer VickersArmstrongs exemplifies Chandler’s transition from “family-entrepreneurial,” to “managerial” capitalism, and also illustrates the role governments have played in the development and protection from failure of large MuBEs. William Armstrong (1810–1900), made Baron Armstrong of Cragside in 1887, was a gifted British engineer, inventor and entrepreneur. He laid the foundations of hydroelectric power with a water pressure wheel in 1839, and a hydroelectric machine in 1844; patented the hydraulic crane in 1846; invented a hydraulic pressure accumulator in 1850; designed submarine mines in the Crimean War and developed the rifled-bore, breech-loading gun. Not content with solving the energy challenges of his own time, he is said to have contributed to solving ours, by being the first to conceive of the idea of using solar energy. In some ways, he was a throwback to the Industrial Revolution. He held his own patents and had a strong sense of civic duty. He left his patent rights to the nation, and was a generous benefactor of his home city of Newcastle. In other ways, Armstrong was the very model of a modern industrialist. He built his engineering works at Elswick in 1847 and in 1859, the year he became “Sir William” and was appointed engineer of rifled ordnance at Woolwich arsenal, he formed the Elswick Ordnance Co., to make guns for the government. (He resigned his Woolwich appointment in 1863, when the government returned to muzzle-loading ordnance for a brief period.) Armstrong decided to build ships in 1868, and in 1882 entered into a partnership with Messrs. Mitchell & Swan, to build warships at Elswick. Within a year, the new yard launched the first iron-clad cruiser, the Esmeralda, for Chile’s navy. In 1885 Armstrong opened a branch in Naples to make guns for Italy, and in 1897 merged his business with Sir Joseph Whitworth’s. Armstrong died in 1900 while ArmstrongWhitworth was entering the armored-plate business.

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Sheffield steelmaker, Vickers, a joint stock company formed in the 1860s, made steel for most uses, including armaments. In 1897, it acquired the Naval Construction and Armaments Company at Barrow, and the Maxim-Nordenfelt Machine Gun Company at Erith. In 1902, it acquired the Robert Napier shipbuilding firm, builder of the first iron-clads, and bought a share of William Beardmore’s shipbuilding company in Glasgow. Vickers and Armstrong-Whitworth both prospered during the war, but experienced financial difficulties subsequently. They might have collapsed (as did Beardmores), had the British government not seen them as “strategically important” and deserving of subsidy. Partly at the government’s instigation, Armstrong-Whitworth was bought by Vickers in 1924, to form Vickers-Armstrongs. Vickers survives in a much truncated form as a subsidiary of the Rolls-Royce aero engine group. It was renamed Vinters in March 2003.

References 1 2 3 4 5 6 7 8 9 10 11 12 13 14

The Visible Hand: The Managerial Revolution in American Business, Harvard University Press, 1977. “The Nature of the Firm,” Economica, 1937. “The Modern Corporation: Origins, Evolution, Attributes,” Journal of Economic Literature, 1981. “The Economics of Organization: The Transaction Cost Approach,” American Journal of Sociology, 1981. At Home in the Universe, Oxford University Press, 1995. The New Organizational Wealth, Berrett-Koehler, 1997. An Economic History of Modern Britain, three volumes, Cambridge, 1926–38. Relevance Lost: The Rise and Fall of Management Accounting, Harvard Business School Press, 1987. “The Inside Contracting System,” Journal of Economic History, Summer, 1952. “Measure Costs Right: Make the Right Decisions,” Harvard Business Review, September/ October 1988, 96–103. The New Rules: How to Succeed in Today’s Post-Corporate World, Free Press, 1995. “Harvard’s Masters of the Apocalypse,” Sunday Times, March 1, 2009. The Modern Corporation and Private Property, Macmillan, 1933. Power without Property: A New Development in American Political Economy, Harcourt Brace, 1959.

4 The decadent corporation

“Multi-unit business enterprise” (MuBE), the name coined by Chandler to describe the new business organization that emerged in the mid19th century, conveyed the MuBE’s complexity, but not its shape. As we have seen, the MuBE inherited its hierarchy from the military. This gave it a triangular shape seen in elevation and a concentric groundplan. By concentric I mean that, unlike the other corporate forms it eventually vanquished in the 20th century, and by which it is challenged in the 21st century (see Chapter 7), it had a unique center around which other parts are organized, and to the purposes of which all other parts are subordinated. It can be pictured as a laminated cone, or cone of laminated cones in the case of a multi-divisional firm, consisting of disk-shaped layers of management of decreasing size and increasing power piled on top of one another. At the tip of the cone one person, the CEO, holds all the reins of power and embodies the whole organization’s agency. This shape has turned out, particularly in the past two decades or so, to be inimical to the MuBE’s host political system of liberal democracy, because pay has followed power up MuBE hierarchies, and produced distributions of wealth that are widely seen by voters as profoundly unfair. Some people object strongly to the baldness of this statement, and insist that it’s very difficult to say what is “fair” in any given situation. It’s not difficult at all.

Justice as fairness Many people who read John Rawls or encounter his two principles of justice for the first time, are hit by an almost visceral feeling of recog nition. “Yes of course,” they immediately realize. “That’s right – that’s what I’ve always believed, but have never been able to put into words.” Rawls sought to answer the question: “What principles would we all agree should form the basis of the social contract between us, if we

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knew nothing of the society we were about to enter, and nothing of our own abilities, aptitudes and inclinations?” His answer was: All social primary goods – liberty and opportunity, income and wealth, and the bases of self-respect – are to be distributed equally unless an unequal distribution of any or all of these goods is to the advantage of the least favored.1 What could be simpler? A fair and just society, according to Rawls, is not an egalitarian society. Equality is the basic principle, but Rawls’s “difference principle” permits a certain amount of inequality if and insofar as it is of benefit to the disadvantaged. Abilities and aptitudes differ, and it would not be fair, or in the interests of the least favored, to deny able and industrious people the right to improve their circumstances to the best of their abilities. Tax rates must be progressive, to ensure redistribution, but not so progressive that those able to generate significant wealth lack the motivation to do so or move to societies that tax them less heavily. The sense of recognition many – I suspect, most – people feel when they encounter Rawls’s principles suggests that his conception of “justice as fairness,” or something very like it, lies at the root of the consensus that sustains the liberal capitalist system. That was certainly Rawls’s belief. Most of us accept liberal capitalism and vote for liberal capitalist governments and policies, because we believe that, by and large, they produce fair outcomes, broadly consistent with the principles Rawls set out. So far, the liberal capitalist consensus has proved robust, in the sense that it tolerates – has deemed to be in the interests of the least advantaged – considerable inequality. But wide acceptance of the system is not unconditional. The consensus must be maintained. If people begin to believe the system they have supported hitherto has started to produce outcomes that are inconsistent with Rawls’s principles, they may lose faith in the system (and respect for its institutions), and vote for governments and policies that offer to restore the distributive justice they feel is being eroded. Rawls was very conscious of this danger. In Justice as Fairness: A Restatement,2 published shortly before his death in 2002, he expressed alarm at the growing inequalities and concentrations of economic power in the hands of small elites in capitalist states. He was so worried by the threats these posed to what he called the “social basis” of respect that he modified the model of liberalism he had described 30 years earlier in A Theory of Justice.

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the decadent corporation

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Having lost his faith that liberal principles could be realized in a “capitalist welfare state,” he suggested they could only survive in what he called a “property owning democracy,” where ownership of “productive assets and human capital” is more widespread, or in what he called a “liberal socialist regime,” where political power is widely shared, and “economic power is dispersed among firms, as when, for example, a firm’s direction and management is elected by if not directly in the hands of its workforce.” Before the crash, that would have been a cue for howls of derision and the patient explanation to Rawls, the economic innocent, that a firm would not work as a democracy, and it would be absurd if CEOs had to be elected by employees, or had to put their strategies and management policies to employee votes. Now such a casual dismissal of the concerns of such a distinguished philosopher would, itself, seem ingenuous. We are at a watershed. The status quo doesn’t work any more. Rawls was concerned with the basis of a fair society. We should heed his warning about the erosion of the “social basis” of respect. I sometimes wonder if things might have turned out differently, if Harvard Business School had asked Rawls to talk to its MBA classes from time to time. He was only down the road after all, at Harvard University. Perhaps he was invited. If so, he either didn’t go, or the trainee masters of the universe took no notice of his warnings about inequalities and concentrations of economic power. For those of us who believe that liberal democracy and free market capitalism constitute the best system so far devised for creating and maintaining fair, free and prosperous societies, it would be a tragedy if the inequalities and unfairness of our societies led to the replacement of liberal capitalism by old-fashioned socialism. The U.S. and the U.K. have not reached the crisis point, but they may have come perilously close to it, and there are reasons to believe this is partly, perhaps even largely, because today’s large companies (modern versions of Chandler’s MuBE) have, in addition to altering the basic structures of their industries and of their economies as a whole, contributed to growing distributive injustice. There are two main danger signs. Inequality has reached levels in both countries that are unprecedented in modern times and there’s a growing public perception, supported by plenty of evidence, that some people are getting much more than their fair shares. An important implication of Rawls’s “difference principle” is that the inequality it permits should be proportionate. This means that in addition to limiting the degree of inequality in the population as a

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whole to that which is in the interests of the disadvantaged, it imposes limits on the income of individuals. Some people can be paid more than others, but their income can never exceed the value they create, because any excess of pay received over value created is clearly not in the interests of the disadvantaged. (Unless, of course, one subscribes to tournament theory and sees the wealth of the few as a price worth paying for the motivation of the many.) Let’s look more closely at these threats to the liberal capitalist consensus.

Growing inequality The Gini coefficient is the most widely used measure of inequality in a group or a population. Named after the Italian statistician, Corrado Gini, who proposed it in 1912, it is derived from a Lorenz curve of cumulative income distribution. A Gini coefficient of “0” (a straight Lorenz curve 45 degrees to the axis) indicates perfect equality; everyone has the same income. A Gini coefficient of “1” (a reverse “L” curve tracking the horizontal axis, and then rising vertically) is perfect inequality; one person has all the income. National Gini coefficients are calculated by various organizations including the United Nations (UN) and the U.S. Central Intelligence Agency (CIA). In the following tables and analysis I have used CIA figures, published in The World FactBook, because they are more up to date and comprehensive. It’s no surprise that several Scandinavian countries appear in the top ten most equal countries or that sub-Saharan African countries dominate the bottom ten (high Gini) positions. The CIA is interested in Gini coefficients, because high Ginis are good predictors of civil unrest. The agency’s Gini “danger line,” above which public disturbances, protests, riots, revolt and civil war become increasingly likely, is 0.45. The alleged link between increasing inequality and civil unrest is corroborated by political instability and civil unrest in several high-Gini countries, including (at the time of writing) Zimbabwe, Bolivia and Haiti. Much the most discussed Gini coefficient on the web is China’s 0.47. It is significantly above the CIA danger line and many people, including many Chinese, are worried about it. According to official People’s Republic of China (PRC) figures the number of “public order disturbances” in the PRC soared by nearly 50

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percent in two years, from 58,000 incidents in 2003, to 87,000 in 2005. A 2006 U.S. Congressional Research Services study citing these figures noted that social unrest among Chinese farmers and workers had been reported since the early 1990s, but that “recent protest activities have been broader in scope, larger in average size, greater in frequency, and more brash, than those of a decade ago.”3 Table 4.1 National equality rankings – top 10 and bottom 10 Top 10

Bottom 10

Country

Gini

year

Country

Gini

year

Sweden

0.23

2005

Namibia

0.71

2003

Denmark

0.24

2005

South Africa

0.65

2005

Slovenia

0.24

2005

Botswana

0.63

1993

Iceland

0.25

2005

Lesotho

0.63

1995

Norway

0.25

2008

Sierra Leone

0.63

1989

Austria

0.26

2007

C. African Rep.

0.61

1993

Czech Republic

0.26

2005

Bolivia

0.59

2006

Malta

0.26

2007

Haiti

0.59

2001

Albania

0.27

2005

Brazil

0.57

2005

Germany

0.27

2006

Paraguay

0.57

2008

Source: CIA, The World FactBook, updated April 2, 2009.

In major disturbances in Xinjiang province in western China during the Beijing Olympics in summer 2008 over 30 people died in three separate attacks on police and government buildings. In one of the incidents, in Kuqa, more than a dozen bombs exploded before dawn in what appeared to be a coordinated attack. Ethnic tensions were said to be the proximate causes of the violence, but the perceived lack of background fairness in modern China created fertile ground for turning festering resentments into violent action.4 Some are sanguine about China’s high Gini coefficient. They expect it to fall and civil unrest to abate over the next decade or so as China’s economy matures. This is predicted by a theory of economic development proposed by Nobel laureate economist, Simon Kuznets, in 1955. According to the Kuznets hypothesis, economic inequality tends to increase as a country develops and then, after a critical average income is reached, begins to fall. The Kuznets curve, with time, economic development, or per capita income on the horizontal axis and some inequality measure, such as the Gini coefficient, on the vertical axis, is an inverted “U.”

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In the initial stages of economic development workers migrate from agriculture to industry and from rural areas to the towns. Because industry pays better than agriculture, inequality rises, but falls thereafter if growth continues because industry’s hunger for ever more educated workers requires mass education normally accompanied by other income redistribution processes. China’s dangerously high Gini coefficient of 0.47, which according to an Asian Development Bank Institute estimate compares with a very low Gini of 0.16 before China launched its reform and opening policies in 1978, is, therefore, temporary. China’s Gini will fall as the economy matures. Something of this sort occurred during the economic development of the U.S. In the late 18th century the top 1 percent of Americans are thought to have owned about 15 percent of the wealth. By 1855 the figure had risen to 30 percent, according to the U.S. Census. Inequality reached a peak around 1935, when the top 1 percent owned 45 percent of the national wealth and then began to fall to civil-war levels from World War II to the 1970s. But the end of the Kuznets curve is not the end of the story. From the 1970s inequality began rising again. By the time of Kuznets’s death in 1985 it was close to its putative development peak in the late 1930s, and it has kept on rising. The same is true of the U.K. Inequality has been rising steadily, apart from a brief dip in the late 1990s, and is currently at a historic high. As the table below of OECD and other selected Ginis shows, not all mature economies have Scandinavian-style equality. Table 4.2 Gini coefficients for OECD and other countries Country

OECD

Gini

Year

0.57

2005

0.49

2007

0.48

2006

0.47

2007

Brazil Argentina Mexico

yes

China United States

0.45

2007

Iran

yes

0.45

2006

Kenya

0.45

1997

0.44

2003

Russia

0.42

2008

Israel

0.39

2005

CIA Danger Line Turkey

yes

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Portugal

yes

Japan

yes

India

0.39

2007

0.38

2002

0.37

2004

New Zealand

yes

0.36

1997

Poland

yes

0.35

2005

United Kingdom

yes

0.34

2005

Switzerland

yes

0.34

2008

Greece

yes

0.33

2005

France

yes

0.33

2008

Italy

yes

0.32

2006

Canada

yes

0.32

2005

Spain

yes

0.32

2005

Ireland

yes

0.32

2005

Australia

yes

0.31

2006

South Korea

yes

0.31

2007

Netherlands

yes

0.31

2007

0.31

2005

European Union Finland

yes

0.30

2007

Belgium

yes

0.28

2005

Hungary

yes

0.28

2005

Germany

yes

0.27

2006

Luxembourg

yes

0.26

2005

Austria

yes

0.26

2007

Slovakia

yes

0.26

2005

Czech Republic

yes

0.26

2005

Norway

yes

0.25

2008

Iceland

yes

0.25

2005

Denmark

yes

0.24

2005

Sweden

yes

0.23

2005

Source: CIA, The World FactBook, updated April 2, 2009.

The table suggests the Kuznets hypothesis is probably true as far as it goes (economic development does increase inequality), but other factors also drive inequality and seem to remain active long after economic maturity is reached. Since the U.S. and the U.K. are arguably the most mature liberal capitalist economies, it is cause for some concern that, among OECD countries, only Mexico has a higher Gini than the U.S. and that, among European OECD countries, only Portugal and Poland have higher Ginis than the U.K.

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High levels of inequality cause serious social problems. In their book, The Spirit Level, Richard Wilkinson and Kate Pickett marshal a wealth of evidence showing that social ills, including rates of physical and mental illness, teenage births, crime, obesity and violence, and relatively low educational performance and social mobility, all correlate much more closely with the degree of inequality within societies than with absolute levels of income. Inequality is the curse of mature, liberal capitalist societies, particularly of the U.S. and the U.K. Wilkinson and Pickett argue that instead of addressing social ills on a piecemeal basis, policymakers should focus on reducing inequality.5 It’s not inevitable, of course, that all countries will follow the U.S. and U.K. path toward growing inequality. In Europe, there seems to be a divergence between the U.K. and southern European countries on the one hand, and more egalitarian patterns in Scandinavia and Germany on the other. Moreover, Ginis are influenced by traditions reflected in tax rates, as well as by distributions of value added within companies. It remains to be seen whether such national path dependencies (the tendency for traditional distributions of income and wealth to be maintained) will be strong enough to resist the upward pressure on national Ginis exerted by large, global corporations, organized on Anglo-Saxon lines. This book focuses on the U.S. and the U.K., however, and for these two countries, the danger is clear. We are in uncharted territory. Mature liberal capitalist societies have never been tested by such inequalities. No one knows how they will react. Protests, certainly. Riots, very possibly. Revolts and civil wars, unlikely. But there could well be a political lurch to the left, a return to some form of socialism, and a loss of market freedoms. Those who fear any such developments should be afraid. According to the U.K. Institute for Fiscal Studies (IFS) the U.K. Gini coefficient soared from 0.25 in 1979, to 0.34 in the early 1990s. “The scale of this rise in inequality,” the IFS authors commented, “has been shown elsewhere to be unparalleled both historically and compared with the changes taking place at the same time in most other developed countries.”6 The proximate causes of riots in Brixton, London; Moss Side, Manchester; and Toxteth, Liverpool in summer 1981 were said to be racial tensions, and the heavy-handed use by the police of the “sus” (suspicion) laws. But in his report on the causes of the Brixton riots Lord Scarman suggested “complex political, social and economic factors” had created a “disposition towards violent protest.” It seems likely that among these factors was the erosion of the public’s percep-

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tion of background fairness during a period in which inequality was rising at an unprecedented rate. The rapidly rising Gini during most of the Thatcher era (after the cuts in marginal tax rates, inequality fell in the mid-1990s) may have contributed to New Labour’s general election victory in 1997. People sensed the rich were getting richer and the fat cats in the City were coining it, resented the growing inequalities, and chose the party with the stronger egalitarian tradition. If this is what they thought, they were disappointed. After falling slightly in the early to mid-1990s at the end of the Thatcher era, the U.K.’s Gini rose again in Labour’s first term to a new peak of 0.35 in 2000–01. During Labour’s second term, it fell slightly, before resuming its growth and passing the previous peak in 2006–07. Insofar as voting for Labour in 1997 was voting against the growth of inequality during the Thatcher era, it was futile. Although there was no recurrence of inner city riots following New Labour’s signal lack of success in reducing inequality, there were rumblings of discontent. In the first of a series of articles in the Telegraph in early 2008 Judith Woods bemoaned the fate of what she called “the coping classes,” who were not in fact, as the IFS later pointed out, but felt impoverished. “While the working class is topped up with family credits and hedge fund managers cream off millions, it is Britain’s beleaguered middle earners who are under siege” claimed Woods.7 The IFS suggested this feeling of impoverishment among people with rising and well above average incomes may have had something to do with the rapid increase in the highest incomes. The authors looked at the 99 : 50 income ratio; incomes at the 99th percentile (the top 1 percent) relative to incomes in the middle. The ratio rose by over 15 percent between 1997 and 2007 “suggesting that incomes at the very top of the distribution have grown faster than incomes in the middle … This also means, of course, that incomes at the very top have been accelerating away from incomes at the 90th percentile [which had grown at the same rate as the median income]. This may go some way to explaining the sense of injustice allegedly felt by the outwardly affluent ‘coping classes’.” Since a consensus is sustained more by beliefs than by facts, what people perceive to be the case is more important for the future of liberalism capitalism than the facts of the case. Judith Woods’ “coping classes” are not actually impoverished, but the “millions” being “creamed off ” (interesting metaphor, see Chapter 5) by city fat cats and

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senior executives make them feel impoverished. This sense of injustice (the feeling that the background fairness that most people demand in return for their compliance with the system, which is by no means confined to the coping classes, of course) is deepened by the publicity now given to what are widely regarded as the excessive sums paid to company leaders. Ordinary people seem to have got it into their heads that city fat cats and company leaders are being paid not only hundreds of times more than the average, but much more than their “fair share”; much more than the Rawlsian difference principle allows; much more than the economic value they add. They are coming to be seen as “robber barons,” accumulating enormous wealth by means that are tantamount to institutionalized theft from the savings of ordinary people.

More than fair shares The financial crisis of 2007–08 is likely to be seen in retrospect as a turning point in the evolution of liberal capitalism. The consensus that sustained the system had been undermined by the erosion of background fairness during the previous decade, but had survived because the rising tide of stable economic growth had, as promised, lifted all ships. The difference principle that required inequalities to be in the interests of the disadvantaged seemed to be working, more or less. Ordinary people may have grumbled a bit, but, by and large they trusted the putatively extraordinary people who were managing the system (the CEOs and fat-cat financiers) and tolerated their manifestly extraordinary pay levels. Executive pay was certainly an irritant, but not a provocation. While the system was delivering the goods, most people accepted these pay packets as the going rates for the allegedly “rare skills” needed to do these vital system management jobs. It was natural that when the system crashed, the system’s managers should be called to account. The irritation with executive and fat-cat pay became indignation, bordering on outrage, when some of the fat cats and CEOs walked away with bulging pockets from the disaster they had helped to bring about. Charles (“Chuck”) Prince resigned as CEO of Citigroup, the largest U.S. bank, in November 2007, shortly before the company announced a fourth quarter loss of almost $10 billion, after over $22 billion of write-downs for subprime mortgages and consumer loans granted on

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his watch. In a farewell statement Prince said: “given the size of the recent losses in our mortgage-backed securities business, the only honorable course for me to take … is to step down.”8 Honorable, he may have been, but Prince was hardly destitute. His severance package consisted of vested options, deferred stock and restricted shares, and a pro rata slice of his 2006 bonus adjusted for 2007 shareholder returns. That added up to about $40 million.9 Merrill Lynch, the “thundering herd” financial services group, was forced into a rescue merger with Bank of America after making a $7.8 billion net loss in 2007. Chairman and CEO, Stanley O’Neal, retired in October 2007 taking $161.5 million worth of securities and retirement benefits with him.10 It was “punishments” for mismanagement such as these that led the U.S. Democrats to insist on the inclusion of restraints on executive pay in legislation giving effect to the government’s $700 billion Troubled Asset Relief Program (TARP). These restrictions, which at the time of writing in early 2009 were widely expected to become a model for comprehensive federal legislation limiting executive pay in general, and reducing tax reliefs associated with it, reflected the nature of public concerns about the way senior executives were being rewarded.

TARP restrictions on executive pay Outgoing U.S. President George W. Bush signed into law the Emergency Economic Stabilization Act of 2008 (EESA) on October 3, 2008. EESA authorized the Department of the Treasury to use a “Troubled Asset Relief Program” (TARP) to buy up to $700 billion of residential or commercial mortgages, mortgage-related securities, obligations or other instruments originated or issued on or before March 14, 2008 from financial institutions either directly or at auction.11 In response to the concerns that taxpayers’ money might be used to enrich the executives of firms taking advantage of the TARP, EESA included provisions restricting compensation for “senior executive officers” (the top five most highly paid executive officers) and reducing associated tax deductions under the 1986 Internal Revenue Code, at participating institutions. When a financial institution sells assets directly to Treasury and Treasury gains “a meaningful equity or debt position,” the company has to meet “appropriate standards for executive compensation and

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corporate governance” while Treasury holds the equity or debt. The appropriate standards include: ■■ No incentive arrangements that encourage senior executives to take

“unnecessary and excessive risks that threaten the value of the financial institution.” ■■ The company must claw back any bonus or incentive payments to senior executives based on financial reports that later prove to be “materially inaccurate.” ■■ No “golden parachute” payments to departing senior executives while Treasury holds the equity or debt. When a participating institution sells over $300 million of assets to Treasury, it cannot sign new employment agreements with senior executives that include golden parachute arrangements in the event of an involuntary termination, a bankruptcy filing, insolvency, or receivership, for as long as the TARP is in effect (until December 31, 2009 initially, but it can be extended until October 3, 2010). The tax code’s $1 million a year limit on the deductibility of the pay of top executives of public companies, introduced during Bill Clinton’s presidency, is reduced by EESA to $500,000 for financial institutions that sell over $300 million of assets to Treasury. The exception for performance-based rewards, such as shareholder-approved, equitybased incentive plans, is withdrawn; their income counts toward the $500,000 cap. These lower caps remain in effect while the TARP remains in effect. The tax code imposes a deduction limit on parachute payments after a change in control, and a 20 percent tax on any excess. The EESA extends these provisions to payments to “covered executives” (CEO, CFO, and the three other most highly paid officers) of companies receiving $300 million or more from the TARP, in the event of involuntary termination of employment by the institution, bankruptcy filing, insolvency or receivership, whether or not there is a change of control. The EESA specifically states that the amounts treated as EESA golden parachute payments cannot be reduced by amounts deemed reasonable compensation in the change-in-control provisions. Here too, the provisions apply while the TARP remains in effect. These restrictions on executive compensation at TARP beneficiaries have been criticized for not going nearly far enough, for going so far that institutions affected will be unable to hire sufficiently talented executives, for being unworkable or easily evaded and for not defining key terms,

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such as “involuntary termination,” “golden parachute,” “meaningful equity or debt position,” “unnecessary and excessive risks” and “appropriate standards” for executive pay and corporate governance. Whether or not any of these criticisms have any merit, and whether or not the TARP rules effectively rein in excessive executive pay, the EESA conditions for TARP participation illuminate the concerns of Americans about executive pay in the midst of a major financial crisis and on the brink of what seemed at the end of 2008 to be an unavoidable recession, likely to be both deep and prolonged. There were four major concerns. The first was that the incentive plans for top executives designed to reduce agency costs by identifying the interests of executives with those of shareholders, were having the unintended consequence of encouraging executives to take “unnecessary and excessive risks that threaten the value of the financial institution” or companies in general. This was largely because the incentives were “up-side loaded” – there were rewards for outperformance, but no penalties for underperformance. Some senior Democrats, including Massachusetts congressman, Barney Frank, chairman of the House of Representatives financial services committee, want to outlaw such asymmetry. “If you take a risk and it pays off, you get a bonus,” Frank told the Financial Times. “If you take a risk and lose the company money you break even. That is a bad incentive. I don’t care about bonuses going forward, as long as we deal with deductions going backward. We have to find some way to make that a law … They can have any bonus they want as long as it’s a two-way street.”12 The second concern was that, because incentive plans were based on numbers in financial statements over which senior executives had a considerable amount of influence, there was scope for “gaming” the plans by fudging the figures. This was why the TARP rules required participating companies to claw back incentive plan payments based on figures that later proved to be “materially inaccurate.” The third “concern,” if that’s not too mild a word to describe the indignation of many Americans at the huge pay-offs to the likes of Chuck Prince and Stan O’Neal (see above), is with the particularly provocative manifestation of upside loading, known as the “golden parachute.” Huge rewards for failure strike people struggling with the consequences of such failures as outrageous affronts to normal standards of fairness. In Rawlsian terms they are gross violations of the difference principle’s implicit requirement that pay should be proportionate to economic value added. TARP conditions ban new golden parachute

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contracts with senior executives of participating institutions and, at the time of writing, there’s pressure to make them generally illegal. The fourth concern revealed by the TARP rules is that, quite apart from the reckless risk-taking encouraged by the upside loading of incentive plans and the unfairness of golden parachutes, senior U.S. executives are paid too much. This is reflected in the halving of the tax code’s $1 million a year limit on the deductibility of the pay of some senior executives of public companies participating in the TARP.

The gathering storm A puzzling feature of the U.S. and to a lesser extent the U.K. debates on executive compensation is that, so far at any rate, people seem less concerned about the absolute levels of executive pay than the asymmetry of incentives and rewards for failure. Despite high and growing inequality in both countries (as indicated by their Gini coefficients), there seems to be a wide public acceptance that it is reasonable to pay “C-level” executives orders of magnitude more than ordinary employees. Graef Crystal, doyen of American executive pay commentators, takes an admirably hard line on CEO pay packets, but, as two articles on his excellent website in late 2008 showed, he reserves most of his scorn for high pay without high performance. He expressed disgust at the $21 million paid to H. J. Heinz Co.’s CEO, William Johnson, for 2007–08, because Heinz’s performance that year was average, but approved of the $27 million a year paid to Hank Paulson, Secretary of the Treasury in George W. Bush’s government, during his stint as CEO of Goldman Sachs, because the bank handsomely out-performed during his stewardship.13 Leaving aside, for the moment, doubts the reader may harbor about assigning credit and blame for above and below average performance to CEOs alone, public indignation about executive pay before the crash was focused on high pay for average or below average company performance, rather than on high pay itself. Possible explanations for the hitherto sanguine public attitude to very high levels of executive pay include the belief that they are actually worth what they are paid (this is less plausible and less prevalent since the crash), good public relations (calling senior executive pay “compensation” was a PR masterstroke), a lack of resolution in public perceptions (an extra million or so a year is neither here nor there) and the distinctive American culture (the “American dream”) which idolizes entrepreneurs and admires wealth itself.

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But, as noted at the beginning of this chapter, wide acceptance of the system and, in this case, executive pay, is not unconditional. The consensus must be maintained. Another million here and another million there and pretty soon you’re talking about serious money. People will notice. If they begin to believe the inequalities they’ve tolerated hitherto are getting out of hand, or that the system is rigged, their admiration for the wealthy and successful could turn to resentment. Executive compensation was already an issue before the crash. When the chairman of the U.S. Securities and Exchange Commission (SEC), Christopher Cox, announced his review of executive pay disclosure rules, the recommendations of which were implemented in 2006, the SEC received a then record 30,000 letters from investors and other interested parties.12 The crash, and particularly the shower of golden parachutes it ejected, heightened public sensitivity and reduced Americans’ admiration for wealth. As former SEC chairman, Harvey Pitt, said: “It is decidedly un-American to pay people when they don’t perform and don’t do the job[s] they were hired to do. It’s a huge issue that boards have not really addressed in the way they should be addressing it.”12 This is a critical period for the liberal capitalist consensus. If board Remuneration Committees (RemCos) do not substantially rein-in Anglo-Saxon senior executive pay levels in the next year or so, popular demands for legislation imposing restrictions much tighter than those contained in the EESA could become irresistible. It will not be easy for RemCos, for political, legal and technical reasons, to achieve such a reining-in.

Barriers to reform A Democrat in the White House, and a Democrat majority in Congress provide a more threatening political environment, which should, on the face of it, make it easier for RemCo reformers to insist that, if companies do not regulate executive pay themselves, legislators will do it for them. But there is still plenty of political support for, and opposition to, changes in the status quo in executive pay. Free marketeers have billed plans to reintroduce a so-called “say on pay” law, similar to those in the U.K. and elsewhere, which would give shareholders a non-binding vote on executive pay, as a left-wing bid for power in company boardrooms, and the bill itself as a gross, unwar-

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ranted intervention in the workings of the market. The original bill was passed by Congress, but got stuck in the Senate, where its sponsor was the then senator for Illinois, Barack Obama. The bill could be law by the time you read this, but some suggest fund managers who vote against pay packages designed to motivate executives to improve performance could be in breach of their duty to fund beneficiaries to maximize the value of their holdings. Given the non-binding nature of the proposed “say on pay” vote and the fairly relaxed attitude to executive pay of most institutional shareholders, apart from union pension funds and a few “socially responsible” investors, the bill was hardly a major threat, on its own, to the status quo. The opposition of American liberals to the bill probably stemmed more from philosophical, than from practical concerns. They saw it as an ominous, if minor, withdrawal of hard-won freedoms; as a small step on The Road to Serfdom (the title of an important libertarian book by the liberal philosopher and Nobel laureate economist, Friedrich von Hayek). The vigilance of American libertarians in protecting freedoms, and opposing any developments or proposals that could be construed as thin ends of wedges leading to more state control is admirable and healthy, because it’s true that the road to neo-socialism is paved with good intentions. But better the thin end than the thick. A much more potent threat to liberal capitalism than non-binding “say on pay” legislation is the alarming possibility that, rather than moderating in the wake of the crash, for technical reasons relating to options, executive pay could explode again as equity markets recover. When compensation consultants are asked to recommend pay deals for top executives, their normal practice is to identify a “comparator group” of companies of a similar size in the same industry, trade information with the comparators on total pay, including the value at grant of stock options (estimated with the Black-Scholes model) for the positions concerned, and make recommendations based on the RemCo’s brief. This could be the average for the comparator group, or, if a client wants a reputation for paying well, a higher point in the distribution, such as the 75th percentile (the top quarter). Options are important components of pay packages, because they are seen by investors as identifying the interests of executives with those of shareholders. But a key variable, when estimating BlackScholes present values, is recent share price performance. If the company has performed well and its share price is high, the Black-

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Scholes value of options will be high on date of grant. This leads to the perverse result that, if the desired position within the comparator group is to be maintained, fewer options can be granted when the company’s share price is high. Apart from making a mockery of the putative incentive effect (when a share price is high, it’s likely to be harder for the CEO to get it higher, so more options are needed to maintain the incentive), this has alarming implications for executive pay rises in the next year or so. We have seen why fewer options can be granted when the share price is high. The reverse is also true. In the absence of agreement between companies to moderate option grants, more would have to be granted when the price was low, if the desired position within the comparator group is to be maintained. Since all share prices plummeted during the 2008 crash, the normal practice for compensation directors and consultants, would be to recommend grants of very large numbers of options in 2009. If, as expected and fervently hoped, equity markets recover over the next few years, these will become very valuable and cause executive pay to rocket. As Crystal put it: “If you think ordinary Americans are pissed now over high executive pay, fasten your seatbelt.”13 The executive pay explosion may be even larger if RemCos decide to compensate executives for the fact that so many of their pre-2008 options are “under water” (worthless), by granting them even more options than Black-Scholes values may suggest. The same applies to grants of restricted shares that “vest” after a specified period, which have become popular recently for motivating and retaining executives. Extra large grants of restricted shares to compensate for losses on those granted before 2008 will also supercharge pay in recovering equity markets. There’s a ratchet at work here. When markets tumble, BlackScholes calculations and RemCos anxious to retain executives whose options are worthless and whose restricted shares are worth much less, sow the seeds of another executive pay explosion during the subsequent upswing.

A dangerous decadence Although to understand the calculus of executive compensation, is to have some sympathy with the RemCo’s dilemma, it should be clear to company directors, who in their executive roles are among the greatest

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and most conspicuous beneficiaries of liberal capitalism, that the system needs yet another executive pay explosion over the next few years like it needs a hole in the head. But they can’t see the wood for the trees. They are locked into a comparative, rather than an absolute, way of looking at executive pay. They do not want to be too generous relative to their peers because investors would object, but neither do they want to appear pennypinching, or to break ranks and adopt pay policies that seem fair to ordinary people. They don’t want even to think about that, because they know, deep down, that a pay policy that seems fair to the man on Main Street would require reductions in current levels of executive pay of at least an order of magnitude; reductions, in other words, of at least 90 percent. Directors hear the public outrage, but they don’t heed it. They’re much too busy watching their peers and making sure that, according to the benchmarks, they and their senior executives are overpaid enough. They must heed the public outrage, try to see themselves as others see them, and particularly as voters see them, and wean themselves from their addiction to already enormous and constantly rising pay packets. So persistent is the upward surge of executive pay, so egregious is its level and so heedless are the executives themselves of popular objections to it, that it is easy for ordinary people to see it as evidence of a fin de siècle decadence and to see CEOs as sybaritic Bourbon monarchs, advised by obsequious courtiers (including their compensation consultants), heedless of the breadless masses on the eve of the French Revolution. But to suppose it’s all because of greed would be to miss the most important point.

The argument so far Companies, and the work they provide, are not as most people would like them to be, because the company has not adapted sufficiently to today’s business environment. Moreover, the power and pay large companies assign to their CEOs has led to growing inequality and a pervading sense of injustice, which threaten to erode the liberal capitalist consensus. The question we turn to in the next chapter is whether this inequality and injustice are prices we have to pay for the system’s economic efficiency.

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References 1 2 3 4 5 6 7 8 9 10 11 12 13

A Theory of Justice, page 303, Oxford University Press, 1972. Belknap Press, 2001. Social Unrest in China, May 8, 2006, CRS. “Distant Thunder,” August 18, Financial Times. The Spirit Level: Why More Equal Societies Almost Always Do Better, Richard Wilkinson and Kate Pickett, Allen Lane, 2009. Poverty and Inequality in the U.K.: 2008, Mike Brewer, Alastair Muriel, David Phillips and Luke Sibieta, Institute for Fiscal Studies, Commentary 105. “The Coping Classes – Part 1: Why do we all feel so damn poor?” Telegraph, January 29, 2008. Citigroup press release, November 4, 2007. “Citigroup gives ex-CEO Prince $40 million severance package,” by Dan Wilchins, International Business Times, November 10, 2007. U.S. Securities and Exchange Commission filing, October 30, 2007. U.S. Department of the Treasury, HP-1207, October 14, 2008. “Fear of falling,” Francesco Guerrera and Joanna Chung, Financial Times, January 6, 2009. The Crystal Report on Executive Compensation, GraefCrystal.com.

5 Not so much greed

We saw in Chapter 4 how the high current levels of executive pay are undermining the political consensus on which the survival of liberal capitalism depends by increasing inequality to a dangerous level, and eroding the public’s belief that, by and large, liberal capitalism produces fair and reasonable distributions of wealth. This chapter will focus on the questions of why, given its obvious dangers for liberal capitalism in general and company executives in particular, this unfairness arose in the first place and why, in the face of the growing chorus of opposition, it persists. Various answers to these two questions have been proposed over the years, and I shall suggest some more later on. But I want to start with a suggested answer that is widely subscribed to, and probably contains an element of truth, but which is, in my view, inadequate at best, unhelpful and distracts attention from far more important issues.

Greed Many people who object strongly to what they see, quite rightly in my view, as obscenely high levels of executive pay, attribute these annual king’s ransoms to greed. It is an appropriately ugly word, which, with a little practice and the addition of adjectives such as “sheer,” “breathtaking” or “insatiable,” all of us can spit out with considerable venom and indignation. It is usually left at that. Today’s breathtakingly high levels of senior executive pay are explained as the products of a character flaw that afflicts the tiny fraction of the population who succeed in climbing to the tops of corporate ziggurats. There are three implied assumptions in this explanation – greed is bad; greed is unnatural; if others with natural appetites ran our corporations they would not demand such huge pay packets, and the social tensions they are beginning to cause, which make them in my view the Achilles heel of modern capitalism, would be eased. 88

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All three assumptions are open to question. The word “greed” has many meanings. It is excessive consumption of or a desire to consume excessively, food, as in “greedy guts”, and is thus a synonym for gluttony. Through metaphorical extensions it has come to mean excessive consumption of – or a desire to consume excessively – more or less any thing or any sensation, and has in the process acquired overtones of selfishness and rapacity. It is also used as a synonym for avarice and acquisitiveness, and, more generally, for hunger and desire, when a pejorative implication is intended. In the context at hand, it means a hunger or desire for money, and although a pejorative implication is most certainly intended, it’s arguable whether it’s warranted. In the 1987 film, Wall Street, Gordon Gekko, the anti-hero played by Michael Douglas, said in a speech at a general meeting of a company he was planning to acquire that greed was good. In the film, this was merely a disingenuous apologia for avarice, cobbled together for the “good prevails over evil” plot. But, as is often the way with a parody, it contained truth. It was also an eloquent articulation of the dynamic and situational logic of free markets. Greed is hunger, without which free markets would not keep moving resources to higher value uses. Greed, in the sense it is used in the executive pay debate, is not good or bad in my view, and nor is it “unnatural.” In the passage quoted in Chapter 2, Max Weber made the same point: The impulse to acquisition, pursuit of gain, of money … exists and has existed among waiters, physicians, coachmen, artists, prostitutes, dishonest officials, soldiers, nobles, crusaders, gamblers and beggars … it has been common to all sorts … of men, at all times … wherever the … possibility of it is or has been given.1 If greed, in Weber’s sense of “The impulse to acquisition, pursuit of gain, of money” is natural, we can’t be sure that a change of personnel at the top of our major companies would moderate senior executive pay sufficiently to remove the deep sense of unfairness that is eroding the liberal capitalist consensus. I do not believe it would. Given the opportunity, almost all of us are acquisitive. Those who rail against the greed of company executives should ask themselves whether they would behave any differently if they found their way into an orchard where money grows on trees. To explain the executive pay explosion as evidence of an unnatural greed is to miss the point and divert attention away from the real and

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serious problem; that there’s something wrong with the system. If greed is the only explanation, if the political–economic system we have chosen cannot help but allow a few people to indulge their impulse to acquisition so extravagantly, liberal democracy and its economic system of capitalism are in trouble, because it’s hard to imagine how any political–economic system could survive such gross inequities in the long term. Those who rely entirely on greed to explain today’s extremely high levels of executive pay must confront the logical implications of their explanation; namely, that these rewards are the creatures of capitalism itself, or rather, of the interactions of natural human impulses with the capitalist system. Their proposition is that the freedom to indulge our natural human impulses within a free market system leads, inevitably, to huge disparities in income and wealth and such disparities, and the sense of unfairness they foster, are the price we have to pay for the superior allocative efficiency of the free market system. I hope, we should all hope, this isn’t true and I don’t believe it to be true for two reasons. The first is that it is the growing sense of unfairness created by gross disparities in income and wealth that is eroding the liberal capitalist consensus, not the disparities themselves. People don’t begrudge entrepreneurs their wealth. I don’t believe the wealth of very successful entrepreneurs such as Bill Gates, Steve Jobs, Sir Richard Branson, James Dyson and Anita Roddick, contributes to the public sense of unfairness, and thus to the erosion of the liberal capitalist consensus. Most people admire entrepreneurs and regard their wealth as a fair reward for their creativity. Few people see it in these terms, but most believe, in effect, that in making entrepreneurs wealthy, the system is working efficiently and, therefore, fairly. It is the greedy guts, those who seem to be taking more than their fair shares, who cause resentment. The deep sense of unfairness is generated entirely by the rewards being paid to executives, not to those being earned by entrepreneurs. It stems from the widespread belief that, when granting these rewards to executives, the system is working inefficiently and therefore unfairly; that executives are paid extremely well, not because they are (like entrepreneurs) extremely creative, but because they have found a way to evade the system’s automatic regulators and, in common parlance, “rip it and the rest of us off.” They’re grabbing more than their fair shares. Their rewards are out of all proportion to the economic value they create for the shareholders who employ them.

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This perception is basically sound. The system that sets executive pay levels isn’t working properly. But there is no conspiracy. Top executives aren’t all consumed by greed and cynically manipulating their reward systems to line their own pockets. Some might wish to. Some may try to. Some may even succeed to some extent. But there are regulators, in the form of shareholders, and corporate governances laws, rules and codes of practice. It’s true they do not work well, but an unlawful manipulation of the system can still lead to a jail sentence. That such corruption is rare is partly because most executives are law-abiding, partly because it is risky and partly because there’s no need. CEOs can do very well for themselves without cheating. The real problem lies, not so much in greed or in low standards of compliance with executive reward systems, as in fundamental flaws in the executive reward system itself. It produces “more than fair share” rewards, because: ■■ In the absence of any suitable performance measurement for CEOs,

their reward systems default to what I call “asset-skimming.” ■■ The CEO “market” operates within an alliance (between companies and capital markets) that is riddled with conflicts of interest and conflicts of interest and duty. ■■ The executive pay explosion in the 1980s was the consequence of the arrival of shareholder value analysis and the deregulation of financial services. ■■ The transformation of the CEO from the most senior “manager” to the superstar “leader” effectively closed the CEO market. This is the second reason why I don’t believe that unfairness is a price we must pay for the free markets. Enormous executive rewards are the result of a “market inefficiency” the system has so far failed to correct. The market in question is the market in management and “leadership skills.” Whatever else divides those who find today’s high levels of executive pay acceptable, and those who see them as evidence of sheer greed, they are united in believing that the market in these skills is efficient. If it is not, then the actual pay rate is not the market clearing rate (it may be higher or lower) and, on the far from heroic assumption that it’s higher, sheer unnatural greed is not the only explanation for it. It’s one thing to allege a market inefficiency, however, and quite another to demonstrate and describe it.

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Asset-skimming Years ago when I was a young financial journalist I wrote a letter to an estate agent who had just sold my mother’s house. I was very rude. I told the agent that, for a deal in which an aggressive and unscrupulous buyer had “reverse gazumped” my mother (unilaterally reduced the agreed price) the day before she went on holiday, his fee for printing a few brochures and attending a few viewings was much too high. I went on to say that what irritated me most of all was that his professional qualifications as a valuer and surveyor, the initials of which he proudly displayed on his literature, were of no relevance at all to the business of selling a house. I received a rather sniffy reply, which conveyed (quite eloquently if I recall) a nice blend of injured pride and mild reproof, and pointed out that my mother had agreed his terms – 2.5 percent of the sale price – before his engagement. The correspondence ended there. I had had my say and was not involved in buying and selling houses often enough to feel inclined to make an issue of it. But I wasn’t alone in those days in thinking there was something a bit “shady” (as my mother would have said) about the estate agency business, and that agents were getting more than their fair share. Estate agency fees have come down since. I paid 1.25 percent when I sold my mother’s last house. But, in view of what had happened to house prices in the intervening 30 years, it still seemed a bit of a rip-off. My impression is that many people feel the same way today about estate agents with their flashy cars, tailored suits and patronizing airs. They seem, or seemed until the house market stalled in 2008, like a bunch of spivs who were charging much more than the services they provided were worth. Most people are paid for the value they add, either directly, with piece rate or more usually nowadays through the “proxy” of time worked or spent in the office. Estate agents, investment bankers, securities brokers and fund managers don’t get paid for the value they add or the time they work. Their income takes the form of a levy on the assets that pass through their hands, or are entrusted to their care. It is the same for senior company executives. They do get paid for time worked, in the form of a basic salary and of contributions to their pension funds, but this is usually just pocket money. By far the largest components of their pay are equity incentives, such as issues of options and restricted stock, both of which skim a slice off the company’s value by diluting the holdings of other owners.

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Asset-skimming of this kind yields substantial rewards that have little to do with the economic value executives add while markets are buoyant. And, as we saw in Chapter 4, extra issues of options and stock are quite common after markets take a dive. Bear markets are very useful for executives, because they increase their gains in subsequent bull markets. It works like a ratchet, or the jiggle siphon you use to drain your fuel tank when you don’t want a mouth full of petrol. The more the market jiggles, the more options and stock senior executives accumulate, and thus the greater their pay packets over the whole cycle.

An unwholesome alliance Partly because they are paid in the same “asset-skimming” way CEOs and City and Wall Street investment bankers share similar outlooks and have common interests. They share, for example, an intense interest in balance sheets. The influence of the CEO on a company’s profit and loss account is more limited than is normally supposed, because any improvement in operating profitability is the achievement of many employees, not, as is implied by his or her pay packet, the personal achievement of the CEO. The CEO’s real power base is the balance sheet. That’s where he or she (almost invariably he) bets the farm by borrowing, making acquisitions, launching new businesses or investing more in existing businesses, and, by proxy (through putatively independent non-executive directors on the RemCo) diverting value into his own pocket with issues of options and restricted stock. RemCos themselves have their own conflicts of interest and duty. Those who support the status quo in executive pay usually cite the huge pay packets of sport stars, such as David Beckham, and suggest it is inconsistent to be sanguine about the latter, while opposing the former. I will examine this argument in more depth in the next chapter. Suffice it to say here that the rewards of sports stars are not decided by other sports stars, whereas members of RemCos, although non-executive directors, are usually executive directors of other companies, and thus have a clear interest in ensuring the level of executive pay in general remains high. Because investment bankers make most of their money from corporate balance sheet operations, such as bond and share issues (on which they earn large, asset-skimming underwriting fees) and mergers and acquisitions (M&A), they encourage CEOs to exploit their balance sheet powers to expand their businesses by these means. CEOs tend to

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be favorably disposed toward such encouragement, because there is a strong link between the size of a company and the size of its CEO’s pay packet. Since there is no such link between company size and profitability, insofar as CEOs seek higher rewards by pursuing growth opportunities that offer returns below the cost of capital, shareholders suffer. In this case, the interests of the investment banker (who earns transaction fees) and the CEO (who is paid more) coincide, but are in conflict with the interests of shareholders. And the interests of the CEO are also in conflict with his duty to shareholders to maximize shareholder value. The quest for size at the expense of shareholder value is a common agency cost that’s sometimes actually encouraged by those, or their representatives, who incur it. When U.K. retailer Kingfisher announced plans to sell its Superdrug and Woolworths businesses in August 2001, a National Association of Pension Funds (NAPF) spokesman took what in any other context would have been a commendably tough line on the pay of Sir Geoff Mulcahy, Kingfisher’s CEO, by arguing that, since the size of the company would diminish, Sir Geoff’s pay should be reduced.2 But this was dangerous talk, because it appeared to endorse a link between size and pay, and thus to encourage CEOs to overpay for acquisitions and to refrain from making value-creating divestments. Conflicts of interest, and conflicts of interest and duty were also evident after U.K. cellphone operator Vodafone’s acquisition of the German conglomerate Mannesmann (one of the largest takeovers on record) in 2000. Top Mannesmann and Vodafone executives, including Vodafone’s CEO Sir Christopher Gent who received a £10 million “transaction bonus” in shares and cash, and the investment banks involved, did extremely well out of the deal, but Vodafone’s shareholders subsequently suffered a substantial fall in the value of their holdings. Wealth itself is part of the bond between an investment banker and his or her CEO client. Thanks to their asset-skimming success both are extremely wealthy by normal standards. They feel comfortable in each other’s company for that reason and see the world from the wealthy person’s point of view. Most are honest, law-abiding and ethical, but because of the balance-sheet power of CEOs and of the investment bankers who have influence over them, the world is more manipulable for them than it is for ordinary people. And nothing CEOs do is more intense and exciting than exercising that power to manipulate by making bold, industry restructuring acquisitions. Imagine how the CEO feels at a meeting with his investment bankers after a rival bidder has offered more for the target. The bid team is

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discussing whether to withdraw or increase the offer. The deal is on a knife-edge. Adrenalin surges through his body. To withdraw now is to lose. His investment bankers, fearing the loss of their success bonuses and the underwriting fees on the share issue that will finance the acquisition, urge him to stick with it, bid again and “dare to be great.” It may be in the interests of shareholders to withdraw from the auction, but it is in the interests of no one in the room. Even for a CEO who is scrupulous about acting in the interests of shareholders, the temptation to run the due diligence numbers again with more optimistic assumptions on postmerger cost savings, so that they justify a higher bid, can be irresistible.

An unhappy coincidence One of the puzzling questions about senior executive pay is why it took off so dramatically in the late 1980s. According to a recent study by America’s Economic Policy Institute (EPI) the CEOs of the 350 largest U.S. public companies were paid on average 24 times the pay of a typical U.S. worker in 1965. The ratio rose steadily, but not dramatically over the next decade or so, to reach 35 in 1978. Over the following decade, the ratio doubled, to 71 in 1989 and then rocketed to reach 298 in 2000. The bursting of the dot. com bubble reduced the value of equity-based compensation and the figure fell to 143 in 2002. But the ratio of CEO to worker pay quickly resumed its rapid rate of growth and within five years was close to its 2000 peak at 275. “In other words,” the EPI study pointed out, “in 2007 a CEO earned more in one work day [there are 260 in a year] than the typical worker earned all year.”3 Executive pay packets aren’t as enormous in the U.K., but they’re in the same ballpark. The Guardian newspaper’s 2008 annual survey of executive pay found that 34 of the 956 directors of FTSE 100 index companies were paid, including salary, bonuses and shares but not pension contributions, more than £5 million in 2007, up from 20 in the previous year. Eight directors were paid more than £10 million and three took home more than £20 million.4 The average CEO’s pay fell slightly, from £2.9 million in 2006, to £2.8 million in 2007, compared to the average U.K. employee’s pay of £24,000. That means the average FTSE 100 CEO was paid 117 times more than the average employee. You have to take care with the figures, because some analysts with axes to grind count options when they’re granted (at Black-Scholes

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values) and when they’re exercised, and so end up with much higher ratios than the EPI’s. But all the time-series analyses of the CEO pay : typical worker’s pay show that sudden acceleration in the late 1980s. I was a financial journalist at the time and preoccupied with two major, long-running stories. The first was the run-up to and fall-out from Big Bang – the deregulation of financial services – in 1986, which led to the development of modern investment banks. The second major story, less dramatic at the time, was the arrival of a new (to most CEOs at the time, at any rate) and, it transpired, influential idea about how companies should be managed. It came to be known as “shareholder value” and was, initially, not so much a prescription for a company leader, as a description of how markets valued companies. Jack Welch, CEO of U.S. giant General Electric (GE), is usually said to have been the first CEO of a major company to adopt shareholder value as a fundamental strategic objective, but there were several precursors, including James (later Lord) Hanson of Hanson Trust, who employed shareholder value strategies before they became known as such. Alfred Rappaport provided the intellectual basis for the shareholder value revolution in his 1986 book Creating $hareholder Value: The New Standard for Business Performance.5 It became the bible for a new generation of company leaders dedicated to the maximization of shareholder value. I found and still find the idea that the sole purpose of a company is to maximize shareholder value, in the form of capital gains and dividends (“total shareholder returns”), very appealing. It seems to me to be true, in the sense that the share price of a company that has a purpose other than shareholder value maximization (SVM) will be lower than it would otherwise be and the company will be vulnerable to a takeover. It is an evolutionary process. Companies that don’t maximize value are consumed by those that do. The SVM prescription is little more than an “exploration of the situational logic,” as Sir Karl Popper described Darwin’s theory of evolution. Others object strongly to the SVM imperative, and insist companies should have higher purposes. Advocates of this “stakeholder” model of the company argue that companies have responsibilities, which they should acknowledge, to employees, customers, suppliers, local communities, society at large and the environment, as well as to their shareholders. This is silly. The capitalist system does not, and would not work that way. A non-owner stakeholder (I prefer the word “constituency”) cannot (and should not be empowered to) hold a company to account as can its shareholders. But a company that doesn’t take employees,

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customers, suppliers, communities, society at large and the environment into account would find it hard to create value for anyone. The SVM idea is valid and healthy, and its adoption by most listed companies has probably led to the movement of a vast quantity of productive resources to higher value uses. But its success has had an unfortunate side effect. The main benefit for shareholders when a company adopts SVM as its principal objective is that, other things equal, the agency costs they incur when their hired managers have other objectives will be reduced. It followed from this that the best way to ensure senior executives focused on shareholder value was to give them “skin in the game,” in the form of equity-based incentives. Because of the market’s poor performance during the 1970s executive stock options had been out of fashion since the mid-1960s. They came back with a bang during the shareholder value revolution and have since soared way past their peak in the mid-1960s when, according to Rappaport, gains on options accounted for roughly a third of senior executive compensation. SVM evangelists, like Joel Stern, the co-founder, chairman and CEO of Stern Stewart, an influential “managing for value” consultancy, say that as far as equity-based incentives are concerned, the more the better. I had lunch with Stern in London, when SVM was getting into its stride. I liked him. He’s great company; a showman in the dry numbercrunching SVM world, who could talk the hind legs off a donkey. “If the sky’s the limit” he told me, “people tend to reach for the sky.” Stern Stewart’s concepts of Economic Value Added and the “bonus bank” were healthy restraints on the indiscriminate use of stock options in executive pay, but it was thanks to Joel Stern and others like him that it became conventional wisdom in the U.S. and U.K. investment communities that, if shareholders wanted maximum value, they had to offer CEOs the prospect of becoming seriously rich. There was no suggestion that this was necessary to encourage others as tournament theory suggests (see Chapter 2). The incentives were for the CEOs themselves. The puzzle is why the investment community accepted these huge CEO rewards. It was in the interests of asset managers, and the savers they act for, to deter CEOs from imposing agency costs associated with non-SVM strategies, but it seems odd on the face of it that they were so sanguine about exchanging one kind of agency cost for another; namely huge CEO pay packets. Some institutional investors have been quite aggressive in demanding more effective performance links and shorter contract terms, but the investment community as a whole has

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exerted very little downward pressure on the obviously excessive absolute level of executive pay. One possible explanation for this curiously relaxed attitude to an important and growing agency cost is the impact on the vigor with which institutional investors police agency costs of the emergence of large, integrated investment banks after the deregulation of financial services in the 1980s. There were supposed to be barriers or “Chinese Walls,” as they were called, between the activities of integrated investment banks, but even Chinese Walls have ears. Investment banking is the most profitable activity, and is thus in the driving seat at integrated banks. Notwithstanding the Chinese Walls, therefore, it’s not in the interests of brokers, securities traders, investment analysts and fund managers, whose bonuses may be affected by group results, to do anything or say anything that might damage in any way the relationships between their investment banking colleagues and the latter’s CEO clients. The conflict between the duty of fund managers, as agents of their beneficiaries, and their own interests as colleagues of investment bankers, may, in other words, be partly responsible for the signal lack of opposition from investors to soaring CEO pay packets.

The cult of leadership If we reject greed as an adequate explanation for excessive levels of CEO pay, and we accept asset-skimming as a form of remuneration unconstrained by a link to value added or time spent working, our explanation so far for the high absolute levels of executive pay consists of two components. The first is the inferences drawn, by management theorists, Remcos and the investment community, about executive rewards from the new shareholder value performance standard. The second is the lack of opposition to “the sky’s the limit” pay packets from the investors who pay them, which may itself be a consequence of the integration of investment banking and fund management under one corporate roof and the impact this has had on the willingness of fund managers to object to such pay packets. This is consistent with the description of the CEO market provided by Harvard Business School professor, Rakesh Khurana, in his brave book – it is dangerous to bite the hand that feeds you consultancy work – Searching for a Corporate Savior.6

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Khurana argues that the market for “external” CEOs – as opposed to CEOs appointed from within the company – is not a “market” at all, in the neoclassical sense, where large numbers of transactions set the equilibrium price, no single transaction influences the market as a whole and perfect competition between applicants for jobs and employers for applicants guarantees both parties the market price. He says the CEO market is a social construction (witness all those conflicts of interests and of interest and duty). It’s “closed” in Max Weber’s sense,7 in that CEO positions at large, listed U.S. and U.K. companies are only open to people “who fit certain socially defined criteria.” Three common “social matching” criteria when a board is drawing up a list of candidates for the CEO job are: the current position of the candidate, and the performance and stature of the candidate’s company. These automatically exclude from the candidates’ pool the good people who just miss the cut as far as rank is concerned, the good people who work for currently underperforming companies, and the good people who work for smaller, less illustrious companies. When thinning down the long list of those who satisfy these rather arbitrary tests, the most important criterion for elevation to the short list is the requirement that the candidates are superstars. Khurana argues that Alfred Chandler’s “managerial capitalism” (see Chapter 3) was replaced by what he calls “investor capitalism” in the late 1970s, after the markets of large American companies were successfully attacked by more efficient European and Asian (mostly Japanese) companies. Previously supine investors demanded action, and it soon became apparent that the action most likely to appease them was the appointment of a high-profile “leader,” unencumbered by allegiance to the past or the status quo, and capable of taking the drastic action needed to see off the foreign invaders. It was unfortunate that the merits of this half-baked theory, that all that was needed to revive an ailing company was a “charismatic leader” and “change agent,” with a novel “mindset,” and a profound understanding of the “paradigm shifts” that were occurring in his economy and industry, were soon corroborated by the transformation of Chrysler Corporation under Lee Iacocca’s leadership. Chrysler was on the brink of collapse when Iacocca, recently fired by Ford (where he had been president) after falling out with Henry Ford II, was appointed president and CEO in 1978, and chairman the following year. Within three years Chrysler was back in profit and continued to flourish under Iacocca’s leadership until he retired in 1992.

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So great was his fame by then, his book, Iacocca, an Autobiography co-written with William Novak (Bantam, 1984) was the best-selling non-fiction hardback book in both 1984 and 1985. Talking Straight (Bantam, 1988), a response to Sony founder Akio Morita’s book Made in Japan (Dutton, 1986) praising American creativity, was likewise a big seller. Iacocca was in no doubt about the importance of leaders to society as a whole, as well as to companies. In Where Have All the Leaders Gone? co-written with Catherine Whitney (Simon & Schuster, 2007), Chrysler’s erstwhile leader angrily complains about living in what he sees as leaderless times: Am I the only guy in this country who’s fed up with what’s happening? Where the hell is our outrage? We should be screaming bloody murder. We’ve got a gang of clueless bozos steering our ship of state right over a cliff, we’ve got corporate gangsters stealing us blind [WorldCom, Enron, and so on], and we can’t even clean up after a hurricane [Katrina] much less build a hybrid car. But instead of getting mad, everyone sits around and nods their heads when the politicians say, “Stay the course.” Stay the course? You’ve got to be kidding. This is America, not the damned Titanic. I’ll give you a sound bite: Throw the bums out! He, like other charismatic company leaders, knows the power of the sound bite. On his website launched in late 2007 to promote Where Have All the Leaders Gone?, he invited visitors to rate candidates in the 2008 presidential election by nine qualities beginning with “c” – curiosity, creativity, communication, character, courage, conviction, charisma, competence, common sense – which he said all true leaders possess. Some companies, such as GE in the U.S. and ICI in the U.K., were lucky enough to breed their own superstars. GE’s Jack Welch, the pioneer of “managing for value” and the most stellar of the new generation of “leaders” (it was no longer enough to be a mere “manager”) who emerged in the 1980s, joined GE in 1960 when he was 25. He was CEO from 1981 until 2001, during which time the company’s market value rose from $14 billion to $410 billion. Welch, whose personal fortune was estimated, by Boston Magazine in March 2006, to be about $720 million, was affronted by criticisms of executive pay, and insisted that the market in executive talent was free, and should not be interfered with. After his retirement, Welch followed

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Lee Iacocca’s lead and co-wrote with his third wife Suzy Wetlaufer the best-selling, Winning (HarperCollins, 2005). John Harvey-Jones (made Sir John in 1985) joined Imperial Chemical Industries (ICI) in 1956, at the age of 32, after a distinguished career in Naval Intelligence. He was appointed CEO in 1982. In his first two-and-a-half years as leader, ICI’s U.K. workforce was pruned by a third, losses were transformed into £1 billion of profits and the share price doubled. Sir John was the exemplary change agent. Among his best known quotations was “I’m more interested in speed, than in direction.” After retiring in 1987, Sir John embarked on a new career as a TV star, in the BBC’s Troubleshooter series, first broadcast in 1990, in which he advised struggling businesses. The ratings were good enough for five series and several specials, and the series won Sir John a BAFTA award. For a while he was, as one U.K. newspaper put it, “the most famous industrialist since Isambard Kingdom Brunel.” His obligatory book Making it Happen: Reflections on Leadership was published by Collins in 1988. This cult of personality infected the entire system. Institutional investors demanding change saw the CEO as the crucial variable in business success and failure, and put pressure on ailing companies less blessed than GE and ICI with home-grown talent to look beyond the company for the necessary charisma and box-office qualities. Investment analysts responded to this leader-centric view of their ultimate clients, exploited investor relations strategies that co-opted CEOs as their principal marketing assets and substituted for an analysis of the intrinsic strengths of a company’s business, an assessment of its CEO’s character, philosophy and management style and detailed examinations of his or her pronouncements, statements and sound bites. The “CEO as hero” cult was convenient for asset managers and stock analysts, because having a personification or embodiment to focus on, and attribute success and failure to, made a detailed analysis of the large company’s increasingly complicated and geographically dispersed affairs if not entirely superfluous, at least much less essential. Moreover, the role of a drama critic of superstar CEOs was far more appealing to many analysts than that of a back-office number cruncher. Investment bankers, whose views on these matters were, for reasons discussed above, of great interest to their fund manager and stock analyst colleagues, also found the CEO cult convenient, because it endowed their celebrity CEO intimates with the power to make major balance sheet decisions quickly without consulting others. This is an advantage for investment banks, because the economics of asset-

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skimming clearly favor a few large quickly concluded deals, over several smaller, more protracted ones. Almost the only downside of the CEO cult is the fuss people make about the enormous pay packets of the CEO superstars. Another downside of the CEO cult for us pedants is what it’s doing to the language. I blame, maybe unfairly (the B-schools have a lot to answer for, too), the idea that the CEOs of large companies are special people, endowed with all Iacocca’s nine “c”s (and probably Jack Welch’s Six Sigmas too), for the import of “management-speak” into daily usage. CEOs doubtless possess many admirable qualities, but a respect for the language isn’t one of them. Ugly neologisms, such as “commoditization” and “credentialed,” hijacking innocent nouns, such as “task,” “source,” “impact,” “critique,” and “access” to serve as verbs (and occasionally vice versa as in “new hires”), the use of “utilize” when “use” is fine, additions of superfluous words, such as “in order to,” and “put in place.” I hope the probable ejection of the CEO, following the 2007–8 crash, from the pantheon of contemporary heroes will lead to a purification of the English language. But I fear it’s too late.

The buck and the bucks stop here The elevation of CEOs into omnipotent superstars with pay packets to match, is not, thank goodness, an inevitable consequence of the interaction of natural human impulses with the capitalist system. It is, rather, the product of a “market failure” that can and must be corrected if liberal capitalism is to survive. It’s also the consequence of the characteristic hierarchical shape of the joint stock company. CEOs would not have acquired the power or the pay they enjoy today if the way companies are organized had not required one person to occupy the pinnacle position. The power of the CEO is derived, not from the value he or she adds, but from the topographical fact that he or she is peerless.

The argument so far Large modern companies are not as we would like them to be, partly because of their hierarchical shape and the omnipotence it assigns to CEOs. But the explosion of CEO pay in recent years associated with that omnipotence, which is undermining the liberal capitalist consensus,

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was not inevitable; it was the consequence of a market inefficiency. But the fact that the CEO market doesn’t work, doesn’t mean that the work CEOs do is worthless. The question we turn to in the next chapter is “how much is it worth?”

References 1 2 3 4 5 6 7

The Protestant Ethic and the Spirit of Capitalism, Allen & Unwin, 1930. Financial Times, August 4, 2001. The State of Working America, 2008. “Credit crunch halts boom in executive pay,” by David Teather and Julia Finch, Guardian, Thursday 11 September, 2008. The Free Press, 1986. Searching for a Corporate Savior: The Irrational Quest for Charismatic CEOs, Princeton University Press, 2002. Economy and Society, University of California Press, 1947.

6 The myth of leadership

The usual rationale for paying the CEOs of large, global companies ridiculous sums of money is that these organizations are extremely hard to run, and the mix of skills, abilities and talent needed to run them well is so rare that the extraordinary people who possess it can command extraordinary rewards. It’s supply and demand. Huge CEO pay packets are just market-clearing prices for skills as rare as hen’s teeth. The stock argument here is the one referred to briefly in the last chapter; that it is inconsistent to be sanguine about the huge pay packets of sports stars, but to oppose those of CEOs. I pointed out that the pay of sports stars is not decided by other sports stars, whereas the non-executive members of RemCos are usually executive directors of other companies and thus have an interest in ensuring the general level of executive pay remains high. Simon Kuper did a more comprehensive demolition job on this specious argument in the Financial Times in February 2009.1 He said sportspeople have to pass four stringent tests before they become high-paid stars. The first is genuinely competitive entry; millions of young men want to play football in the English Premier League and demonstrable skill is the only criterion for making it. The second test is that, once hired, performance is all; there are no bad professional footballers. Kuper cited a study by economists Stefan Szymanski and Tim Kuypers that found salary costs explained 92 percent of English football league success. Third, only a few outstanding players are very highly paid. Only 1,000 or so worldwide earn over £1 million a year. The fourth test is that a star’s performance is under constant review on the pitch. If you start to play badly, you’re on the bench or you’re fired. The same sort of tests have been passed by high-earning actors, TV presenters, musicians, writers and entrepreneurs. CEO pay packets pass none of these tests. But that doesn’t necessarily mean a CEO’s job is easy. Perhaps the social construction that passes for a market in CEOs gets it about right, despite its inefficiency. If a large global company is very hard to run and someone has to run it, a CEO may be worth what his or her huge pay packet suggests. 104

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The CEO system What does “run” mean in this context? Hard to say. It varies. Some CEOs are better at some things than others. One may be described, on his or her appointment, as a “safe pair of hands”; another will be lauded as “charismatic,” “dynamic,” “inspirational” or “battle-hardened”; a “brilliant strategist, marketer or financier” and the like. But none of them run everything, or take every decision. How could they? The global company is too large, too complicated, and too polyglot for someone to run it single-handed. It is probable that 99.9 percent of decisions taken in a global company each day would be taken the same way with or without a CEO. The organization is run day-to-day by the tacit knowledge embedded in the minds of its employees, and written down in thousands of processes, procedures, routines and conventions; and by the momentum imparted to a company by being in business, and dealing regularly with customers, suppliers and other interested parties. It is the other 0.01 percent of CEO decisions that allegedly make the difference – timely strategic moves; audacious acquisitions; cleverly designed procedures; perceptive market diagnoses; the reinvigoration of a disheartened workforce with an inspiring vision, eloquent mission statement, or clear and relevant set of corporate values. But the transformation of that three-legged corporate horse into a Derby winner is never, despite what the CEO’s Long-term Incentive Plan (Ltip) might suggest, the triumph of one man or woman. Other employees also play their parts and armies of highly paid external professionals, including investment bankers, coaches, lawyers and accountants, and strategy, corporate identity, communications, and IT consultants, also contribute to corporate performance. Some suggest that Jack Welch is given more credit than he deserves for GE’s success (see previous chapter); that Gary Wendt, head of GE Capital, which contributed substantially to GE earnings, played an important role, and that NBC’s strong profits growth during the Welch stewardship was the achievement of the network’s CEO, Robert Wright. Wendt and Wright were doubtless also wellserved by groups of able and creative lieutenants, each of whom in their turn … and so on. I don’t know how much work McKinsey, the market leader in strategy consulting, did for GE during Welch’s time as CEO, but Welch must have got to know the firm well during its assignments in the 1970s from which emerged the McKinsey/GE matrix, a business portfolio

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screening tool, familiar to MBA students, which relates “business unit strength” to “market attractiveness.” McKinsey claims to work for 70 percent of the Fortune 500 (America’s largest companies), and clear evidence of the firm’s influence in the highest echelons of global business is the 70 or so McKinsey alumni who are or have been CEOs of Fortune 500 companies. They include Louis Gerstner, a former CEO of IBM; James McNerney, CEO of Boeing; Helmut Panke, a former CEO of BMW; Christopher Sinclair, a former CEO of PepsiCo; Peter Wuffli, a former CEO of UBS; Stephen Green, chairman of HSBC and the notorious Jeffrey Skilling, former CEO of Enron. That Skilling was subsequently convicted and imprisoned on charges relating to Enron’s collapse should not be taken to mean there is anything sinister or unhealthy about the close links and exchanges of personnel between large companies and the strategy consultants. An organization the size of McKinsey & Co is bound to hire the odd bad apple. My point here is that some of the achievements the CEOs of large companies receive material credit for in huge pay packets are more properly attributed to outsiders. Actual and aspiring CEOs often assemble teams of these counselors and consultants who follow them, like courtiers following monarchs from palace to palace, when they move from one CEO position to the next. The allegiance of these people is to the CEO, rather than to the shareholders who pay their fees. They cultivate relationships with individuals, rather than organizations. Their objective is to enhance their CEO clients’ reputations, by delivering performance improvements during the CEOs’ periods in office (rarely more than a few years), so that the CEOs are offered better jobs where their retinues can work their magic again. Prominent among those who have the ear of the CEO are the strategy consultants – McKinsey, Bain, Boston Consulting Group, and so on. I am not among those who see strategy consultants as people who borrow your watch and charge you a large fee to tell you the time. I have met many senior strategy consultants, and have worked with several on various projects. I count some as friends. By and large, I have found them charming, smart, well-informed, perceptive, thoughtful, creative and tuned in to the management discourse. My impression has been that they can and do add value to the companies they work at, as well as to the reputations (and market value) of the CEOs they work for. Strategy consultants also play a vital role in the development and dissemination of management ideas.

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The management ideas market The suppliers of new management ideas and concepts are academics working at business schools (mostly American) and some consultants and other business thinkers. They develop new ideas, package them in the form of books, articles, videos, or lectures, and then sell them to the buyers of management ideas. These are of two kinds: distributors, including management consultants and suppliers of executive education (B-schools, conference organizers, publishers, and so on), and consumers (companies, government departments/agencies and other organizations, such as non-profits). The value chain isn’t a simple one, however. Academics, the main suppliers, may sell direct to consumers (when they act as gurus to CEOs, for instance), and many of them have close links with the consultants, who are the main distributors. It is also common for academics to collaborate with consultants on books and assignments with clients. There’s nothing to object to in this. Academics need to maintain close links with consumers to keep in touch with their concerns and test their ideas in the real world. The leading strategy consultants make excellent intermediaries for academics, because their clients are always in the market for new ideas; they speak both the client’s and academic’s languages; they have plenty of practical experience, and their feel for the market enables them to criticize ideas constructively and suggest how and where they might be tested. For their part, consultants are eager to help management academics test and develop their ideas and will sometimes finance promising research. They are even willing to pay retainers for what amount to non-exclusive licenses to use the new ideas, because they know there’s no better way to attract and keep clients, than to be among the first to offer services based on the latest management fashions. The relationships between management academics and consultants are sometimes stormy, but often close; somewhat like the relationships between movie actors and directors. The academics are free agents, but may associate themselves with particular consultancies if they like the people and enjoy working with their clients. They may get wheeled out to give after dinner talks about their latest ideas to gatherings of clients and play an important marketing role for the consultants they choose to associate themselves with. And there is much toing and froing between academe and consulting. Consultants may become academics when they retire and academics often quit the campuses to join consultancies, or set up their own “boutiques” to consult independently, or act as subcontractors for larger firms.

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The intimacy of the relationship between academics and consultants inevitably means that these two key groups in the management ideas value chain have come to share a general view about the market. Rational suppliers will tailor their products to suit the needs of their customers. A few management writers earn a lot of money from books and articles, but they are exceptions, and very few of them write primarily for money. Unlike academics in other disciplines, management academics do not write primarily for kudos either. They write to market themselves and their ideas so that they can charge high rates for speaking “gigs” and consulting with large companies as personal CEO gurus or famous brains in teams of consultants. Nothing that management academics do is as lucrative as consulting for large companies. Everything else, from how they plan their own careers to what they write and how they think is dominated by this fact. For them, success is measured not by how well their books, videos and lectures are received, but how high a day rate they can charge. Some charge higher day rates than top consultants. There’s nothing to object to here, either. I do not share the view that management consultants, including management academics acting as consultants, are greedy and grossly overpaid. Some of them may be greedy and some may be overpaid, but the fault in the latter case at least, lies not in them, but in those who overpay. The desire for a high day rate is no more a sign of greed in a consultant than is the desire for a high share rating in an entrepreneur. The problem here is that the buyers who set consultants’ day rates are CEOs of large companies. Almost all hirers of consultants work for large companies, because the client pays, and SMEs (small and mediumsized enterprises) do not use consultants, partly because they cannot afford to, and partly because, being still young, they have not acquired the big company vices that it is the business of consultants to remedy. These close relationships between academics, consultants and large companies mean that the supply-side of the management ideas market is focused exclusively on meeting the needs of large company CEOs. Since they are the principal paymasters, the ideas worth most (to an academic) are those that address their problems and challenges. In this way, the needs and outlooks of the CEOs of large companies dominate and define the management ideas market. Academics tend to ignore the undergrowth of business, where new kinds of enterprises are most likely to emerge, because there’s no money in it. Moreover, although in times like the present of retrenchment, the CEOs of many large companies are busy reducing costs, cutting payrolls

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and pruning business portfolios, size is still important to them. Their ambitions, to become the CEO of a Fortune 500 or FTSE-100 company, were couched in size terms. All their experience and the moves they’ve made to rise to their elevated positions attest to their belief that large joint stock companies are now, and will continue to be, the highest form of business life. This is why demergers are so rare, and why CEOs embark on them so reluctantly in response to crises, hostile bids or lobbying by investors eager to release “hidden” value. So not only is the management ideas market heavily skewed in favor of large companies; it is also prejudiced in favor of size itself. It is hard to find new management ideas that address the interests of SMEs and virtually impossible to find any that don’t assume big is best and that within every SME there is, or at any rate, should be, a large enterprise trying to get out. I shall argue, in the next chapter, that this is a weakness of the modern management ideas market and creates a danger of ambush. The point here of this discussion of the market in management ideas is that the CEOs of large companies are supported, not only by able lieutenants and consultants, but also by a large and sophisticated management innovation system in the form of B-school academics who focus exclusively on big business.

The CEO as principal and conductor Some will argue that, to say CEOs are supported by lieutenants and groups of advisers is to state the obvious, but to infer from this undeniable fact that they’re not, therefore, worth the credit they are given or the money they are paid for success, is to ignore the role they play as the principals of what I call the “CEO system.” According to this view, the lieutenants and advisers, however able and creative, would sit around contemplating their navels without a CEO. Without a CEO, the best “CEO system” would lack agency. It could analyze, identify options, plan and prepare, but without the CEO to choose, decide and press the “go” button, it could not act. This argument is patronizing. It insults smart people, with plenty of business experience who know the problems and opportunities the company faces, and are aware of the need to maximize shareholder value, to suggest they are incapable of acting without a CEO. It’s also circular. It is like saying that tyrannies need tyrants. That is undeniable. But do societies need tyrannies?

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The riposte is to modify the argument slightly and to suggest that a CEO adds substantial value, by selecting the members of the CEO system, in the first place, assembling them into a team, assigning to each a role and tasks, organizing, monitoring, and coordinating their activity, motivating them, and generally giving them purpose and direction. This is more like it. It amounts to arguing that an orchestra needs a conductor, and few would question the need for a strong classical music culture in a civilized society. But does an orchestra really need a conductor? The orchestra has been seen (by Peter Drucker, doyen of management writers, among others) as a model for business organizations, and conductors, the celebrities of classical music, as role models for CEOs. In his book Leadership Ensemble Harvey Seifter, the then executive director of the New York-based Orpheus Chamber Orchestra, explains how this unique musical institution became a world leading chamber orchestra without a conductor.2 The Orpheus Orchestra uses a democratic system, known as the “Orpheus process,” which takes all the decisions made in a conventional orchestra by the conductor. The process is not easy or very efficient in terms of time, but it is very effective. The Orpheus has won several Grammy awards, and the quality of its performances allows it to charge higher concert fees than any other chamber orchestra. In his foreword to Seifter’s book, Richard Hackman, a professor of social and organizational psychology at Harvard University, asks: Rather than relying on a charismatic, visionary leader … might it be possible for all members to share responsibility for leadership and for differences and disagreements to be sources of creativity rather than something that should be suppressed in the interest of uniformity and social harmony? CEOs of companies in which the overwhelming priority is attracting and keeping good people will read the Orpheus labor turnover rate and go green with envy. The average tenure of Orpheus musicians is 20 years. We’ll look more closely at the Orpheus process later. It is enough to note here that the fact that it works well casts doubt on the assumption that large companies can’t be run effectively without a very expensive CEO system. (It is often forgotten that the size of the CEO’s pay packet tends to increase other CEO system costs. Say that a CEO is paid $10 million a year. Assuming 250 working days a year, that amounts to

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about $38,500 a day or, assuming an eight-hour day, about $5,000 an hour. Now suppose the CEO travels around the company’s far-flung offices spreading his or her charisma, and takes six international flights a month. Waiting at airports for two hours each end costs the company $120,000 a month of CEO time, which is roughly equivalent to monthly lease payments on a Cessna Citation Sovereign. “So buy one” says the CFO. If the CEO was paid a more modest $1 million a year a company jet, capable of crossing the Atlantic, would make no sense.) To the direct, ancillary and agency costs, must be added the costs associated with the risks of the CEO system.

Systemic risks A dangerous weakness of the CEO system is that concentrating power in the hands of one person exposes the company, and those who own and depend on it, to the risks associated with that person’s human frailties. Because hierarchy can only select (in the Darwinian sense) for the ability to climb hierarchies and not for honesty, integrity, fairmindedness, wisdom, intelligence, social responsibility, a concern for the environment, and other desirable human traits, there can be no guarantee that those who reach the top will possess the latter qualities. Most CEOs do, because most of them are decent, as well as able, but hierarchy-selection pressure is more focused on other qualities, such as decisiveness, toughness, political skill, charm and, as noted in Chapter 5, charm’s more potent cousin, charisma. Charisma is a very valuable quality when climbing a hierarchy, but can be dangerous in a CEO, because, when unfettered by a sense of right and wrong, it can corrupt others. The CEO appointment system selects for ambition and hierarchy-climbing skills, not virtue, so it is inevitable that, from time to time, a power hungry or amoral person will become the CEO of a large company, and gain power over its balance sheet. Names such as Enron, Madoff, Maxwell, Parmalat, Stanford, Tyco and WorldCom demonstrate that this is more than a theoretical risk, and that the restraints non-executive directors are supposed to impose on delinquent CEOs cannot always be relied on. Scandals such as these led to the U.S. Sarbanes-Oxley Act and to similar laws, regulations, and codes of practice elsewhere. It is not just that power corrupts and some CEOs will be corrupted by their power over the balance sheet. There are risks even when a CEO

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is incorruptible. As we have seen, CEOs also impose a range of so-called “agency costs” on shareholders by recklessly overpaying in a takeover auction, for instance, misjudging demand, misleading capital markets, and by various kinds of incompetence.The tendency of CEOs (encouraged by the close relationship between management consultants and academics), to jump on bandwagons, such as using derivatives to manage risks, can help to destabilize the entire system, as it did in 2007, with destructive consequences we all have to pay for. Another kind of systemic risk is created by CEO behavior that may make some weird kind of sense to the coterie of trusted colleagues and advisers surrounding the CEO, but which, to outsiders, borders on the truly bizarre. The Financial Times, no enemy of CEOs, was horrified by reports of an agreement between Merrill Lynch and Bank of America (BofA) to bring forward payment of $3.6 billion of discretionary bonuses to Merrill Lynch executives after the sale of Merrill to BofA was agreed, just days before the deal – for the digestion of which BofA was seeking additional TARP funds – was completed. The FT pointed out that banks were being supported by public money because the economy couldn’t work without them, not because bankers deserved protection. It warned of a backlash, in the form of stifling regulation, if bankers continued to behave in such a way.3 The backlash the FT editorial had in mind was exemplified the very next day in a double-page spread in the Sunday Times (January 25). It carried police mug shots of seven bank bosses (Sir Fred Goodwin and Sir Tom McKillop, the CEO and chairman of Royal Bank of Scotland respectively; Adam Applegarth and Dr. Matt Ridley, CEO and chairman of Northern Rock respectively; Andy Hornby and Lord Stevenson, CEO and chairman of HBOS respectively; Steven Crawshaw, CEO of Bradford & Bingley) and of Prime Minister, Gordon Brown, complete with charge sheets. Royal Bank of Scotland and Northern Rock had been nationalized and Brown was in the dock, because the banking sector’s problems were, the Sunday Times alleged, partly a consequence of his policies as Chancellor of the Exchequer from 1997 to 2007, before he became U.K. Prime Minister. The criminal abuse of CEO power led to the 2002 Sarbanes-Oxley Act in the U.S. In early 2009 there seemed to be a very grave risk that legal abuses of CEO power resulting from an inexplicable inability of banking CEOs to see themselves as others see them would lead to even tougher regulation.

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Another risk inherent in the CEO system is that charismatic people are not necessarily competent. This was shown in a recent study by Cameron Anderson, associate professor of organizational behavior and industrial relations at the University of California, Berkeley and doctoral candidate, Gavin Kilduff.4 They divided 68 graduate students into four-person teams and asked each team to organize an imaginary non-profit organization. The group that did best would win a $400 prize. The work sessions were videotaped. The members of each group were then asked to rate each other on their influence on the team and their competence. Kilduff and Anderson, and a group of independent observers did the same. All three sets of judges reached the same conclusions. The people who spoke most were rated highest for desirable qualities, such as “general intelligence,” and “dependable and self-disciplined.” The people who didn’t speak very much scored higher for less desirable traits, such as “conventional and uncreative.” “More dominant individuals” Anderson and Kilduff deduced “achieved influence in their groups in part because they were seen as more competent by fellow group members.” Maybe they were. To test this, Anderson and Kilduff ran a second study with other volunteers also divided into teams and competing for a $400 prize. The task, this time, was to answer math questions from the Graduate Management Aptitude Test (GMAT), the standard B-school entrance test. All the volunteers had taken the GMAT, and had told the researchers – but not their fellow team members – their scores on the math section. Once again, those who spoke up more were more likely to be seen by their peers as leaders and more likely to be rated as competent. But the putative “leaders” didn’t provide the most correct answers and hadn’t achieved the highest GMAT scores. “Dominant individuals behaved in ways that made them appear competent” said Anderson and Kilduff, “above and beyond their actual competence.” But charisma is sufficient unto itself, it seems. In 94 percent of cases, other team members accepted the first answer proposed. Commenting on the research in a piece entitled “Competence: Is Your Boss Faking It?” in Time, Jeffrey Kluger said: None of this comes as much of a shock; at least if you’ve been watching the news. You don’t have to be a former homeowner burned by the housing fiasco … to agree that the way we pick our leaders is often based on something other than merit.5

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The probabilistic cost of all these risks must be added to CEO pay packets, expense accounts, private jets, and the costs attributable to the allegiance of the CEO’s retinue of advisers and consultants to the CEO rather than to the company, before an assessment can be made of the net value the CEO system adds for shareholders.

Fortunes from good fortune The superstar CEOs, who rose to prominence in the U.S. and the U.K. in the late 1970s and early 1980s (see Chapter 5), were fortunate in assuming the reins of power at the beginning of a 20-year “bull” market, during which the U.S. S&P 500 and the U.K. FTSE 100 market indices rose about twelvefold and sevenfold respectively. Some companies led by superstar CEOs, including GE, did far better than that, but market value is increased by acquisitions, as well as by improved performance, even when, as is usually the case, the acquirers’ CEOs overpay and destroy value for shareholders. Given the strong performance of NBC following GE’s re-acquisition of its parent, RCA, in 1985, this deal may well have created value for GE shareholders. But the same cannot be said of GE’s acquisition the following year of the Kidder, Peabody & Co. investment bank, which was sold to PaineWebber in 1994. Although some executive compensation consultants advise clients to reduce the “performance for free” consequences of rising markets, by indexing options and stock grants, or deferring them in a Stern Stewartstyle “bonus bank,” CEOs are still rewarded and get credit for commanding ships on a rising tide. They are also rewarded for being in the right place at the right time, when, for example, the growth of internet shopping happens to favor business models they inherited, or when changes in taste or fashion boost their sectors as whole or their particular niches, or when their scientists find “blockbuster” drugs soon after they arrive. Luck, good and bad, has always played and will continue to play an important part in business success and failure. Oil-rich countries are rich because they were lucky, not because their companies were better run than those of other countries. No one deserves luck of either kind, but as the system works at present, CEOs benefit more from good luck than their shareholders and other employees and are better protected, with golden parachutes, from bad luck.

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The CEO as ambassador One CEO role that seems at first (and to some extent second) sight to be valid and valuable is that of an ambassador to the company’s various constituencies. The most important constituency, of course is shareholders. One of the reasons why superstar CEOs have become de rigueur at large U.S. and U.K. companies is that the shareholders, in the persons of fund managers, in the first instance, and stock analysts in the second, are gluttons for celebrity. They and the financial press are much more likely to find time to attend a briefing hosted by a CEO with “box office,” than by an unknown from the “back office.” The halo effect the appointment of a new superstar CEO has on the company’s share price encourages Investor Relations (IR) staff to use their most potent asset as much as they can. In Searching for a Corporate Savior (see Chapter 5), Khurana cites an article in a closed circulation journal about attracting favorable comment from analysts and the financial press: There is no better messenger than your CEO, though the CFO [Chief Financial Officer] can be a close second. Institutional investors expect quality time with the top brass … In one form or the other, they should be spending 40 percent of their time on investor relations. That means a major commitment to investor conference calls, presentations at banking and industry conferences, in-person visits to major shareholders, and last but hardly least, media appearances.6 A company needs an ambassador to cultivate good relationships with investors, equity analysts, and the press. Problems arise, however, when an IR department with a superstar CEO at its disposal tries to use the CEO’s charisma to maximize the share price. This is the wrong objective for an IR department. The goal of an IR department should be to keep the market price of the company’s stock as close as possible to the “right,” or intrinsic price, which is the price that fully, but no more than fully, capitalizes the best available estimate of the company’s prospective free cash flow. When CEO charisma is used to elevate the price above the intrinsic value of the shares, shareholders certainly benefit in the short term, and the company is able, for a while, to buy other companies at an effective discount. But an overvalued share price stores up problems in the

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future. Although the market (thanks, sometimes, to star-struck analysts and journalists) might get it wrong from time to time, it will always correct its mistakes. And such corrections often begin with over-corrections, which demotivate share-holding and option-owning employees, and undermine trust in the investment community. Analysts might be dazzled for a while, but no one likes to be made a fool of, and a temporary overvaluation that requires management to deliver more than they are capable of delivering can all too easily be followed by a hard-to-correct undervaluation. Ensuring the market price of the shares never strays very far from their intrinsic value is a less challenging objective than that of maximizing the market price, but it is better in the long run, and has the additional merit of not requiring the extremely expensive services of a superstar CEO to dazzle fund managers, analysts and the financial press into suspending their disbeliefs in optimistic free cash flow projections. All that it requires is for the company to open its books, set out the reasoning behind its free cash flow projections, and assign to an articulate, well-briefed spokesperson the task of answering any questions about them. The CEO may fit the bill for the job, but it scarcely seems an appropriate use of the time of such an expensive employee.

Leaders and leadership Two decades ago, during what now seems to be something of a golden age in management thinking, the Harvard Business School professor, Rosabeth Moss Kanter, introduced to the business world the idea of “empowerment.” In her book, When Giants Learn to Dance: Mastering the Challenge of Strategy, Management, and Careers in the 1990s, she argued that companies were most productive when employees were “empowered” to make decisions on their own. She urged companies to dismantle their hierarchies, and allow employees to “dance” in the fastchanging business world of the 1990s.7 The empowerment idea acquired a lot of “traction,” as modern parlance has it, partly because Moss Kanter was editor of Harvard Business Review from 1989 to 1992. It went quiet after a few years and a decade after Moss Kanter had introduced it to the management discourse, empowerment was ejected by another Harvard Business School professor, Chris Argyris, in an article in the Harvard Business Review entitled: “Empowerment: The Emperor’s New Clothes.”8

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Argyris argued that the purpose of “empowerment” is to improve the company’s performance, by achieving the “internal,” as opposed to the “external,” commitment of employees. Only external commitment, where employees merely comply with the terms of their contracts, is possible when tasks, and the behavior required to perform them, are set by others, and performance goals and priorities are set by management. Internal commitment only becomes possible if employees are empowered to define their own tasks, and how to achieve them, and performance goals and priorities are set jointly, by employees and management. The experiment failed, according to Argyris, because although CEOs paid lip service to the then fashionable idea of empowerment, they were unwilling, when it came down to it, to surrender enough power to achieve “internal” commitment. They realized that empowerment is a subversive idea, as far as the CEO system is concerned, which raises disturbing questions about the nature of leadership and the role of the CEO. When employees are empowered, it seems inevitable that, notwithstanding Moss Kanter’s protestations to the contrary – “by empowering others” she insisted, “a leader does not decrease his power” – some others, particularly those with Rawlsian “powers of sovereignty,” must be correspondingly disempowered. Cynics will suggest that the fact that, 20 years after Moss Kanter urged giants to dance, one hears almost nothing about empowerment, might be because CEOs who yield power to employees will come under pressure to give up equivalent proportions of their enormous pay packets. Not being a cynic, I do not believe that empowerment, as a management approach, was deliberately suppressed by CEOs jealous of their power and pay. It was simply an uncomfortable idea, which did not sit well with their view of their role. But if, as Moss Kanter believed, and Argyris did not deny, shareholders would have benefitted from the empowerment approach, the decision of CEOs not to adopt it must be deemed an agency cost. Embedded in the empowerment idea is the distinction between leader and leadership. During empowerment’s brief flowering as a serious management idea, there was a lot of talk about leadership at every level. The CEO was the leader, but the hierarchical structure left plenty of roles for lieutenants and “other ranks” to lead at lower levels. This was sophistry, but it was a only short step from here to detach leadership from the position and the person entirely and to argue that leadership is just a role, the baton of which should be passed between people, depending on who in the circumstances is best qualified to discharge it.

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Something of the sort happens anyway as when, for example, the CEO “gives the floor” to the CFO in an executive committee meeting, to deliver the latest cash flow projections. But the CEO remains the primus inter pares and retains both control of the meeting and the power to make decisions. A different kind of leadership is employed by the Nhunggabarra, an Australian aboriginal people. In their book, Treading Lightly: The Hidden Wisdom of the World’s Oldest People,9 Karl-Erik Sveiby and Tex Skuthorpe call it “context-specific” leadership: Everyone in society had a leadership role in a specific area of know ledge, and the leader role shifted depending on the context and who, within that context, was the most knowledgeable. This is a highly advanced form of leadership, found primarily in highperforming teams and in knowledge-intensive organisations. It was unknown to the English military commanders who arrived on the Australian continent and its significance has not been understood among other observers until this day. The Nhunggabarra had no chieftains and their law stories, told and re-told over tens of thousands of years, include many principles and rules that seem to have been specifically designed to prevent individuals from achieving the power of chieftains. The provisions protecting Nhunggabarra from tyranny and all forms of centralized power are so strong that Sveiby and Skuthorpe speculate that they may have experienced centralized power at one time long ago, hated it, overthrew it, and proscribed it permanently. Those tempted to dismiss these ethnographic speculations about the serious business of business as “flaky,” the management equivalent of organic rice and leather sandals, should consider two things. First, consider the ethnographers Skuthorpe and Sveiby. Skuthorpe is the storyteller – the contemporary steward of the Nhunggabarra law stories passed down to him from the “old people.” There was no question here of fitting half-remembered tales to suit some half-baked theory about “empowerment” or corporate democracy. Skuthorpe had to tell it truly. He was responsible. And Sveiby is no amateur dabbler in the science of management. He is professor of Knowledge Management at Hanken Business School in Helsinki, a pioneer (some would say the pioneer) of the whole Knowledge Management area, and the leading authority on valuing and managing intangible assets. Second, consider the time. The Nhunggabarra developed their system of context-specific, knowledge-based leadership tens of thou-

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sands of years ago. It is the creature of many millennia of selection by trial and error. It has literally stood the test of eons. For the Nhunggabarra people it may be, to put it in Churchill’s way, a bad leadership system, but it’s better than all the other systems they have tried from time to time over the millennia. By comparison the CEO leadership system is an early experiment in how to run a large business in the age of industry and the internet. How would a dispassionate observer judge this experiment so far? I think a kind judge would say it was like the curate’s egg; good in parts.

Progress report The CEO system of corporate leadership is far from ideal, and very unlikely to turn out to be the default to which all other systems would revert. It is extremely expensive in terms of direct costs and, although it is hard to be sure one way or the other, it seems inconceivable that the economic value CEOs add, by themselves, can amount to anything approaching what shareholders have to pay them. Moreover, the CEO system also imposes agency costs on shareholders in addition to direct CEO costs and, as we have seen in previous chapters, it imposes another kind of agency cost on society as a whole, in the damage very high, more than fair share levels of CEO pay are doing to the consensus that sustains liberal capitalism. If I were a betting man, I wouldn’t back the CEO system to survive if other systems better suited to the contemporary environment and less costly for shareholders, and society at large, were to emerge from the corporate undergrowth and challenge the CEO system. But the CEO system has the advantage of being the incumbent. It is safe as long as no serious challengers emerge.

The argument so far Large modern companies aren’t as we would like them to be, because they have not adapted to today’s business environment, and because the power and pay of their CEOs leads to inequality that threatens the liberal capitalist consensus. Thankfully, very high CEO pay is the result of market inefficiencies, not of the liberal capitalist system itself. Moreover the CEO system, the costs of which include but aren’t confined to CEO pay packets, is extremely expensive and very unlikely to be a cost-

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effective way to run large enterprises. The question we turn to in the next chapter is whether other forms of enterprise could emerge to challenge CEO-led companies.

References 1 2 3 4

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“Bankers Can Learn from Sport about Fair Play on Pay,” Financial Times, February 28, 2009. Times Books, 2002. “Thain Behavior. Bankers Need to Start Seeing Themselves as Others See Them.” Financial Times, January 24, 2009. “Why do Dominant Personalities Attain Influence in Face-to-face Groups? The CompetenceSignaling Effects of Trait Dominance.” Journal of Personality and Social Psychology, 2009, Volume 96, Issue 2. Time, February 11, 2009. “Seven Ways to Attract Analysts and Investors,” Corporate Board Member, Spring, 2001. Simon & Schuster, 1989. “Empowerment: The Emperor’s New Clothes,” Harvard Business Review, May–June 1998. Allen & Unwin, 2006.

PART II Reforming big business


7 Leaderless competitors

The hierarchical corporation run by, or rather under the control of, an omnipotent CEO, is not the only form of enterprise making a decent living these days. There are well-established traditions of dual leadership in publishing (editor/publisher) and the theatre (director/ producer). Joint ventures, strategic alliances and other inter-firm collaborations comprise another class of enterprise in which control is in more than one pair of hands (see Chapter 9) and the partnership model still thrives in professional services, such as law and accountancy. By and large, professional partnerships seem to have done a better job at adapting to what people want from their work, and in their workplaces, than large joint stock companies. KPMG in the U.K., the U.K. member of one of the “big four” global accounting networks and an organization I happen to know quite well, was ranked “the best big company to work for,” in the Sunday Times 2009 “Best companies to work for” survey. It was the third time KPMG had come first in the five-year-old ranking. It has never come lower than third. Two other “big four” firms, Deloitte and PricewaterhouseCoopers, also made it into the top 20 big company ranking.1 To begin our examination of what can be done to adapt big business to its more challenging environment, this chapter will discuss other enterprise forms that are emerging from the undergrowth, which may challenge and, in some cases, are already challenging, the CEO-led MuBE. The large CEO-led company is vulnerable to challenge, because it’s not as solidly based on foundations of contemporary economic logic as it appears. We have already discussed, in earlier chapters, its accidental origins and contingency – its emergence, in the mid-19th century, from a number of fortuitous circumstances that prevail no longer. Moreover, a case can be made for arguing that the MuBE wasn’t just the creature of the economic circumstances prevailing at the time of its birth, but was also a social construction that emerged from the personal prejudices, interests, relationships and ambitions of its creators, as much as from those natural economic laws to which Adam Smith attributed the rise of capitalism. 123

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To paraphrase Khurana when he describes the external CEO market as a “social construction,”2 to call the CEO-led MuBE a socially constructed institution is not to say that it is an institution in the normal sense. It is an institution in the sociologist’s sense: a pattern of practices, relationships and obligations so taken for granted that they assume the status of rules governing thought and action. This isn’t to say there are no natural economic laws. Any business institution, whether or not it’s socially constructed, must comply with fundamental economic logic if it is to survive and prosper. But there is scope, within that constraint, for a wide variety of enterprise forms, all of which will be socially constructed to some extent. As Khurana pointed out, one of the most important lessons of the sociology of knowledge is that “very little in society had to be the way it is.” An institution that was socially constructed in one way could have been constructed in many other ways. “Part of the process of social construction is to camouflage this fact, since society becomes more stable, when people accept institutions as simply given and share a common explanation for events.”

Roads not taken An irony in the evolution of forms of enterprise is that while the early American railroads were producing Chandler’s MuBE (multi-unit business enterprise) they were experimenting with a different form of enterprise which, had it been allowed to develop, may well have stopped the MuBE in its tracks, so to speak.3 The weakness of the early railroad systems was that roads entering a terminal city from different directions had no direct rail links and, because they used different gauges and equipment, the cars of one road could not be transferred to the track of another. In 1865 the Boston Board of Trade put the cost of unloading and reloading freight between Boston and Chicago at over $500,000 a year. These high trans-shipment costs were in no one’s interests, so the roads got together and agreed to standardize gauges, equipment and procedures. As a result of this inter-firm cooperation, by 1880 a rail shipment could travel from one part of the country to another without a single trans-shipment. But standardization increased the intensity of competition between roads. Because railroads are capital-intensive, they have steeply declining marginal costs and their economics are extremely volume-sensitive. A small change in traffic could turn a

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profitable line into a loss-maker and vice versa. Railroad managers were, for this reason, under considerable pressure to poach business from rival lines by aggressive advertising and rate cutting. Such competition is dangerous in a highly capital-intensive industry, because once the line has been built, it is worth taking new business at prices that cover variable costs. Since a road’s variable costs were only a small proportion of its total costs competitive rate-cutting, if left unchecked, would continue to way below breakeven. The solution was for rival lines to cooperate on setting rates in the same way as adjacent lines had cooperated on connections. Federations were established with their own legislative, executive and judicial bodies to set standard rates. When they too failed to prevent periodic outbreaks of rate cutting, the major trunk lines signed various agreements, culminating in the formation in 1878 of the Joint Executive Committee, chaired by Albert Fink, to approve rates calculated by sub-committees and associations throughout the country. Fink believed this cartel arrangement was the only way to prevent the “centralization and absorption of the roads under the absolute control of one or a few persons. It makes the separate, individual existence of these roads possible … puts a check on the consolidation of [the industry, and] secures all the advantages of consolidation without its disadvantages.” But he realized this solution relied on “the intelligence and good faith of the parties composing it” and when he and his allies were unable to persuade Congress to give his committees’ rulings legal sanction, the whole system of associations and sub-committees fell apart, and it was just a matter of time before the “centralization and absorption” Fink feared became a reality. Chandler admitted “such co-operation might have worked” – managers might have been more rigorous in maintaining rates, and might have worked more closely with Fink in seeking out and fining violators of agreements. It’s certain that if the cartel agreements had been legally enforceable the costs of breaking them would have been far higher. “Given the basic nature of railroad competition,” Chandler concluded, a “legalization of the cartel arrangements was probably the only effective method to control competition and so remove the incentive for system building.” Sadly for this early flowering of a form of enterprise which might have challenged the MuBE for the position of “boss” institution in business, Congress was in no mood to sanction what seemed, to most Americans, to be price-rigging. The 1887 Interstate Commerce Act outlawed the Joint Executive Committee’s pooling arrangements and the scene was set for the epic battle between the

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speculators, led by the “Mephistopheles of Wall Street,” Jay Gould, and the “system builders,” led by the Vanderbilts. Insofar as Fink’s failures opened the way for system builders, the MuBE itself, like the CEO market (see Chapter 5), can be seen as a social construction built not by inexorable economic logic, but by a scheduler’s blunder on the Western Railroad in 1841, the failure of the American railroads to adopt the telegraph earlier, the lack of price discipline in Fink’s cartel, Congress’s refusal to give legal sanction to the cartel’s price agreements, and the prejudice against price-fixing, which led to the Interstate Commerce Act. The pooling arrangements Americans had objected to as price-fixing (and Congress duly outlawed) effectively developed anyway, within the “systems” built by Cornelius Vanderbilt and others. They were required by the industry’s capital-intensity. When effecting them by a cartel within a disintegrated industry was proscribed, system building became the only option. The U.S. electricity utility industry is also a socially constructed institution, according to economic sociologists Mark Granovetter, Patrick McGuire and Michael Schwartz. In their paper Thomas Edison and the Social Construction of the Early Electricity Industry in America,4 they argued that, when the industry was born in the 1880s, three development roads were open: power generation at the household, or neighborhood level; public ownership of generation and distribution grids; and private companies, serving large areas from central power stations. That the U.S. electricity industry took the third road was not due, according to Granovetter, McGuire and Schwartz, to any compelling economic case for such an arrangement, but to interactions within a social network consisting of trade associations, interlocking directorships, and generating equipment manufacturers. Another road not taken was the plan to split “Big Blue” (nickname of IBM, until it was robbed of the PC market it had dominated by a “multi-agent enterprise”; see under Linux below) into a brood of “Baby Blues.” Louis Gerstner abandoned the Balkanization plan when appointed CEO of IBM in 1993, and gained much kudos for turning the ailing giant into a different, and subsequently successful, IT services company. But who’s to say the Baby Blues would not have, collectively, been equally if not more successful?

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A fractured landscape If you asked an alien economist from a distant star system how the modern, CEO-led company could be adapted, to suit today’s business environment, the dude might be either cryptic, and say: “Chop off their heads,” or unhelpful, and say: “If it is adaptation you want don’t start from here.” Where would you start? If you had a clean sheet of paper how would you go about constructing a business institution perfectly adapted to the modern environment? The first step, if you’re persuaded that the institution would, as well as complying with natural economic laws, need to be “socially constructed” to some extent, would be to list the qualities that most people want in their work and workplaces. The list suggested in Chapter 1 included “free,” “fair,” “reasonable” and “decent,” and distributions of primary goods including income, wealth, power and the bases of self-respect, consistent with Rawls’s “difference principle.” The second step would be to consider the environment in which such people with such desires will construct business institutions. One quality that will be immediately apparent is that the environment is infinitely more varied and complicated than the environments in which the U.S. railroad and power industries chose their paths. Many more roads are open, to many more people, with a wider variety of skills and aptitudes. And modern communications, particularly the internet, create a space for the social construction of a business institution that spans the globe. For today’s business institution builders it is this enormous increase in complexity and the vastly greater number of challenges and opportunities it brings with it, that distinguishes most clearly their environment from that of the mid-19th and early 20th centuries. To illustrate the importance of this difference and to introduce a set of ideas, the sciences of complexity, that I believe are vital to any understanding of how new businesses will emerge and develop in the future, consider Stuart Kauffman’s analysis of “patch” size on a “cost surface” (see box below). Kauffman, whose conjecture about the origin of life I quoted in Chapter 3 when discussing the origin of Chandler’s MuBE, is a world-leading complexity scientist who pioneered the use of complex systems methods to solve business problems.5

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Patches on landscapes Kauffman says the size of the “patches” (in this context, units of organization or departments) in a “system” (a business or company) travelling on a “cost surface” or “landscape” (seeking to minimize costs, or maximize shareholder value), is a crucial determinant of the entire system’s ability to find the global minimum (the lowest possible cost, or the greatest possible value). He says that, on complex cost surfaces, a system can be trapped in a poor local minimum and that one way to avoid the trap, and allow the system to search a wider space, is to introduce the equivalent of heat. A physical system tends to change in ways that lower its internal energy and take the system “downhill.” But occasionally a system will change in a way that increases internal energy, and so allow the system to escape a poor local minimum. It follows from this that if an organization wishes to avoid being trapped in poor local minima, it should try to contrive occasional injections of heat that will make the system ignore the “minimize cost” imperative and move “the wrong way” (increase cost). One way to achieve this, is to change the size of patches that act independently and selfishly. Selfish action is desirable, because it can move the whole system the wrong way, and allow it to escape poor local minima. As Kauffman puts it “well chosen partitions can produce markedly enhanced optimization.” Take the case of an integrated system or organization, acting as a single department. It will accept all opportunities to change that take the system downhill toward lower costs, but refuse all other moves. Such systems always descend to a nearby minimum, and become trapped there. When the organization is divided into independent departments, the criteria for screening opportunities change, because opportunities that can take the department downhill will be accepted, even when they take neighboring departments uphill. An integrated system in which all departments are “singing from the same hymn sheet” can’t escape a poor local minimum, but a system divided up into patches will only remain trapped in a poor local minimum, if it is a local minimum for each patch, which is unlikely if the minimum is poor. The maths are difficult, but Kauffman shows that when connectivity (communication) between patches is low, energy falls as patch size increases. When connectivity is high, however, systems are better at finding the global minimum with smaller patches. The degree of connectivity between the patches determines the size of patch that will maximize the system’s ability to find the global minimum. As connectivity increases the system approaches a tipping-point or cusp. It works best at first with large patches, but then suddenly flips and works best with small patches.

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One way to picture the implications of Kauffman’s patch size model for business, is to imagine that companies travel to their futures across “fitness landscapes.” Their mission is to climb the highest peak in their landscapes, because only there will their “fitness,” whether measured in terms of cost, profits, cash flow, shareholder value or some other variable, be maximized. In the past, the fitness landscape was even and although the climb was strenuous, particularly close to the top, the goal was clear. A single peak with smoothly sloping flanks like Japan’s Mount Fuji beckoned in the distance. Visibility was excellent, the path was clear and the physical demands were predictable. Fuelled by a good breakfast, and armed with intent, and the climbing method known as kaizen (continuous improvement) the firm could confidently set out to conquer its Fuji. Nowadays, fitness mountaineering is not so simple. For one thing the landscape’s topography has changed. Its previous evenness has been puckered by valleys and foothills, and fractured by gorges and chasms. Fuji’s silhouette is less distinct, although whether this is because it is no longer there, having been broken and eroded by the forces that fractured the foothills, or whether it’s simply obscured by intermediate peaks and the swirling clouds of unknowing that have enveloped the landscape, the climber cannot be sure. For another thing the fitness landscape remains active. The forces that have fractured its former symmetry show no signs of abating. New peaks erupt constantly. What were heights yesterday are depths today, and may be heights again tomorrow. The landscape is in a state of constant chaotic deformation. There’s no terra firma. All is turbulence and upheaval. As if that were not enough, climbers are becoming aware of another new phenomenon; each time they take a step in what seems to be the right direction the ground quivers. They have become agents of the landscape’s deformation, and there is no proportion to cause and effect. A small step can have huge consequences elsewhere, through a complex series of amplifying resonances that occur far below the threshold of the climbers’ awareness. Once quite separate entities, climber and landscape are now locked in a process of co-evolution. Neither can move without affecting the other in potentially profound, but intrinsically unpredictable ways. What happened? What transformed this smooth, stable, singlepeaked landscape into a quaking, multi-peaked morass, where foresight and resolve seem less important than luck and balance?

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Part of the answer is that the fitness landscape of each firm is a creature of the fitness landscapes of other firms. In the past, there were only a few climbers and they were too far apart to affect each other. Nowadays, the landscapes teem with climbers. Some fall into chasms or are crushed by rock slides, but each is replaced by several new climbers. And climbers are communicating more. It’s not just that in crowded landscapes others are within earshot; it’s also that all climbers are now equipped with powerful communications equipment. The air is alive with climbing chatter. Kauffman’s model showed that, as the number of climbers multiplies and the connections between them rise, landscapes become steadily more rugged and changeable, and reaching the highest peak becomes progressively harder. Unable to see the entire landscape, climbers have to aim for nearby peaks. If they’re kaizen climbers, they may reach them, but might then see higher peaks they could have aimed for had they been less intent on continuous improvement, or find that the landscape has deformed and what looked like the summit at the start has become a ledge on the flank of another peak. Having been stranded on low local peaks once or twice climbers may begin to question the value of route planning in poor visibility, through a constantly deforming landscape, and even doubt the value of ascent itself, when all that it achieves is a far from splendid isolation, on a far from optimal peak. In this new, confusing world, structure becomes paramount. The key question becomes: “What enterprise shape is most likely to prevent the company from becoming stranded in a sub-optimal position?”

Phase transition Kauffman’s analysis suggests integrated MuBEs, run by all-powerful CEOs, work better when communication between units is limited, but that business enterprises consisting of many independent selfishly optimizing units will work better when communication between units is high. Let’s return for a moment to the two business institution builders living in the late 19th and early 21st centuries. The former faces an environment in which connectivity is relatively low and favors integ ration and an omnipotent CEO. The latter faces an environment in which connectivity is much higher and favors disintegration and no CEO. (Perhaps the alien wasn’t being cryptic after all.)

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There’s an intriguing correspondence between this arcane discovery of complexity science, and the debates about the architecture of a business enterprise from Adam Smith to Alfred Chandler. Smith believed in the wisdom of the market’s “invisible hand,” and favored unfettered entrepreneurial capitalism. Chandler believed that although it led to market imperfections the “visible hand” of managerial coordination was superior to market coordination, and favored large, integrated companies. Kauffman says they’re both right under certain conditions and that what is best in particular circumstances, depends on the degree of connectivity, or information richness. As connectivity rises, the strengths of integrated enterprise are apparent. When it increases further, the system “flips” and the best results are found, “as if by an invisible hand,” when its units are acting independently and selfishly. It is a small step from here to conclude that the huge increase in information richness that has been occurring in the business world in recent years will reach, and may have already passed, the point where disintegrated enterprises and entrepreneurial capitalism are superior to integrated enterprise and managerial capitalism. If connectivity is seen as a measure of market efficiency, one can say that, as market efficiency rose in the late 19th and early 20th centuries, the integrated organization had the edge, but that when market efficiency improved even further in the late 20th and early 21st centuries, disintegrated enterprise became superior. Or one could say Smith was wrong to be contemptuous of the company when he wrote, but would have been right, if he had been writing a couple of centuries later. The change in the optimal unit size occurs suddenly when the whole system flips from order to chaos. When a system is integrated, it is ordered. When divided into small, independent units, it becomes chaotic. The fact that problem-solving by small independent units, none of which is “minding the whole store,” outperforms central problem-solving for the benefit of the whole system, suggests flat structures (as opposed to hierarchies) produce better results and “democracy” (see Chapter 10) is a “co-evolutionary problem-solving device,” as Kauffman called it, which finds reasonable compromises among conflicting interests. A business enterprise in which each participant acts independently and selfishly seems like a nightmare for a CEO, but for people in search of “free,” “fair,” “reasonable” and “decent” workplaces and distributions of income, wealth, power, and self-respect consistent with Rawls’s “difference principle,” it has a lot going for it.

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The poverty of strategy A brief reminder of how the sciences of complexity change our view of business will be helpful at this stage. The CEO-system is based on a linear view of the world that assumes there is a unique effect or outcome for each cause or action. In a nonlinear world a cause or action can have many different effects or outcomes. In math a linear equation has a unique solution, but a nonlinear equation has many solutions and is thus insoluble. A linear system can be understood and controlled by understanding and controlling all of its sub-systems, but a non-linear system is “synergistic”; it has qualities and behaves in ways that cannot be understood and controlled by understanding and controlling all its sub-systems. Most managers accept that their companies display a certain amount of non-linearity, but seem to believe this can be accommodated by adding “noise” variables to their linear models. They assume large shocks have large effects on the system, but the infinity of small shocks they can’t see, let alone measure, can be ignored. In other words, they don’t believe positive feedback can turn small shocks into earthquakes. Complexity scientists disagree. They say that non-linear feedback systems, or “complex adaptive systems” as they are known, are very sensitive to initial conditions, and small shocks can and often do lead to fundamental changes in the behavior of the whole system. The usual example is the so-called “butterfly effect.” When taking wing in Tokyo, a butterfly can cause a gale in New York and no one will be able to trace the intervening set of causes and effects. A better example here would be that a decision by a young homeowner in Cleveland, Ohio, to spend his limited funds on a ticket for the ball game instead of his monthly mortgage payment can, by a series of events no one could have predicted, bring the world’s financial system to the brink of collapse. This means that if companies are “complex adaptive systems,” which seems to me undeniable, they cannot be directed, and the enormous sums they spend on CEOs and strategy consultants are being wasted. Complex adaptive systems develop through a process of “spontaneous self-organization.” Members of such a system, such as the CEO, can contribute to its development, but no one can control it. Because it takes time for tiny changes to upset a system’s equilibrium, it is reasonable to plan and manage for the short term and perhaps do some scenario planning, but even short-term plans may go awry, and there’s no guarantee that any scenario examined will be realized.

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According to the “linear” view of business, exemplified by Michael Porter’s “four forces”,6 successful companies were those that achieved equilibrium adaptation to stable environments. Complexity science tells us that “complex adaptive systems” are in a state of constant disequilibrium and are not, therefore, constrained by the environment. They “co-evolve” with it. Members of such systems can do what they want, but can never predict the long-term outcomes of their actions. The choice is between stable stagnation achieved by bounding the system with rules and plans, total (and so terminal) instability, and unpredictable creativity achieved by letting the system organize itself. This challenges a long tradition in management thinking that firms can, and should seek to, achieve adaptation to a stable, or slowly changing environment. This was why there was so much talk about “change management,” and why the new CEO was often described as a “change agent.” Some said change was needed, because the previous leadership had allowed the company to drift out of fit with the environment. Others said that the company had stood still while the environment changed; that a natural, institutional inertia had caused the firm to cling to the status quo until the mismatch with the environment became critical (or, as Laurence Peter put it, “until long after the quo had lost its status”). Either way, a CEO-led change program was needed to restore equilibrium. Peter Senge, for example, although he recognized the complexity of business and was an eloquent advocate of the “systems” view of the company, urged leaders to articulate visions, and purposes.7 Michael Porter and Tom Peters8 acknowledged the complexity of business, but they too believed there’s a discoverable calculus of success. C. K. Prahalad and Gary Hamel said companies succeeded by matching their “core competencies” to a “strategic intent.”9 The successes of the companies all four of these authors described to support their own theories are just as likely to have been the fortuitous and unpredictable consequences of the self-organization of complex adaptive systems. For complexity scientists, words such as “fit” and “intent” are meaningless here, because systems only become changeable when they achieve the instability that develops when the system is far from equilibrium. Companies can be adapted to the past and try to adapt to the present, but they can’t adapt or fit themselves to a future that is unknowable. “The survivors and thrivers,” say David Parker and Ralph Stacey, among the pioneers in the application of complexity science to business, “are [companies] that are sustained far from equi-

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librium in bounded instability. In the paradoxical state known as chaos they are inherently changeable [and therefore] capable of continuing innovation and variety.”10 The problem with strategies is that they are relatively inflexible plans for wholly unknowable futures. They’re attempts to stabilize organizations (and thus make them less agile, flexible, alert, and creative), by aligning employees with a view of the future that is certain to prove inaccurate. Instability is a necessary condition for adaptability, but it must be constrained, because total instability is fatal. The challenge, for managers, is to keep their company poised on the edge of total instability. “The only sensible response to relentless change,” say Parker and Stacey, “is relentless adaptation.” Managers should not plan long term. They should try, instead, to make the organization changeable. The CEO system is a bad system if relentless adaptation is the key to success, because power exercised dictatorially creates too much stability and stability is the enemy of agility. But where, if not from the CEO, can these bounds required to prevent an organization from falling apart altogether, come from? An enterprise consisting of a number of small, independent firms and individuals (computer scientists would call this a “multi-agent system”) will be nimble, flexible, alert and, above all, creative. But what will prevent it from falling apart altogether? The answer is self-organization. In a chaotic system, subtle, often imperceptible, but nonetheless powerful self-organizing forces are usually at work. Left to itself a chaotic system may collapse, but it may also organize itself enough to maintain its balance on the edge of the abyss. It will have no strategy or intent, but, as we have seen, that’s no bad thing. Without a CEO and a strategy, such an enterprise would rely instead for its survival and prosperity on the aimless interplay of ideas and actions on the strategy-free edge of bounded instability. It will be under control, but no one will be in control. Self-organizing multi-agent systems don’t try to optimize anything at system level, but because each agent optimizes selfishly and so takes the system “the wrong way,” from time to time, the system as a whole (as Kauffman’s patch analysis showed), gravitates toward the “attractors” of global (as opposed to local) minimum costs and maximum value. The lack of an optimizing intent, therefore, doesn’t mean, as some have argued, that an optimizing CEO system will always outperform a leaderless system, with no system-level ambition. Enlightened by the strange truths of complexity science, it’s not hard to imagine a company focused by its CEO on maximizing shareholder value, with the sights of

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all its employees firmly set on some grand strategic goal, being casually overhauled by an unorganized, aimless group of small firms and individuals teetering on the brink of collapse. Moreover, complexity scientists will say that, even if the CEO-led optimizer wins, it will be by chance, not because of any merits of the CEO system itself. The problem with this conjecture is that it is hard to prove. If a new kind of unstable, self-organizing enterprise threatens CEO-led companies (and may, even now, be stealing market share from them), how can we know? Such enterprises are, by definition, always in a state of flux; constantly coalescing, changing shape, coming apart and re-forming. They may not be recognizable as enterprises in the normal sense, and their own agents may be only dimly aware they’re interacting in selforganized ways. Moreover, anything more than a dim awareness of association, would in theory, be undesirable, for with awareness of being part of a group, comes the dangerous idea of a “strategy” and thus the beginning of the end for the cardinal chaotic virtues.

New roads It is still early days for the emergence of formidable, leaderless competitors of CEO-led companies, but two multi-agent systems have already become substantial enterprises through the internet. Both can be seen as creatures of phase transitions similar to the phase transition to the auto-catalytic set, which Kauffman suggested may have led to life.

Linux

In 1983, “open-source” software pioneer Richard Stallman launched the GNU Project to construct a “complete Unix-compatible software system” out of free software. (GNU is a recursive acronym, a wordplay much loved by computer experts and very popular at Stallman’s alma mater, MIT. GNU stands for GNU’s Not Unix). Stallman founded the Free Software Foundation in 1984, and in 1989 he published the GNU General Public License (GNU GPL), which set out the conditions on which GNU software was available. By then, open-source zealots, eager to liberate the world of computing from what they saw as the tyranny of Microsoft, were into their stride. By 1990, most of the components of an operating system, including libraries, compilers, text editors, a Unix shell and a windowing system,

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were done. Only low-level elements, such as device drivers, and the crucial system “kernel,” were still lacking. Enter Finnish programmer Linus Torvalds. He said later that if the GNU kernel had been available, he would not have decided to write his own. In 1991, he turned MINIX, a truncated version of the Unix operating system used in teaching, into Linux. The rest is still unfolding history. The Linux kernel, supporting applications and utilities are freely available and all the source code, applications, and utilities are published under GPLs, which prevent any restriction on their “open-source” availability. Torvalds still oversees the system’s overall development, but anyone can develop applications and interfaces. The system is very robust, because problems are instantly aired on the internet, and quickly fixed. Linux is the flagship of the GNU Project and the Free Software Foundation. In recognition of their joint achievement Stallman and Torvalds shared the 1998 Electronic Frontier Foundation’s Pioneer award. Linux is no plaything for techies. It is seen by Microsoft, which open-source zealots regard as the enemy, as a formidable rival to Windows. In November 1998 a leaked internal Microsoft document (the first “Halloween” document) warned that open-source processes could command creative resources far in excess of those that were available to commercial software companies.11 Mutual sniping between Microsoft and The Free Software Foundation (FSF) became a popular industry soap opera, with the FSF claiming Microsoft’s production of proprietary software is bad for software users, because it denies them “their rightful freedom”.12 The rivalry became more heated in early 2004, when Microsoft published a study, Get the Facts, on its own website comparing the costs of Windows and Linux. Based on case studies, analysts’ research, and some Microsoft-sponsored inquiries, it claimed that using Linux on servers compared unfavorably, in terms of reliability, security and total cost of ownership, with using Windows. Linux distributors and aficionados, including Novell, IBM, and Red Hat (among the most successful Linux systems developers) responded with their own studies, surveys, and customer testimonials refuting Microsoft’s claims. Market share comparison is difficult, because open-source software installations, such as Linux, are not recorded in the same way as installations of proprietary software, such as Windows. According to IDC, the most authoritative provider of IT market intelligence, Linux-based

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systems in the global server market achieved a 10 percent revenue growth in the second quarter of 2008, and their share of global server revenues had grown from 9.4 percent, to 13.4 percent in the previous 12 months.13 Comparisons in the desktop market where, until recently, Linux had made only a little headway, are even more difficult, because Linux systems are rarely paid for. It would, therefore, be possible for Linux to have no official market share, while all PCs were running Linux. Estimates of the Linux share in the desktop market in early 2009 ranged from just under 1 percent, to slightly over 2 percent. All estimates had Linux growing much faster than the desktop segment as a whole. Two recent developments help to explain this sudden acceleration. The first is the appearance of more “user-friendly” Linux desktop operating systems, such as Ubuntu, which claimed about 30 percent of Linux desktop installations in 2007. Ubuntu (a Zulu concept, of which one translation is: “I can only be me through your eyes”) is free, opensource software available under the terms of a GNU GPL. It is sponsored by U.K.-based Canonical Ltd., owned by South African entrepreneur Mark Shuttleworth. Canonical’s business model is to earn revenues by selling technical support. By keeping Ubuntu open source, the company encourages other programmers to develop Ubuntu components, in the same way as did Torvalds with Linux itself, without having to develop the whole system. The Ubuntu system is also used on some servers, including those of the Wikimedia Foundation. The other important development adding considerable impetus to the Linux penetration of the PC market is the emergence of so-called “netbooks” or “ultra-low-cost personal computers” (ULCPCs), as the fastest growing segment of the PC market. Typically costing less than $500, these lean machines have only limited on-board software and rely instead on applications software running on the internet. Running webresident software on netbooks is known, poetically, as “cloud computing.” Linux has two major advantages for netbooks. It is faster than the code-heavy Windows Vista, which reduces netbook hardware costs, so making them cheaper to manufacture. And because Linux is free, the software costs are also much lower. According to an analyst quoted in a Bloomberg.com article in November 2008, equipping a computer with Linux costs about $5, against $40–50 for Windows XP, and $100 for Vista. The Bloomberg article estimated that Acer and Asustek Computer, which together claimed 90 percent of the netbook market at the time, were using Linux systems on some 30 percent of their netbooks.14

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It remains to be seen how this netbook software battle between Microsoft and the army of unorganized, self-organizing, open-source zealots will turn out. But Microsoft already knows it has a fight on its hands. Despite regressing to Vista’s predecessor, XP, for netbooks, it lost the first round to Linux. It is pinning its hopes of winning the second round on Vista’s allegedly less clunky successor, Windows 7. But victory is by no means assured. There are other examples of open-source challengers to proprietary software suppliers. Perl, originally developed by Larry Wall, is a popular dynamic language for Web applications used on particularly busy sites, such as bbc.co.uk, Amazon.com, and Ticketmaster. It is also used widely in finance and bio-informatics, because it allows rapid application development and deployment, and can handle large data sets. It is free software licensed under the Artistic License and the GNU GPL. Larry Wall still oversees Perl’s development. Tcl (Tool Command Language, alias “tickle”), a popular programming language created by John Ousterhout, is also free and open-source. The Apache Software Foundation (ASF), a non-profit company set up to support Apache software projects, is “a community of developers and users,” pursuing “a collaborative, consensus-based development process” (www.apache.org). Apache open-source software is free and available under a GPL-compatible license. The Eclipse Foundation, an open-source “community” extruded from IBM’s Eclipse Project, is a not-for-profit with a “governance model” that ensures “no single entity is able to control the strategy, policies, or operations of the Eclipse community” (www.eclipse.org). No one controls Linux, but it is under control. And, with the help of an army of contributors who flock to it and continually explore its development potential, it’s giving CEO-led Microsoft cause for serious concern. Linux and several other user/developer communities within the free software movement are examples of quasi-organizations interacting and coalescing into what I call “multi-agent business enterprises” (MaBEs). Battle has been joined, in the software industry, between traditional MuBEs and these fundamentally different MaBEs. Some will say that Linux could not have emerged as a competitor to Microsoft without the internet and that one cannot generalize from developments in the internet domain to business as a whole. It may be true that self-organizing multi-agent systems can coalesce into enterprises capable of taking on CEO-led MuBEs, such as Microsoft, in

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industries living partly in the net, but that doesn’t mean that CEO-led MuBEs living elsewhere are at risk from such enterprises. There are two objections to this objection. The first is that the internet is an increasingly important domain in the modern business environment and more and more companies and their customers are living more and more of their lives in it. To argue that leaderless MaBEs pose no threat to CEO-led MuBEs living outside the internet is like suggesting in the 1960s that Japanese car makers posed no threat to Detroit, because they didn’t make V8 engines. The other objection to the suggestion that CEO-led MuBEs that have nothing to do with the internet are safe from attack by MaBEs is that it is not true. In the late 1980s Microsoft was a member of a MaBE of small and medium-sized firms (it also included Intel, Dell and Compaq), each of which was pursuing its own goal, that harried the mighty IBM to the brink of collapse in the early 1990s.

Wikipedia

When I was a boy embarking on a lifelong love affair with science fiction, the neatest thing I could imagine was a wrist gizmo that gave the wearer access to all the knowledge in the world. I don’t think color televisions were available at the time – we certainly didn’t have one at home. A sober assessment of the prospects that such a device would become a reality in my lifetime would not have been sanguine. But it, or something very like it, is a reality now, because, with a web-enabled mobile phone, I have access to the Wikipedia. And of all the many blessings the internet has brought us, the Wikipedia, is, in my view, the most wonderful. It’s the library of Alexandria realized. It’s the Aleph in Jorge Luis Borges’s short story.15 Not the least of Wikipedia’s wonders is that it came to be what it is, the largest body of knowledge ever assembled, by accident. That the internet is an ideal environment for assembling knowledge was recognized very early on. Interpedia was launched in 1993, but didn’t stay the course. Richard Stallman, doyen of the open-source movement and founder of the Free Software Foundation (see above), proposed a “Free Universal Encyclopedia and Learning Resource” in 1999. His idea was realized in the GNUPedia, which went online on January 17, 2001. It competed with another, earlier project with a rather similar sounding name.

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Nupedia was started by Jimmy Wales in March 2000. It was designed as a free encyclopedia employing highly qualified contributors and a rigorous peer review process. Despite the appointment of a full-time editor-in-chief, Larry Sanger, a graduate philosophy student, progress was very slow. Barely a dozen articles were signed off in the first 12 months. Wales and Sanger realized they had to produce content more quickly and considered various ideas. Quite who was the first to suggest using wiki software, which enables anyone who visits a web page to contribute to or modify content using a simple markup language, is not clear. Wales and Sanger liked the idea, however. Sanger wrote to Nupedia’s editors and reviewers with the proposal and Wales set up a Nupedia wiki system, which went online on January 10, 2001. A number of editors and reviewers were uncomfortable with the idea of associating Nupedia with a wiki-style website, so Wales decided to give the project, the only purpose of which was to generate new material for Nupedia, its own name, Wikipedia. To distance the new content feeder more clearly from the Nupedia project Wikipedia was launched on its own domain, wikipedia.com, on January 15, 2001. Word of the project spread quickly through the internet thanks, in part, to hundreds of references a day from Google. An explosion of some kind occurred. It was as if Nupedia’s content generator had, quite by accident, touched some switch, the existence of which no one had even suspected, and released an enormous pent-up supply of information. Wikipedia attracted 1,000 articles within a month of launch, and had passed the 10,000 mark by early September. By then the mainstream media were taking notice. The New York Times ran a piece on the phenomenon on September 20 and “network effects” (the more coverage you get, the more coverage you get) added further to the momentum. In its first year Wikipedia fed over 20,000 entries to its Nupedia client and the growth rate was accelerating. The article count had doubled again by the end of August 2002. The tail was wagging the dog to bits. Nupedia was laid to rest in September 2003. By the end of 2008, the English-language Wikipedia (there are many others) had accumulated over 2.7 million articles, equivalent to a traditional encyclopedia of close to one thousand volumes. The wiki site, http://en.wikipedia.org/wiki/Wikipedia:Size_of_Wikipedia, is well worth a visit for any readers interested in the growth of and prospects for Wikipedia. It shows that content growth has followed a “log” curve. More content has led to more traffic, which has led to more content, but growth reduces potential new content, because that’s finite, and ultimately limited by the combined knowledge of all possible contributors.

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Statisticians suggest the maximum number of articles is about four million. There will always be a trickle of new articles as future events unfold, but that will eventually become negligible relative to the existing stock. The peak growth of the English Wikipedia is said to have been reached in August 2006, at a rate of 60,000 new articles a month. By the end of 2008 the article influx had fallen to about 40,000 a month. Quality is likely to improve steadily, as constant editing (a spontaneous version of the Japanese concept of kaizen – “continuous improvement”) causes all articles to converge on versions as close to the truth as contributors can collectively take them. The Wikipedia, as a knowledge gathering (as opposed to a knowledge maintenance) project, is approaching some kind of completion. In barely a decade the dreams of the ancient librarians of Alexandria and Pergamon have been casually surpassed, and a digital Aleph has snapped into existence. What are we to make of this breathtaking achievement? Make of it what you will. Many people have and many more will. For our purposes, I believe there are four things to be said about the Wikipedia. The first is that it has been an achievement by the people and for the people. There was no intention, no strategy, no directing CEO. A combination of the idea of a free encyclopedia, the internet, and wiki software triggered a global orgy of knowledge sharing. No one could possibly have imagined how eager ordinary people are to tell other people what they know, and play a part in creating something good and valuable. We’re all encyclopedists now. The second thing to say is that the process by which the Wikipedia was created was spontaneous self-organization within an inherently unstable system bounded by a few simple rules and by the desire of contributors to do what encyclopedists do; to tell it like it is to the best of their knowledge. The system is deeply democratic. Wiki software is, in a sense, a crystallization of the democratic idea. (Some say Wiki stands for “What I Know Is,” but that’s a so-called “backronym.” The word is Hawaiian for “fast.”) The third thing to say about the Wikipedia is that it would not be what it has become without some rules. The right to edit had to be limited, to prevent vandals from fouling the Wikipedia commons. I have a friend who is a Wikipedia “administrator.” “It just means I have a couple of extra buttons I can press” he says. His job is to keep watch for vandals (persistent and vexatious editors motivated by something other than a desire to improve), order them to desist and withdraw their editing rights if they don’t.

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Finally, the stories of both Linux and Wikipedia tell us something about leadership, for want of a better word, in environments such as today’s in which self-organization fosters more creativity and produces generally better results than the CEO system.

Stewards, seeders, guardians There are protagonists in these stories of new enterprise: Richard Stallman and Linus Torvalds at GNU/Linux; Larry Wall at Perl; John Ousterhout at Tcl; Jimmy Wales and Larry Sanger at Wikipedia. But they are not “leaders” in the normal sense of the word. Perhaps there was a time when Wales could have established “rights of sovereignty” over the Wikipedia project, equivalent to those he already had at Nupedia. But had he done so it is very unlikely, in my view, that the phenomenon of Wikipedia we know today would have “snapped into existence.” The lack of a CEO, an agenda, a strategy and a “business model” was an important part of the attraction for the new encyclopedists. They could do their own thing, knowing that no commercial interest mediated their relationships with those who sought enlightenment from their articles. But the beginnings of things cast shadows over what happens. Those who were there at the beginnings, either because they were in the right places, at the right time, or because things they did or did not do became initial conditions that generated the positive feedback loops that drive complex adaptive systems, have authority and influence. People are interested in beginnings. Although Torvalds and Wales could not have known how the processes they seeded would turn out, they’re respected by Linux and Wikipedia devotees as the creators and patriarchs. How this patriarchal authority is used is crucial. It will be lost if it is mistaken for and used as CEO-type control. Nor should it be used to guide, because no one can know where things are going. The patriarchs of complex adaptive systems are more like guardians and stewards, than guides. The system is owned by all participants collectively. The patriarchs cannot tell them where to go, or what to do, but the regard participants hold them in, and their vantage points above the system, as benign overseers, give them the power to proscribe; to suggest to participants that they’re barking up the wrong trees, re-inventing wheels, or heading down roads others have proved to be dead ends.

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As Piers Ibbotson explains in The Illusion of Leadership,16 a good theatre, or film director encourages the emergence of a great performance from the ensemble, by imposing “creative constraints” that liberate creative energy. “Creative leadership is a balancing act between the emergent and the directed … the changes that will happen in spite of, or without, your interventions and the desired changes that can be encouraged by your actions and directions.” This is the role of patriarchs of MaBEs. The rules that led to the emergence of Linux and the Wikipedia are creative constraints that liberate energy, which the patriarchs protect thereafter by saying “no” from to time. Their model is Holden Caulfield, protagonist and narrator of J. D. Salinger’s novel, Catcher in the Rye, and his imagined role as the guardian of young children playing in a rye field on the edge of a cliff.17

The argument so far Part I was about how big business has got to where it is today and why it is not a good place, either for people or big business. It argued that large, joint stock companies face two main challenges. If they don’t offer work more in tune with what people want, they will find it hard to attract and keep good staff and if they don’t rein in executive pay, they will destroy the political consensus on which their current freedoms depend. Part II is about where big business goes from here and how it can reform itself. It begins in this chapter with a warning: if MuBEs cannot kick their addiction to omnipotent, charismatic leaders they may find it hard to defend their markets against attacks by more adaptable MaBEs. In the last three chapters we look at how MuBEs can take up arms against their sea of troubles.

References 1 2 3 4 5

The Sunday Times 100 best companies to work for, March 8, 2009. Searching for a Corporate Savior: The Irrational Quest for Charismatic CEOs, Princeton University Press, 2002. The Visible Hand: The Managerial Revolution in American Business, Harvard University Press, 1977. Explorations in Economic Sociology, edited by Richard Swedberg, Russell Sage Foundation, 1993. At Home in the Universe: The Search for the Laws of Self-Organization and Complexity, Oxford University Press, 1995.

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11 12 13 14 15 16 17


Competitive Strategy: Techniques for Analyzing Industries and Competitors, Free Press, 1980. The Fifth Discipline, Doubleday, 1990. Thriving on Chaos, Macmillan, 1987. Competing for the Future, Harvard Business School Press, 1994. Chaos, Management and Economics: The Implications of Non-Linear Thinking, Institute of Economic Affairs, Hobart Paper 125, 1994. See also: Complexity and Creativity in Organizations, Ralph Stacey, Berrett-Koehler, 1996. Financial Times, December 7, 1998. Is Microsoft the Great Satan?, FSF, 2007. IDC press release, August 27, 2008. Microsoft Missing Netbook Growth as Linux Wins Sales, November 6, 2008. “El Aleph,” first published in the Argentine journal, Sur, in 1945. The Illusion of Leadership: Directing Creativity in Business and the Arts, Palgrave Macmillan, 2008. Catcher in the Rye, Little, Brown, 1951.

8 The adaptive challenge

That the distributive injustices it’s creating have contributed to the erosion of public trust in the liberal capitalist system; that it denies its employees sufficient bases for self-respect and that its structure is unsuited to the modern business environment, does not mean the large joint stock company is doomed. But it does mean it has some adapting to do if it is not to undermine the liberal capitalist consensus utterly, and lose the able people it needs to maintain its current position to other kinds of enterprise, better suited to the modern world. It has adapted of course, and continues to adapt. Globalization is an adaptation to improved communications and the removal of trade barriers. The unilateral repudiation of the “loyalty for security” psychological contract between companies and their employees was an adaptation to a more volatile and competitive environment. The adoption of shareholder value maximization as the listed company’s primary objective, and the emergence of debt as the main source of company finance, were both adaptations to the growth and increased efficiency of capital markets. But adaptations to environmental pressure in one area often create new environmental pressures in other areas. This chapter examines two adaptive approaches that large companies have pursued over the past two decades with little success, and a third approach that is both more promising and more challenging.

The question of purpose A decade ago, before the management discourse came to be dominated by shareholder value analysis and financial engineering, there was quite a lively debate about the “purposes” of companies. It seemed a potentially powerful adaptive approach, because it addressed the problems created by the large company’s perceived detachment from the moral constraints of civil society. If a company could somehow persuade its existing and prospective employees and customers that it was moved by 145

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a higher purpose than making profits, it could, or so it seemed, become better adapted to the modern environment. Some commentators argued that it was the responsibility of CEOs or “leaders,” as they were coming to be seen, to choose purposes for their companies, and that they could choose whatever purposes they liked, subject to the constraints imposed by capital markets. If it’s true that companies are free to choose whatever purpose or set of purposes they like, they’re free, it was argued, to be what they like; to be, for example, “soft,” rather than “hard”; “nice,” rather than “nasty”; “responsible,” rather than “selfish”; and “cooperative” rather than “competitive.” I was associated with this idea, because of a book I had written a few years before, in which I had argued that companies were coming under pressure to behave in ways that were seen, by their existing and potential employees, customers, suppliers, and neighbors (by which I meant local communities and society at large), to be fair, ethical, responsible, and responsive, because otherwise they would be unable to attract and retain able employees and loyal suppliers and customers.1 I emphasized, however, that what I had called “niceness” was not a purpose, but an aspect of a new shareholder-value-maximizing (SVM) strategy more in tune than the traditional “nice guys finish last” philosophy, with the heightened environmental, moral, and community consciousness of existing and potential employees and customers. Although I have some sympathy with the thinking behind it, the idea that a company can choose its purpose is wrong. A company can have no purpose other than to maximize shareholder value, and that is not so much a purpose as a raison d’être, or fate bequeathed to it by the logic of the capitalist system. Capital moves to its highest value use. If a company declared that (or behaved as if) it regarded SVM as subordinate to some higher purpose, such as supplying quality goods and services to customers or quality of life to employees or other “stakeholders,” it would become less attractive to investors, which would cause its cost of capital to rise, and its ability to achieve any purpose to fall. The debate about the “purposes” of companies and the popularity of what I’ve always thought was the rather facile idea that investors are just one among a number of so-called “stakeholder groups” who have legitimate claims on the company, both stem from the mistaken belief that SVM is irreconcilable with allegedly nobler aims, such as serving customers, caring for employees and the environment, or being a responsible corporate citizen.

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Companies are not free to choose their purposes, but they are both free and duty bound to choose ways to maximize shareholder value. Because SVM is hardly a goal that can stir human blood and inspire extraordinary effort, other purposes, visions or missions may need to be invoked. But it is wrong to see a mission as having priority over or being in some sense “higher” than the goal of SVM. Visions and missions are marketing; means to the end of creating value for shareholders, not ends in themselves. I have never wavered from this position. My view was always that the “nice” strategy was value maximizing, because it acknowledged the value of a class of intangible assets that I call “reputational,” the accumulation and preservation of which were in the interests of shareholders. Although some, including Elaine Sternberg,2 concurred, others took serious issue with this view, and some even seemed to find it downright obnoxious. The quality of giving, in their view, is more to do with the motives that inspire the giving, than with the gift itself, although what earthly difference motivation makes to those who receive I have never been able to fathom. Those who insist there is something disingenuous and cynical about companies that give generously to charities, adopt codes of ethics and promulgate environmentally responsible operational guidelines, not out of the goodness of their corporate hearts but to maximize value for shareholders, are effectively arguing that the owners of companies should subordinate their interests to nobler more caring purposes chosen by executives. This is absurd. Shareholders choose their own causes to support. It is not the job of managers to act as the consciences of their shareholders and nor are they equipped for that role. But that doesn’t mean appeals to the company’s non-existent better nature are pointless. Such appeals are messages from outside about the changing relative value of the various classes of reputational asset, and thus convey important information to value maximizers. Moreover, volunteering, company philanthropy, and Corporate Social Responsibility (CSR) projects engage the humanity of employees who do have “better natures,” and thus add authenticity to the “nice” strategy. Although sincerity and a genuine wish to do good are not necessary when hunting for “reputational assets,” they can help to maintain consistency and reduce the risk of the company’s exposure as a corporate hypocrite. There are many genuinely good, even saintly, people working in the community relations departments of many companies, creating value for shareholders as well as for the clients of their volunteering, philan-

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thropic, and community activities. But there’s no denying the conflict between the company as a value creator and the company as a responsible and generous corporate citizen. To minimize the cost of financial capital, firms must appear to be “value hunters”; but to minimize the cost of human capital (and maximize their ability to attract and keep employees and customers), firms must appear to be “value givers.” In the past the conflict was resolved by the “security for loyalty contract” (keep your nose clean and close to the grindstone, and you’ve got a job for life) before it became a dilemma. When it was “my company, right or wrong” there was no need for the company to be responsive to public opinion. Now that companies have forfeited employee loyalty, by unilaterally repudiating the old security for loyalty contract, the inherent conflict emerges. Philanthropy, CSR, volunteering, and commitments to sustainability or carbon neutrality are all sensible adaptations. Companies can’t disavow a value-hunting destiny bequeathed by nature, but they can try (and many are trying), to resolve the value-hunting vs value-giving dilemma by wearing new clothes, and going about their value-hunting business with an appearance of niceness and the attributes associated with it. The problem with this kind of adaptation is cognitive dissonance. Because it relies on masquerade, on giving the impression that the company is a value giver, while it remains, by its nature, a value hunter, there is a constant risk of being unmasked. Reputational assets are hard to win, but easy to lose. A reputation for being a socially responsible neighbor, earned, for example, by helping the unemployed in the area around a company factory, will be destroyed overnight by a valuehunting decision to close the factory and set up manufacturing overseas where wage costs are lower. Moreover, CEO-led companies could find it hard to earn reputations for being philanthropic, and concerned about the disadvantaged, if they continue to pay their CEOs huge salaries, contribute enormous sums to their pension funds, grant them king’s ransoms in bonuses, stock options, and restricted stock each year, and ferry them about in executive jets.

Soul and community Another kind of adaptation some companies tried was to replace the long-repudiated security for loyalty psychological contract with a new kind of magnetic glue to attract and keep able employees.

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It was proposed, for instance, that since the human hunger for the sacred and profound was no longer satisfied, in this secular age, by nonwork institutions, employee loyalty will be strengthened if the leader can discover (or “conjure up,” if you’re a skeptic) the company’s “soul,” articulate it and embed it in the culture.3 I call this argument “the company as church” and I personally find it repugnant. But the idea that satisfying a spiritual hunger not being met by any external institution should make the company more attractive to employees on whose loyalty it depends, is perfectly sensible. Corporate soul would probably make a great magnetic glue if it existed or could be invented, and if employees were moved by it. But although people certainly do hunger for spiritual meaning, there is no evidence that they seek it in, or would accept it from corporate churches. It’s presumptuous and, therefore, foolish for companies to suppose they can induce people to make such deep personal commitments. They can have our diligence, professionalism and, sometimes, our friendship, but they cannot have our souls and most self-respecting employees would be offended if they asked for them. A more palatable variation on the theme is the idea that companies should turn themselves into working “communities” rather than mere workplaces; that people are starved of a sense of community in the urban environments in which most companies operate, and are likely to work hard for, and become committed to, a company that feels as if it’s a community. CEOs shuttle from site so site, holding “town meetings,” instead of making monologue presentations, to introduce the latest strategic initiative.4 I call this idea “the company as village.” As well as being rather more appealing than the “the company as church,” it’s more in tune with human nature and with how people socially construct their own workplaces. But a large company is too big, and its employees are too dispersed to be one community. Moreover, it is difficult for employees attending a town meeting to see their superstar CEO, who has many other meetings scheduled at other sites, as their locally elected mayor. The town meeting model of CEO–employee interaction invites questions from the floor and it is, therefore, better than simply issuing orders. But when all is said and done it’s merely a rallying of the troops, masquerading as an exercise in democracy. Asking for questions from the floor is just a courtesy. Everyone knows there can be no debate; that the CEO system has already made up its mind by then. The trouble with these assumed qualities and roles is that they’re hard to reconcile with the qualities expected in “the company as a value

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creator.” As CSR managers who have to fight with their CFOs to retain their budgets at the bottom of business cycles know only too well, this isn’t just a theoretical problem. There’s something about large, modern companies that makes them look awkward wearing “nice” and “soft” attributes. It is almost as if they’re the wrong sex for such finery.

Too few women Efforts to acquire reputations for being soft, nice, sensitive, and caring amount in my view to the most coherent and, potentially at any rate, the most promising, of the adaptive strategies currently being deployed by large companies. Since soft, nice, sensitive, and caring are adjectives applied more often to women than to men, the adaptation can be characterized as an attempt by companies to get in touch with, and project, their feminine sides. How could companies go about this adaptive change? It seems fairly obvious that the best way would be to appoint more women to senior executive positions. I say “more,” because, at present, there are very few women in powerful positions in large U.S. and U.K. companies. According to Catalyst, a U.S. non-profit focused on women’s issues, women accounted for barely 15 percent of board positions in large U.S. companies (Fortune 500 companies) in 2008. And according to The Female FTSE Report, published each year by Cranfield University’s School of Management, women accounted for less than 12 percent of the directors of large U.K. companies in 2008. The position is worse than these figures suggest, because of the 131 women on the boards of FTSE 100 companies in 2008, only 12 were executive directors. Why so few women at a time when there is supposed to be a “war for talent,” companies are under pressure to project a more caring and sensitive image and, as I and my friends and co-authors Peninah Thomson and Jacey Graham reported in our book, A Woman’s Place is in the Boardroom: The Business Case,5 many of the male chairmen and CEOs of our large companies seem genuinely keen to appoint more women to their boards? We related, in the book, what we all felt was a revealing exchange during a “diversity workshop” at a large U.K. company. A group of 30 or so middle managers, about half women and half men, had gathered off-site to discuss their company’s new “diversity” program: “OK!” said the facilitator loudly enough to be heard above the largely female chatter. “Everyone’s here, so let’s get started. The first

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thing I want you to do is spend a minute or two jotting down some thoughts about the company you all work for. Since the subject today is diversity, it would be good to have diverse perspectives, so I want women to describe what it’s like being a woman working for the company, and men to describe what it’s like being a man working for the company.” There was silence for a few moments, as the 30 participants collected their thoughts. Then they started writing furiously. Or, rather the women started writing furiously. It seemed the men needed longer to gather their thoughts – so long that, eventually, the facilitator asked one of them whether there was a problem. He looked around at the other men and, reassured to see his own puzzlement reflected on their faces, said: “Yes. I’m sorry, but I’m not sure I understand the question.” What struck us most about this exchange was not the hapless male’s obtuseness, but what his and his fellow males’ confusion revealed about their company and companies in general. What is it about the modern company that made the men react to what seemed, on the face of it, a fairly straightforward question, as fish might react when asked to describe water? It is not just that, in the upper echelons of corporate hierarchies at least, men outnumber women, and that this majority is reflected in company cultures. There seems to be something more profound and deep-seated about this maleness of companies than a male numerical superiority. We decided that, as the ladybird found in the animated film A Bug’s Life, with his deep voice and belligerent manner, it is not easy to get in touch with your feminine side with testosterone coursing through your veins. Matt Ridley, former chairman of the state-owned U.K. mortgage lender Northern Rock (see Chapter 6), supplied a clue to where the inherent maleness of modern companies might have come from in his book, The Red Queen.6 Ridley’s not a banker. He’s a science popularizer and an evolutionary psychologist. In The Red Queen, he pointed out that humans are unique among the apes in having developed a sexual division of labor. In chimpanzee societies females and males seek the same foods, but in early human societies women and men looked for different foods. Women gathered, and needed to read the shapes of trees and plants, the patterns of foliage where edible berries, nuts, and roots might be growing, and the colors of their ripeness. Men hunted,

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and needed a sense of direction and location, of where they were, so they could find their way home after the chase. These differences in the skills required for gathering and hunting in the Pleistocene period can be summarized by saying women had to be good at pattern recognition, which made them better at reading faces and judging character and mood than men, and that men had to be good at reading maps. These contrasting aptitudes of gatherers and hunters survive to the present day. When a couple in a car get lost she wants to stop and ask someone the way, but he reaches for the map. Both are playing to their strengths. She’s relying on her pattern recognition ability and associated social skills inherited from her foremothers. He’s relying on his sense of direction and “bump of locality” inherited from his forefathers, who had to find the way home after hunting trips. Differences between the minds as well as the bodies of female and male humans evolved, because they played different roles in Pleistocene society. The differences transcend cultures. Men everywhere want to be seen as “practical,” “shrewd,” “assertive,” “dominant,” “competitive,” “critical,” and “self-controlled,” and women everywhere want to be seen as “loving,” “affectionate,” “impulsive,” “sympathetic,” and “generous.”7 We talk in different ways too, and for different reasons. Male conversation is public, competitive, status-seeking, factual, and designed to demonstrate knowledge. Female conversation is private, cooperative, reassuring, empathetic and enjoyable for its own sake.8 Ridley says that some of the differences stem from the division of labor (gathering, hunting); some stem from our ape heritage (adult females leave their groups and live with strangers, males live among their kin); and others are attributes of all mammals and many birds (females raise the young, males compete for females). “It surely cannot be a coincidence” he says “that men are obsessed with status … and that male chimpanzees compete for status, in strict hierarchies of dominance.” He suggests that our human and mammalian heritage may also explain why men and women differ in their ambition. In all early societies male reproductive success, the only success evolution cares about, was measured in terms of quantity, and depended on status; how far the male climbed up the group or tribal hierarchy. Women were less interested in hierarchy-climbing, because quality was the measure of their reproductive success, and that depended on the status of their mates. They had to judge the quality of possible mates, find allies in the tribes into which they married and improve the well-being of their children by persuading others to help them. The few women who are ambitious do

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relatively well, but not, Ridley says, because “male chauvinism” is a powerful selection mechanism that only exceptional women overcome. He says ambitious women do better than ambitious men, because they are more intuitive, better judges of character and less preoccupied with their own status. As we pointed out in A Woman’s Place, there are other explanations for women’s apparent lack of appetite for hierarchy-climbing. The psychiatrist Anna Fels, for example, suggested women are reluctant to compete for top jobs in business, because of their deep-seated, largely unconscious belief that “to be seen as feminine, they must provide or relinquish resources, including recognition, to others”.9 To be seen as masculine imposes no such constraints on male ambition. On the contrary, that men will compete aggressively for position and recognition with all comers, is an expectation rooted just as deeply in the culture’s ideals of masculinity. Whether the reluctance of women to engage in hierarchy-climbing is socially conditioned, as Fels has suggested, or innate, as Ridley believes – it’s probably a bit of both – it seems clear that women have a problem with hierarchies. Hierarchy-climbing is a man thing. It is how men attract mates and increase their chances of passing on their genes. Hierarchy is the creature of men. All social hierarchies have men climbing up them. The presence of men is both a necessary and a sufficient condition for the emergence of a social hierarchy. A social hierarchy can be defined as a structure with men climbing up it. Women are not barred from hierarchy-climbing competition, but they dislike it, they are not well equipped for it psychologically, and the rules are stacked against them. This is both a problem and an opportunity for large companies. It is a problem, because the difficulties women have with hierarchies and ambition are deep-seated and will be hard to overcome. It’s an opportunity, because the companies that succeed in overcoming them will have a competitive advantage.

Feminine management Some of the benefits companies gain when they’re better than their competitors at attracting and keeping able women are obvious. They have access to a larger pool of talent. They are more sensitive to the concerns of their markets, because most of their customers are women. They are also likely to be better at acquiring and keeping the “soft,”

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“nice” reputational assets, and resolving the conflict between the company as value-hunter and value-giver. Other benefits are less obvious. I argued in Chapter 6 that the value of “leadership” in business has been grossly overrated, but there’s no escaping the fact that leadership is the leitmotiv of the management discourse. It’s hard to find studies, books, and articles that don’t take it for granted that business success nowadays is mostly to do with the quality of the company’s CEO. This is a problem for ambitious women, because the qualities most of us, including women, associate with leaders and leadership are much closer to those we associate with men than those we associate with women. Alice Eagly, Mary Johannesen-Schmidt and Marloes van Engen said in their meta-analysis of 45 studies of different leadership styles: incongruity between leader roles and the female gender role [makes it] difficult for women to attain leadership roles, and produce disapproval when their behavior in these roles fails to … [conform sufficiently] with the communal requirements of the female gender role.10 Women who do attain leadership roles, however, make a pretty good fist of it. We summarized this research in A Woman’s Place (see Note 5). Eagly et al. compared the perceived performance of men and women as “transactional” and “transformational” leaders. (This comparison is common in leadership studies. “Transactional” leaders reward or punish appropriate or inappropriate behavior. “Transformational” leaders are admired, respected and trusted, motivate and inspire, encourage followers to question assumptions, attempt to understand each follower’s needs and desires, and see it as part of their job to help their followers realize their potential.) They found wide agreement among the 45 studies that female leaders were more transformational than male leaders, transformational was more effective that transactional leadership, and all aspects of leadership style where women were better, correlated positively to leader effectiveness, whereas all aspects of style where men were better either had no impact or a negative impact on effectiveness. In other words, women are better than men at the things leaders do that have the most impact on performance. The American social scientist, Mary Parker Follett (1868–1933), is periodically rediscovered by management academics, because many of

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her ideas anticipated those of modern management thinking, such as total quality management, empowerment, networked organizations, and corporate social responsibility (CSR). She saw companies as social institutions; emphasized the importance of group dynamics and what she called the “law of the situation” according to which conflicts should be resolved; reconciled competition, with cooperation; and distinguished between “power-with” and “power-over”.11 Although she did not consider the gender issue directly, Follett’s ideas endorsed the view that, as in other areas of life including childrearing, female and male management qualities complement one another, and companies are better run by men and women than by men or women. This belief has shaped the management system at the employeeowned John Lewis Partnership (JLP), one of the U.K.’s largest, oldest, and most successful retailing groups. The JLP Constitution established the position of “registrar” in stores and other functions, which constitutes a separate line of authority. Registrars, according to the Constitution, “have independent status within the Partnership, and are responsible for ensuring that the Partnership’s principles and policies are applied consistently.”12 An intriguing feature of this office is that it was stipulated, by JLP’s founder John Spedan Lewis, that registrars should be women. Spedan Lewis’s gender rule was never part of the Constitution, and is no longer adhered to, but most JLP registrars are women to this day. Women are established in the JLP registrar role. Spedan Lewis saw the JLP as a family. Pauline Graham, a former JLP store manager, explained his reasoning in her book Integrative Management:13 “Just as in the family, the husband was the go-getter and aggressive breadwinner and the wife the peacemaker and the upholder of the family’s conscience so, Spedan Lewis deduced, it had to be in business.” The manager’s responsibility is to make a profit. The registrar’s responsibility is to ensure that profit was achieved “fairly and justly.” Graham says her registrar “was a tremendous support and comfort … Being in a way outside the hurly-burly of the business side, she was an impartial and disinterested observer … whose business judgement I valued highly.” The idea that the combination of male and female management styles is synergistic – that it creates a hybrid style superior to either – was explored by Carlotta Tyler, in an article in OD Practitioner (OD – Organization Development) published in 2002.14

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The arrow and the spiral Tyler concluded, from her research between 1981 and 1997 with over 1,500 senior female managers, that women’s ways of conceptualizing and managing work were different from but complementary to men’s; that combining the best of both created “an entirely new paradigm” that could help organizations achieve “wholeness and balance”; but that, to achieve such fusion, we must examine “the core beliefs we bring to … the design and operation of our organizations.” She found that workplaces designed by women reflected a preference for organic structures and collaborative working in which the flow of work defined the organizational form and information was shared freely. There was an emphasis on building relationships; as much attention was paid to processes as outcomes and (echoing Follett’s emphasis on language) the words, symbols, and metaphors used in the organizations designed and run by women were often quite different from those used in organizations designed and run by men. In one organization run by women, biological and botanic metaphors were used, because managers disliked the way traditional business language distanced people from the system. Strategic planning was “midwifing” the new organization. Surveying stakeholder inputs was “tilling the soil.” Effectiveness improvement was “nurturing.” New investment was “watering.” Marketing was “seeding.” New programs were “buds.” Existing programs were “flowers.” The components of existing programs were “petals.” The traditional business language with its military and mechanical themes reflects the organizational model the company adopted, when it emerged in the 19th century. It is the creature of hierarchical structures in which orders come down from the top and reports move up from the bottom, information rights attach to position, and the emphasis is on outcomes, rather than processes. Tyler says men and women also pursue goals in different ways too. Citing Business and the Feminine Principle by Carol Frenier,15 she says men employ “a focused consciousness, notice content and seek a finite solution” when solving problems, while “women use a diffuse lens, notice context and remain open to multiple potential resolutions.” Their goal isn’t to find the solution, “but to allow a multiplicity of ideas to emerge and expand.” Tyler also contrasted the shapes of the two approaches. Men favor the “arrow” – a linear, sequential progression from conception to completion, where each step is deliberate and attention is focused on

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outcomes. Women favor the “spiral” – a circuitous route, which moves from idea generation to attracting interest and involvement. Once attracted those involved can move in and out of collaboration according to their circumstances and responsibilities. Both models have strengths and weaknesses. The “arrow” model keeps the objective in view, but can miss emerging trends that could be vital (such as an anomalous rise in the rate of mortgage defaults in the American mid-west in early 2007), and lacks the flexibility required in times of rapid change and uncertainty. The “spiral” is more flexible, but less clear. It encourages collaboration, a free flow of information and experimentation, and tolerates and learns from mistakes. Its weakness is that its focus on means rather than ends, and its emphasis on inclusion, can make it indecisive. Tyler sees “a functional fit” between the two models. They are yin and yang; two parts of a whole. Combining them completes both. The spiral generates ideas, the arrow transforms them into products or services. Combining the two, she suggests, ensures that ideas “are successfully grown and launched into the system.” Just as there is synergy in the parenting styles of the mother and father, with one protecting and the other preparing, so there is, in my view, much for companies to gain from making themselves more attractive to able women, and somehow or other ensuring that their inherent maleness doesn’t continue to prevent as many women as men from reaching positions of power and influence.

The female advantage Appointing more women to senior positions will change a company in a number of ways, and mostly for the better. Some of these changes are hard to predict beforehand, and not all companies will derive the same benefits to the same degree. But the kinds of benefit it is reasonable to expect can be summarized as follows:

Talent

Since talent and ability are distributed equally between the sexes, a company where the gender split among senior managers is close to parity should, other things being equal, have a more able senior management team than a company where the gender split is far from parity.

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Moderating macho

Men behave differently when women are present. One of the chairmen we spoke to while writing A Woman’s Place, recalled that at the board meeting immediately following the company’s appointment of a woman director for the first time, “the egos left the room.” All-male meetings are often treated as opportunities to grandstand and “strut your stuff.” The rules of dialogue are flouted. There’s too much talk, and not enough listening. But macho behavior that seems normal to men in all-male meetings feels over-the-top when a woman is present. As a result, meetings tend to be more constructive and decisions tend to be more considered, and sometimes less reckless.

Risk

When reputations and bonuses are at stake there is a temptation to bend the rules, skimp on due diligence and gamble. Women are more risk averse than men, partly because they are less hungry for the additional status that comes with a successful gamble, and partly because their “gatherer” foremothers had to recognize patterns and shapes in the forest, and were less inclined to overlook important details.

Ethics

There is no clear evidence either way, but it’s my impression that women are more ethical than men. Perhaps it is related to women’s risk aversion, or perhaps it is that women and men together behave more ethically than all-male groups. Whatever the basis for such a prejudice, it seems to me that a company with women on the board and in other senior management positions is less likely to engage in the kind of practices that led to the Sarbanes-Oxley Act than a company with no, or fewer, senior women. In other words, there is likely to be a positive correlation between the number of women in senior management positions, and a company’s standard of corporate governance (see box below).

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Ethics and gender Academic research on whether women are more ethical than men isn’t conclusive, but the balance of results suggests they are. In their review of the literature, Ford and Richardson found seven studies showing women are likely to act more ethically than men in certain situations, and seven that found gender had no impact (“Ethical Decision Making: A Review of the Empirical Literature,” Journal of Business Ethics, 13, 1994.) It’s widely believed, however, that men and women approach ethical and moral dilemmas in different ways. Psychologist Carol Gilligan suggested in In a Different Voice (Harvard University Press, 1982) that men are likely to consider moral issues in terms of rules and individual rights, whereas women tend to consider the same issues in terms of relationships. For women, Gilligan argued, “the moral problem arises from conflicting responsibilities, rather than from competing rights.” It goes back to childhood games. Boys’ games teach respect for the rules and fairness, while girls’ games teach respect for inclusion and the avoidance of hurt. So-called “gender socialization” theory predicts these lessons will remain with adults. This is consistent with the research cited above which found the leadership styles of women tend to be “transformational,” rather than “transactional.”

Pay

There are two reasons why it seems likely that the arrival of more women in the top echelons of company management will moderate the upward pressure on executive pay. The first is that women are less hungry for status than men, and it is hunger for the status money brings, rather than for money itself, that keeps the eyes of executives on the benchmarks. The second is that, as we have seen, women are more concerned with relationships and seeking consensus than men, and are generally better at reading character and mood, and seeing things from the points of view of others. They have more empathy. They are, therefore, more likely to be conscious of, and concerned about, the effects on the motivation and self-respect of employees of very high levels of senior executive pay.

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The promise of women The appointment of more women to senior management positions is no panacea for the ills that beset big business. The male-dominated status quo retains a firm grip on the future and it will take time for the influence of additional women to change large companies in ways that will improve their adaptation to modern conditions. Moreover, the qualities women bring to companies, because they are women, will not survive in isolation. They are predispositions. In practice, the behavior, attitudes and approaches of women and men tend to converge on those that already prevail in the situations in which they find themselves. In male-dominated situations, women will tend to adopt the male approach, and vice versa. This is why “token” women, although better than no women at all, can have only a limited impact on male-dominated cultures. Some of the chairmen and CEOs we spoke to while we were writing A Woman’s Place, said the appointment of the first woman to a board made a difference, but not as much of a difference as the second and third. The full therapeutic effects of the infusion of women into large companies won’t be fully realized until women are as firmly established at the top of large companies as they are in the registrar role at the John Lewis Partnership. But there is adaptive potential here. Women will make a difference if they become established in senior positions at large companies. Their desire to seek consensus and act on common ground, and their interest in “power with,” rather than “power over,” as Mary Parker Follett put it, could even change the shape of companies.

The argument so far Large companies are threatened, not only by the defection of their good people and a possible withdrawal of their licenses to operate following their inadvertent destruction of the liberal capitalist consensus, but also by a new kind of competitor, better suited to today’s environment. This chapter has looked at two unsuccessful attempts by companies to adapt to their changing environment and advocated a third adaptation, which amounts to “feminization.” The next and penultimate chapter examines another promising adaptation derived from the growth of business partnerships in recent years.

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References 1 2 3

4

5 6 7 8 9 10

11 12 13 14 15

The “nice” company, Bloomsbury, 1990. Just Business, Little, Brown, 1994. For example: Awakening Corporate Soul, by Eric Klein, Fairwinds Press, 1999; Saving the Corporate Soul, by David Batstone, Jossey-Bass, 2003; Corporate Soul: The Monk Within the Manager, by Moid Siddiqui, Sage, 2005. For example: The Strategy-focused Organization: How Balanced Scorecard Companies Thrive in the New Business Environment, by Robert Kaplan and David Norton, Harvard Business Press, 2001. Palgrave Macmillan, 2005. See also A Woman’s Place is in the Boardroom: The Roadmap, Palgrave Macmillan, 2008. The Red Queen: Sex and the Evolution of Human Nature, Viking, 1993. Sex Differences, K. B. Hoyenga and K. Hoyenga, Little Brown, 1980. You Just Don’t Understand: Women and Men in Conversation, D. Tannen, William Morrow, 1990. “Do Women Lack Ambition?,” Harvard Business Review, April 2004. Transformational, Transactional and Laissez-Faire Leadership Styles: A Meta-Analysis “Comparing Women and Men,” A. H. Eagly, M. C. Johannesen-Schmidt, M. L. van Engen, Psychological Bulletin 2003, Vol. 129, No. 4. Mary Parker Follett, Prophet of Management: A Celebration of Writings from the 1920s, edited by Pauline Graham, Beard Books, 2003. The Constitution of the John Lewis Partnership: Introduction, Principles and Rules, January 2000, 2nd edition, April 2004. Integrative Management: Creating Unity from Diversity, Pauline Graham, Basil Blackwell, 1991. “In the Company of Women: Complementary Ways of Organizing Work,” Carlotta Tyler, OD Practitioner, Vol. 34, No. 3, 2002. Business and the Feminine Principle, Carol R. Frenier, Butterworth-Heinemann, 1997.

9 Size and shape

If a company’s management system is a hierarchy with an omnipotent CEO at the top, and if the CEO’s pay depends in part on the size of the company, it should come as no surprise if the company grows like Topsy. Nor should it be surprising if acquisitions loom large in the company’s growth strategy; or that the company tends to pay over the odds for them; or that in due course, as the economies of the world became increasingly integrated, CEOs begin to talk about their “global strategies.” This is sociologists’ nonsense, of course. As we all know from our economics 101 lectures, “economies of scale” explain the emergence of today’s giant companies. Companies become gigantic, not because CEOs and their investment banking cronies have personal interests in size, but because marginal and average costs decline, as volume rises. A big company can produce widgets at a lower unit cost than a small company, can charge lower prices and will, therefore, sell more. Volume will rise further, unit costs will fall further, and, were it not for anti-trust legislation, which leads to “oligopoly” (a few companies dominating the market), one company would in due course monopolize the world’s widget market. The giant company is the creature of economics. It’s not socially constructed. Is that clear? Crystal. It explains everything, like, for example, why Detroit’s big three (GM, Ford and Chrysler) dominate the world’s mass market for cars, why “big blue” (IBM) dominates the global personal computer market and why everyone, everywhere writes letters with Parker pens. That corporate giantism is socially constructed, by the power, pay, and status-seeking of CEOs, and their unhealthy alliances with the leading investment banks, seems much more plausible to me than the idea that it is the creature of natural economic laws. Sure, there are economies of scale, and diseconomies too, but only in a closed system where nothing ever changes. Real business isn’t like that, and in the real business world, size is not the blessing classical micro-economics supposed it to be. 162

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Real business The business drama is not, as the conventional wisdom supposes, an incessant struggle for value between managed organizations, led by charismatic CEOs with grand plans and strategies. IBM wasn’t brought to its knees by a better led competitor. It was humbled by a chain of events triggered by its decision to take on Apple, and enter the personal computer market. It was “hoist with its own petard” in a process no one controlled. The epitome of the planned corporation was brought low by an unplanned and inherently unpredictable sequence of events. GM, Ford, and Chrysler were similarly humbled by a concatenation of events on the other side of the Pacific they could not possibly have foreseen. Their nemesis wasn’t Toyota, Honda, or Nissan, but a new system of production, often attributed to American consultant, Edwards Deming, the significance of which was below the threshold of the big three’s awareness at the time. The Japanese auto makers didn’t set out to conquer Detroit. They adopted JIT (just-in-time) supply, because they lacked the capital to invest in stocks, and they embraced TQM (total quality management) to reduce rework and after-sales costs. It is not the struggle between giant CEO-led companies that shapes the business landscape. It is the winds of chance and the restless seas of technological change. But chance, technological change, and people hungry for self-esteem are potential, not direct threats to CEO-led companies. The direct threats come from agents within the business world, because in the struggle for value there are no winds so ill they blow no one any good. While IBM was losing the struggle for value in the PC market others, such as Compaq, Dell (derided as “hollow corporations” at the time), Microsoft, and Intel, were winning it. They comprised a powerful business enterprise IBM failed to spot, because it had no recognizable shape or threatening intent. I’ve called such quasi-businesses Multi-agent Business Enterprises (MaBEs), to distinguish them from Chandler’s Multi-unit Business Enterprises (MuBEs). Linux is an MaBE and, although not strictly business enterprises, the internet and Wikipedia are MaBE-like. Both are substantial institutions that have “emerged,” rather than been created. The former is destroying the conventional telephony business and the latter has helped to bury commercial encyclopedia publishing (see Chapter 7). Among the MaBE’s distinguishing characteristics is that its agency is distributed among individuals and relatively small firms and it has no

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collective intent. What might seem to have been a strategy, such as conquering Detroit, was in retrospect merely a fortuitous and unpredictable interference pattern generated by the interplay of the actions of the MaBE’s constituent agents, as each explored its adjacent possibilities. Because MaBEs don’t know where they’re going, all destinations are open to them. Many allegedly “intentional” strategies are probably like that. An accident or chance encounter leads to a series of small steps each of which makes sense on its own; a critical combination of actions and circumstance produces an unlooked for success; the CEO is said to have devised and implemented a brilliant strategy, retro-fitted on to a sequence of more or less fortuitous events, and it is not in his or her interests to disabuse the hero-worshippers and admit that “it just happened.” There are lessons here for large companies.

Small and local Some say that a strength of large companies is that they have more people than small companies in direct contact with customers. This is obviously true – a large circle has a larger circumference than a small circle. But it’s also true that the combined circumference of 10 circles is over three times the circumference of one circle with the same total area. It’s the proportion of employees who are customer-facing that determines an enterprise’s sensitivity to the market and by that measure a 10-agent MaBE beats a CEO-led company of the same size hands down. Another great strength of the MaBE, which is seen by many of those who acknowledge its existence as a great weakness, is its lack of global intent. The great weakness of today’s giant company, which is often seen as its great strength, is its subordination of local intent, of which the MaBE has plenty, to a global vision. Local intent and locally selfish actions that may not always be in the interests of the whole enterprise make the MaBE more sensitive to its environment and more adaptable. It follows from this that a large, CEO-led company eager to become more sensitive and adaptable to its local marketplaces around the world should yield more power to its local units and allow them to pursue their own, local goals, even if when so doing they act in ways that appear to be against the interests of the global company as a whole. Dream on, seems the obvious response to that suggestion. No CEO being paid a king’s ransom each year to align the company behind a

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grand global strategy is going to allow local baronies to go their own ways, ride roughshod over the rules designed to ensure global alignment, or generally refuse to sing from the group hymn sheet. Giving power away requires surrendering power, and only omnipotence can justify today’s CEO pay packets. This is why CEOs tend nowadays, when embarking on the classic CEO project of restructuring the company (almost de rigueur for a new CEO because it affects everyone and is thus a clear demonst ration of CEO omnipotence), to rein in local baronies by switching from a geography-based to a business-based structure. If globalization is to deliver value to shareholders, so the theory goes, regional and national operations must be brought under the centre’s control. So hungry are the CEOs of global companies for “power over,” as Mary Parker Follett put it (see Chapter 8), that, far from ceding power to local managers, they take it away. This centralization of power and agency is an integral part of the globalization process. But there’s a disintegration yin within the integration yang.

Power with The CEO-led company is a command organization. The CEO directs and controls, through master–servant and principal–agent relationships with its own employees, teams, and departments, and with its valuechain neighbors (suppliers and distributors). All these have their own plans, but it is taken for granted that they’re subordinate to the central strategy. The center dreams and everyone else realizes its dreams. But, in addition to illustrating the command nature of the CEO-led company, globalization has been modifying it, by encouraging CEO-led companies to form business relationships (strategic alliances, joint ventures, and other kinds of partnership) in which they don’t have full control. Partnership as a means to commercialize technological advances was common long before James Watt linked his engineering genius to the entrepreneurial flair and managerial talents of Matthew Boulton in the 18th century to develop, manufacture, and sell steam engines. In our own time, partnerships between inventive small firms and large companies with marketing and distribution clout were often seen as an alternative to licensing deals during the microelectronics and microbiology revolutions of the 1970s and 1980s and they are still seen as a good way for small, high-technology companies to reach overseas markets. Partner-

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ships, both between CEO-led companies and within MaBEs, seem likely to continue to play an important role in computer software development (see Chapter 7). Partnership was the only way for large companies to enter overseas markets where majority local ownership was required by law. It was also seen as an effective way to respond to major plate shifts in the world economy, such as the disintegration of the Soviet bloc, European integration, the opening up of China and globalization in general. Another partnership theme has been the replacement of conventional market-based relationships between suppliers and buyers with more intimate alliances. First seen as a cheaper and less risky way to exert control over the value chain than vertical integration, this model later developed into the “value-adding partnership” (VAP); a group of independent companies working together to manage the flow of goods and services along their value chain. Some early American railroads resembled VAPs (see Chapter 7) and they’re comparable in some ways to the Japanese keiretsu (business society). The idea of the VAP survives in the modern VAR (value-added reseller); a firm favored by an original supplier, because it adds additional value to its products or services before selling them on. Whatever the motivations for such alliances and partnerships, they all involve, to a greater or lesser extent, the teaming up of CEO-led companies with other organizations that are not their servants or agents, and whose life plans, although compatible with, are not subordinate to theirs. A 1995 study by consultants Booz-Allen & Hamilton, found that the number of joint ventures, licensing deals, collaborative research, exchanges of technology, and marketing alliances had exploded over the previous decade. U.S. companies had formed only 750 partnerships in the 1970s, but were forming thousands a year in the mid-1990s as globalization was getting into its stride. The Booz-Allen study estimated that revenues from alliances in 1995 accounted for 6 percent of the revenues of America’s 1,000 largest companies, against less than 2 percent in 1987. The study’s authors concluded “a new chapter in the evolution of free enterprise” had begun.1 Another study by Andersen Consulting (now Accenture) in 1999 found that 82 percent of Fortune 500 executives surveyed saw alliances as prime vehicles for growth; alliances accounted, on average, for 26 percent of Fortune 500 members’ revenues (up from 11 percent in 1994), and for 6–15 percent of their market value; executives expected alliances to account for 16–25 percent of the company’s market value

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within five years. But there were downside risks. The study estimated that the 15 most successful alliances had created $72 billion of shareholder value, but that the 15 least successful had destroyed $43 billion of shareholder value.2 A study by consultants A. T. Kearney, found that the share prices of the best exponents of partnership (those with a long history of successful partnerships) outperformed their sector peers by over 5 percent, but those with a poor record underperformed by nearly 12 percent.3 Whether it is because of these downside risks, which may have more to do with the inability of CEO-led companies to yield power, than risks inherent in partnership itself (see Partnership problems below), or because there are only so many seats on the strategic alliance bus, and they are all occupied now, one does not hear so much about alliances, joint ventures, and partnerships these days. In the late 1990s, alliances between large, CEO-led companies were seen as the next “big thing” and a lot was written about them. There is still plenty of talk of networks and alliances of small firms, but the idea of partnership strategies at large companies has gone out of fashion. This is a pity, because the growth in partnerships between CEO-led companies could, as Booz-Allen & Hamilton suggested, have been and with luck may still be the start of a new chapter in the evolution of free enterprise. It is difficult but healthy for all-powerful CEOs accustomed to commanding to be obliged, if their partnerships are to thrive, to negotiate, compromise, and concede. Partnerships only account for a fraction of the total revenues of most CEO-led companies, but it’s a vital fraction, because it is where business is going. Imagine a company whose business relationships consist entirely of partnerships; a company like ARM Holdings (see box below).

From an Acorn Acorn Computers designed the world’s first commercial, single chip RISC (reduced instruction set computer) in 1985 and used it in its Archimedes computer, launched in 1987. But Acorn, based in Cambridge in the U.K., knew the potential market for its fast, energy efficient chips, which were easy to program and had good code density (they needed less memory than competing RISCs) extended way beyond personal computers. In an effort to tap the wider market, the company “spun out” the RISC development team in November 1990, to form Advanced RISC Machines (ARM).

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The traditional way to exploit such a lead is to raise a bundle of money and set up an integrated, design, development, manufacturing, and marketing business. When Robin Saxby (now Sir Robin) was being interviewed for the job of ARM’s CEO he proposed another approach. “My idea was to run lean and quickly, and get into profit fast. We had outstanding people, a leading architecture and the chance to transform it from an Acorn, into a global standard. But we did not have the capital for manufacturing.” 3 Saxby saw ARM’s raison d’être as designing and developing advanced RISC processors and systems. ARM would stick to that. Everything else needed to make ARM’s chips world beaters would be provided by what Saxby called “partnering in multiple dimensions.” ARM did not form partnerships from time to time as expediency dictated. It was built on them. “That’s the benefit of a clean sheet of paper,” said Saxby. “We had no history so we could plan for [partnerships] from the outset and concentrate on doing what we were best at.” ARM licenses its designs to its partners, who manufacture, develop applications and market their products. “We can license to anyone we want,” said Saxby. “We charge an upfront license fee and then a royalty per piece.” One important attraction for ARM’s partners is that ARM’s multiple partnerships make it easy for them to arrange local sources of supply. Another attraction is the ARM practice of publishing its product development plans, or “roadmaps” as Saxby called them. This allowed ARM’s partners to plan their own product development around specifications for more advanced chips that ARM had committed itself to developing. The roadmaps exemplified ARM’s partnering philosophy, because they revealed to partners product development plans that a conventional semiconductor company would have regarded as highly confidential. Saxby saw it differently. He wanted ARM’s partners to commit long term to the ARM architecture. To be willing to do that, they would need, he believed, to know what ARM was planning. “It costs us and our semiconductor partners, several million dollars to develop a new chip … we have to be sure there are products ready and waiting for it.” ARM’s research and development is also based on partnerships, with universities and other research institutions. As Saxby put it, “We recycle intellectual property.” ARM was part of what Saxby called the “Cambridge keiretsu”; an autocatalytic network of academic and business people, which spawned ARM’s parent, Acorn, and many other high-tech firms that have sprung up around the university town. When I spoke with him in 1997, Saxby was happy with the results of the novel business model that he had proposed at his interview six years earlier. Sales had risen from less than £1 million in 1991, to £10 million in 1995, and after start-up losses of £2 million, operating profits had reached £3 million. “It seems to work in the early stages, at least. We are self-funding and cash generating.” Sales and profits were £42 million and £9 million respectively in 1998, the year ARM’s shares were listed on the London and NASDAQ stock exchanges. Saxby retired as chairman in 2006, leaving ARM in rude health. In the year to December 31st, 2008 ARM revenues were almost £300 million and pre-tax profits reached a new peak of over £100 million.

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ARM’s strategy, if one can call it that, is indistinguishable from its partnership business model. In effect, it borrows its strategy from its partners. It’s part of several distributed enterprises in several markets, and its fate is the fate of all its partners. ARM sees itself and its partners as members of a community. It claimed in a press release issued in February 2009, for example, that the fact that over 60 “ARM Connected Community” members would be showcasing ARM technology at the forthcoming Mobile World Congress, in Barcelona, demonstrated “the impressive strength and growth of the ARM ecosystem.” ARM sees each partnership as long term. It has no idea of where it will lead. It’s content to take one step at a time. Its people are inspired, not by visions, but by faith in the RISC technology they have mastered. They go where it leads. They have no desire to plan its life in detail. They are great project planners, but they have no “strategy,” in the normal sense.

The parasite’s strategy The emergence of companies such as ARM, with what might be called “reduced instruction set” strategies derived from the strategies of other companies, is a sign of evolutionary activity reminiscent of the activity Thomas Ray observed in his computer-simulated, virtual world, Tierra. One of the problems in previous “Alife” (Artificial Life) research had been that self-replicating computer programs were “brittle,” in the sense that any mutation caused them to crash (in biological terms, they became non-viable monsters that were invariably stillborn). Ray realized that the quality of the genetic code that made it so robust when mutating, was its small instruction set; only 64 instructions from the nucleic acid bases, are translated into only 20 amino acids. Ray gave Tierra, which first went live on January 3, 1990, 32 instructions, far less than conventional computers and considerably less even than ARM’s RISC machines.4 After Tierra had been running for a while a “mutant” appeared with a slightly smaller instruction set, which quickly outnumbered its ancestors. A few generations later a program emerged with half the original instruction set (too few to reproduce in the conventional way), which depended on others to reproduce. These parasites were later displaced in their turn by hyper-parasites, which reproduced by forcing other parasites to help them by sharing their operating instructions. This led to the emergence of “societies,” where each creature relied on at least one other to reproduce.

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Ray’s societies are strikingly reminiscent of ARM’s ecosystem, and the Linux community (see Chapter 7). Tierra and other artificial worlds have shown that parasitism is a powerful evolutionary strategy, and there is no reason to suppose the business world is any different. Few firms can produce without the help of other agents and, as outsourcing and partnership-based enterprise increase, companies in general are becoming less self-sufficient. The way they cling to their core competences and key functions suggests CEOs see this reduction of self-sufficiency as a weakness. Tierra suggests the opposite. Plans that are so simple as not to deserve the name “strategy” and must borrow instructions from other agents, are more robust than conventional strategies, because they work with, rather than against, the self-organization that shapes their environment.

Partnership problems A partnership is a more complicated enterprise, both operationally and psychologically, than an integrated, CEO-led company. It has a different shape. It is bipolar, rather than monopolar, and cannot be managed by command. A CEO who, for good business reasons, forms a partnership with another company (or companies), must recognize this difference in shape and adopt a different management approach that relies less on power and more on persuasion. In The Partnering Imperative, Anne Deering and Anne Murphy say the essence of the challenge is the need to confront contradiction and paradox. To succeed in the era of partnership enterprise, agents (individuals and firms) must learn to value difference and make it work for them. CEOs find working with difference hard going. “How can we maintain our sense of identity, while accommodating different ways of doing business locally?” they wonder. “How can we allow our partners and employees to grasp local opportunities, without causing chaos? How can we develop understanding and trust and retain control? How can we share without being exploited; open ourselves to the influence of others and remain true to ourselves; share visions, when we see things differently and see different things?” The choice is between controlling partners, which risks alienating them, and surrendering control, which risks chaos. (As we’ve seen in Chapter 7, it need not be chaos – except in a technical sense – because complex adaptive systems can organize themselves and reach a state where things are under control, but no one is in control.)

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One way to look at the competition between the CEO-led company and new forms of enterprise, such as the MaBE, is as an exploration of a “relationship space.” CEO-led companies favor or are confined by their nature within one particular area of the relationship space, while other forms of enterprise are free to roam further afield to more productive regions. Deering and Murphy aren’t as concerned as I am with the structural implications of different regions of the relationship space, but their “grid,” plotting relationships both within and between partners according to their “ambitions” for the relationship on the vertical axis, and “response to difference” on the horizontal, is an elegant depiction of this space. It is worth summarizing the six boxes generated by their grid.3 Promote the positive

Ambition (reason for partnering)

Hearts and minds

Do and review

Radically new

Command and control

Arm’s length

Gridlock

Tolerate

Value

Avoid the negative Avoid

View of difference

Figure 9.1 The partnering grid Reprinted with the kind permission of John Wiley & Sons Ltd

Command and control (bottom-left) The widely held view is that the source of most of the problems in relationships (including business partnerships), from the trivial, to the life-threatening, is differences between the partners. This leads to policies designed to eliminate or minimize differences in goals, processes, values, and behavior, typically by establishing standards and rules, and requiring all parties to the relationship to comply with them. Such relationships are based on formal contractual agreements, and assume every contingency can and should be planned for in advance. Great care is taken, in pre-contractual preparation, to ensure the partnership is “set up right.” In these relationships, it is usual for one partner, usually the largest, to draft the rules. Because the partnership is

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merely a vehicle for completing a project, or a transaction, and consists of little more than a formal exchange of resources, the relationship is usually seen as short term, and its character usually reflects the character of the dominant partner.

Hearts and minds (top-left) In this box, difference is reduced by a search for alignment rather than an imposition of rules. It’s assumed that if all the partners think alike, they will work harmoniously and achieve the mutually desired outcomes. When leaders stress the need for the partners to “sing from the same hymn sheet,” they’re advocating this hearts and minds approach. CEOs who believe that expressing a “vision” is the way to gain the commitment of their people, tend to bring the same philosophy to their partnerships. Arm’s length (bottom-middle) There’s always a tendency for perceptions of a partnership to move to an adjacent box as partners’ attitudes to difference change. A partnership that begins in hearts and minds, for example, may fail to achieve a cultural fusion and move to command and control, or a command and control partnership may mutate into arm’s length, when partners become more tolerant. The latter move is inevitable when neither partner is dominant and the relationship continues for any length of time, because differences can only be papered over for a while. Sooner or later they will become too obvious to ignore, and will have to be tolerated if the partnership is to survive. In arm’s length relationships, risk is managed by agreeing to differ and formal procedures for resolving disputes. Good communications, and periodic checks on understanding, are seen as absolutely vital in these partnerships. Flexibility is seen as valuable, as long as it does not require the loss of too much identity. Relationships tend to be distant and tinged with mild, mutual suspicion. As with all defensive relationships, there is a temporary quality to arm’s length partnerships. They continue as long as anticipated benefits materialize, but the partners reserve moral as well as contractual rights to withdraw at their convenience, or seek other partners if the relationship encounters problems. Do and review (top-middle) A relationship that tolerates differences but takes a longer term view than an arm’s length partnership, requires more committed and trusting part-

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ners. Do and review extends arm’s length emphasis on planning and process design, from the operational to the strategic aspects of the partnership. Partners accept that goals are multi-dimensional and should change in response to new opportunities and threats. There is an ethic of cooperation, an assumption that the partnership is long term and a focus on learning and improving the partnership’s processes and systems. There is a feeling of sharing a future as well as a present. These partnerships still move step by step, from project to project, but the purpose of the reviews following each step is to learn how to improve the partnership, rather than to decide whether it is worth continuing with.

Gridlock (bottom-right) This box is easy to enter from arm’s length, but hard to occupy for long, because of inherent contradictions. Its location on the grid shows it as lacking ambition, but valuing difference. Deering and Murphy say these attitudes are hard to reconcile. If difference is regarded by both partners as valuable, two things can happen. Its potential can be realized, in which case the partnership will tend to become more ambitious; or can fail to materialize (because of conflict, bad management, or disagreements about the appropriate balance of power), in which case partners will begin to doubt the value of their differences, and be inclined to move to the left of the grid. Radically new (top-right) When differences are not merely valued but actively explored, the partners may begin to see the relationship as a possible solution to the most pressing problem of all; the need to change themselves utterly to cope with a turbulent present and unpredictable future. In these circumstances, the partnership is seen, not as an adjunct to each partner, but part of its essence. Difference is valued and the perspectives of everyone in the two organizations contribute to and define the relationship. Instead of seeking a shared vision of the future, the partners seek a picture of their shared present by exploring each other’s views and outlooks. They stop trying to change, or convert each other (that would take them back to hearts and minds) and embark on a joint search for the “common ground” on which there are opportunities for profitable joint action. The partnership is never defined – it is encouraged to emerge from the day-to-day experiences of working together. All the prejudices of separateness that made gridlock uncomfortable and frustrating are abandoned, and a shared sense of destiny comes to dominate the outlooks of all those involved.

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Deering and Murphy say “radically new” should be seen as a hole in the relationship space, because once you’re there, you are willing to deal with all agents, wherever they are or see themselves to be on the grid. Those in radically new will partner with anyone, the more different the better, and their much wider choice of partners gives them a competitive advantage.

Yielding power On the Deering and Murphy grid the most comfortable habitats for a CEO-led company are command and control, and hearts and minds. The hierarchical shape of such organizations, and the power with which it endows their CEOs, make the middle two boxes hard to enter, and the radically new box virtually inaccessible. Huge CEO pay packets contribute significantly to the immobility of CEO-led companies in the relationship space, because moving to the right of the grid involves yielding power and, as we’ve seen, only omnipotence can justify enormous rewards. Given the complexity of the modern business landscape, the erosion of economic and technological frontiers and the endless battle for competitive advantage, the inability of CEO-led companies to yield power to partners, and to regard difference as desirable and life-sustaining, is a serious weakness. The ability to attract and keep good partners is becoming as crucial as the ability to attract and keep good people. Most CEOs of large companies probably realize they need to move to the partnership area of the strategic space, but because they have a personal interest in the status quo (in integrated, hierarchical organizations where they have all the power) many are unwilling to move to the appropriate area of the relationship space. They play at partnerships on the peripheries of their companies. Even if it could be shown to be in the interests of shareholders, it’s not in their interests to move their companies lock, stock, and barrel to areas in the relationship space where they have less control, but from where I believe the successful enterprises of the future will emerge. A company that wants to move through the hole in the relationship space should identify the business relationships where it has less than complete control and use them as models for all relationships in a new policy of multi-dimensional partnerships. Once the route through the hole has been negotiated, however, what emerges at the other end

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won’t be a CEO-led company. It will be more like part of an MaBE than a self-sufficient MuBE. It is a different world down there. There is more energy and creativity, but less form; things are under control, but no one is in control; speed and agility are more important than direction; intentional strategy is not simply useless, it’s almost inconceivable. Other attributes of managerial capitalism, including management and leadership, also lose much of their meaning. CEO-led companies don’t fit in there. They’re too big, they’re the wrong shape and they don’t talk right.

Creative conversation Stepping through the hole in the relationship space requires a new style of communication. I am referring here, not to the media, but to the philosophy of communication. The electronic media will be important catalysts in the emergence of MaBEs, but their potential to act as the nervous systems of enterprises in which no one has control won’t be realized unless those involved conduct themselves appropriately when they talk to each other. To see why a new communication philosophy is needed, we will start with the uncontroversial idea that the potential of a partnership-based enterprise is some function of the collective potential of its members and associates. The challenge for the enterprise is to map this potential, so that it knows roughly where the partnership can shine most brightly. Changes in an enterprise’s environment, and thus its best fit with that environment, are impossible to predict, of course. There’s no way to avoid this uncertainty. The enterprise can only accommodate it by staying flexible. Another, more soluble problem, however, is the efficiency with which the partners communicate. They must have what Bill Gates calls “high bandwidth” conversation, and the fact is that conversation in CEO-led companies is anything but. It is corrupted by creatures of hierarchy, such as politics, prejudices, false assumptions, and hidden agendas, which combine to prevent the full picture from emerging. It’s very hard, for example, for new members of a strategy team to express doubts about official policies in front of people in whose hands their chances of promotion lie. Unequal distributions of pay and power tend to prevent free and frank discussion. An omnipotent CEO paid ten times as much as anyone else in the room cannot expect his or her views to carry the same weight as everyone else’s.

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Dialogue, as opposed to CEO monologue, is essential in a situation where power is distributed, because attempts to control and direct will put the survival of the partnership in jeopardy. Dialogue is not easy. It requires strict compliance with dialogue rules, such as turn-taking, listening attentively, and being candid about one’s motivations and what one assumes are the motivations of others. Managers used to hierarchical relationships and the pecking orders associated with them see dialogue as messy, inconclusive, and timeconsuming. It is true that getting everything out on the table and giving all involved a chance to speak their minds, is not a recipe for quick decisions. But speed is not the purpose. The great value of dialogue is that it can reveal issues that would otherwise have remained hidden so that all participants grasp the whole situation and can make better decisions. In meetings in which everyone is a subordinate, or a superior, and all but one are usually both, efficiency, clarity, and speed can be achieved, but opportunities, threats, anxieties, suspicions, false assumptions, and the ambitions of participants, any or all of which might, had they been known, have led to different decisions, can’t be given their due consideration. Over the past 160 years or so large CEO-led companies have created a great deal of value for their shareholders. I suspect that they, or rather the resources they commanded, would have created a great deal more value if they had been organized as partnerships, rather than tyrannies.

Partnership enterprise The five qualities of the ideal workplace we identified in Chapter 1 were “free,” “fair,” “reasonable,” “decent,” and “democratic.” It seems obvious to me that these qualities are more likely to obtain in an MaBE consisting of partnerships than in an MuBE commanded by a CEO. The crucial advantage of a partnership over a CEO-led company, and the main reason why I see the adoption of partnership-type systems as a promising adaptation for MuBEs, is that it requires partners to write their own stories. The story of a CEO-led company belongs to its CEO. Its story is the CEO’s story. The organization’s size and shape require the work of other employees to be broken up into jobs that are more or less the same each day, and for employees to be treated and feel as if they’re being treated as interchangeable components. They are denied their own stories, for the sake it is assumed of economic efficiency, and must seek self-respect outside work.

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CEOs have power, money, and story and they’re among the powers that be who are candidates for public honors. In the U.K., for instance, it’s a rare New Year’s honors list that doesn’t ennoble or knight several CEOs. Such honors are recognition of great service to the country and society. They are culminations of careers and stories, and presumably, for those so honored, substantial contributors to self-respect. That there have been angry demands in the aftermath of the banking crisis for some bank CEOs to be stripped of their titles does not alter the fact that CEOs get the recognition for business success to which many contribute (see Chapter 6) while most people have to seek self-respect and stories outside their work in sport, God, and hobbies, for example. It’s sometimes said that the importance of the U.K.’s constitutional monarchy lies, not in the power it has, which is vestigial, but in the power it denies to others. The weakness of the CEO-system is not so much the power it gives to CEOs, which is excessive, but in the recognition and stories it denies to others.

The argument so far The “feminization” of company management advocated in the previous chapter will change companies in several beneficial ways. It will make them better places to work and reduce the toxic effect of the CEO system on the liberal capitalist consensus. This chapter has argued that the risk and costs associated with omnipotent CEOs and their grand strategies will be further reduced if companies become more dependent on other companies through partnerships of one kind or another. The final chapter will look at other remedies for what ails big business, including therapeutic decapitation.

References 1 2 3 4

A Practical Guide to Alliances, Booz-Allen & Hamilton, 1995. Cited in: “Strategic Alliances: The Right Way to Compete in the 21st Century,” Maria Gonzalez, Ivey Business Journal, September/October 2001. The Partnering Imperative: Making Business Partnerships Work, Anne Deering and Anne Murphy, John Wiley, 2003. Evolution, Ecology and Optimization of Digital Organisms, Thomas S. Ray, Santa Fe Institute working paper, 1992.

10 Corporate reformation

Management-speak is littered with the dried husks of English words that meant something in everyday language, but which, through misuse and over-use, retain only a vestige of semantic content in the language of management. They go in and out of fashion. One doesn’t hear so much about “paradigm shifts” or “re-engineering” nowadays, but “global mindset” and “vision” still trip easily and frequently off managers’ tongues, and “transformation” is a hardy perennial. Transformation is what charismatic leaders do. They take an ailing company by the scruff of its neck and transform it into a stellar market performer. They are much more than change agents. They are, or at any rate they are billed as, agents of metamorphosis. That’s what transformation means; a metamorphosis, a change of form or of character; an alteration of function or of nature. Something of the kind may occur eventually at companies that adopt the adaptive strategies advocated in the two previous chapters – promoting more women to senior positions and forming more business partnerships. This chapter has a more modest ambition. It proposes ways in which the large company can be reformed. Reformation isn’t as fundamental as transformation. It simply means the amendment of something that’s faulty, of a corrupt or oppressive institution or practice, for example; or the removal of some abuse or wrong. Transformation is a long-term, evolving thing. Companies can begin to reform themselves right away. But they need a reform objective. We begin with a reform objective borrowed from one of my favorite management gurus, the late Sumantra Ghoshal.

The Individualized Corporation Ghoshal is best known for Managing Across Borders co-authored with his friend and long-time collaborator Christopher Bartlett.1 I interviewed them at London Business School in 1997, soon after the publi-

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cation of their earlier and, in my view, more interesting book, The Individualized Corporation.2 Ghoshal had a great line in cosmic marketing. He said that we were privileged to be witnessing a very rare event in business history; the emergence of a new corporate form. It had happened only twice before and on both those occasions, the birth had been heralded by the return of Halley’s comet. When the comet passed earth in 1835, that fateful collision on the Western Railroad, which led to Alfred Chandler’s MuBE (multi-unit business enterprise) was five years in the future. When the comet returned in 1911 this Mk. 1 company was reaching the limits of its “complexity carrying capacity,” as Ghoshal put it, and managers such as Alfred Sloan and Pierre du Pont would soon begin to experiment with a new multi-divisional form, which would subsequently dominate the world of business. According to Ghoshal the Mk. 2 variant was approaching its sell-by date when the comet returned in 1986. Its emphasis on planning and (under the influence of Frederick Taylor’s “scientific management” principles), its treatment of employees as cogs in a machine, were being challenged by a new breed of management revolutionaries. People like Jack Welch, at General Electric, and Percy Barnevik at ABB were beginning to espouse a new philosophy that saw employees as the prime movers in the process of value-creation. It was from this philosophy that the “individualized corporation,” as Bartlett and Ghoshal called it, was emerging. “We looked at a group of top companies” Ghoshal explained “and saw a different philosophy emerging, that challenges the idea that you cannot run large companies unless you standardize behavior and treat human beings as replaceable parts. It is not applicable in all contexts – it is an approach to managing that sees individuals as the primary source of value creation.” The new form was immature, as its progenitors had been when Halley heralded their birth, and Ghoshal and Bartlett (to reflect their partnership, they liked to alternate the order of their names) expected it to have been much improved by the time Halley’s comet returned in 2062, to herald the next new business form. They insisted, however, that it was much more than a mere refinement of the Mk. 2. They speculated that, if Taylor had been alive to hear Welch say “the talents of our people are greatly underestimated and their skills are underutilized,” or Barnevik to talk of the “tremendous unused potential in our people,” he would have known the game was up for scientific management.

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The title of the book was chosen to reflect William Whyte’s thesis in The Organization Man.3 Whyte argued that corporations had subjugated people, to maintain consistency and control. Bartlett and Ghoshal argued that a new corporate form was emerging in which the organization is subjugated to the individual, to nurture his or her initiative and creativity. I asked Ghoshal what was left for the center following such a role reversal. Does it have any role at all when people are empowered and assumed to be well able to manage themselves and, if so, what might it be? Was business being drawn inexorably to the “virtual” form where there is no center, or is there a new kind of corporate glue, or catalyst that is value-creating, and can only be supplied by the leadership? Ghoshal’s answer was “the secret lies not … in structures, programs or incentives, but in a deep genuine and unshakeable belief in the ability of the individual.” It had long been acknowledged that a weakness of the Mk. 2 form of organization was the way its bureaucratic style stifled individual initiative. But previous attempts to reignite the entrepreneurial flame had endeavored to by-pass bureaucracy, rather than fix it. Managers of individualized corporations were not content to create the odd pocket of entrepreneurship. They were trying to move the entrepreneurial engine, lock, stock, and barrel, from the executive suite to the front line. The challenge, said Ghoshal and Bartlett, was to “release the entrepreneurial hostages” without compromising the integrity of the organization. It was an axiom of the Mk. 2 company that a little knowledge was a dangerous thing on the shop floor. The only valuable knowledge was embedded in the plan, or strategy. In the Mk. 3, “individualized” company, management abandoned what Bartlett and Ghoshal called its “quarter-century-long love affair with strategic planning,” and tried instead to be as sensitive as possible to emerging changes. It saw knowledge as very valuable on the shop floor, assumed that people were innately curious, and naturally motivated to interact with and to learn from each other, and did all it could to remove those features of the Mk. 2 legacy that limit, impede or kill this natural motivation. Too often the old Mk. 2 company became a victim of its success and remained unmoved and immovable as its winning formula degenerated to conventional wisdom, and thence to sacred cow. It could and did refine its winning formula, but lacked the courage to relinquish it or the ability to replace it. According to Ghoshal and Bartlett the new selfrenewing, individualized companies saw refinement as a continuous

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process and sought improvements that would be seen in Mk. 2 companies as ludicrously ambitious. Ghoshal began his explanation of how to turn a Mk. 2, into a Mk. 3 company with an olfactory metaphor. “I visit Calcutta for a month every summer,” he said. “In downtown Calcutta in July it’s 106 degrees, and the humidity is 99 percent. I get tired and spend a lot of time in bed. I go to Fontainebleau [before moving to London Business School, Ghoshal was Professor of Business Policy at INSEAD] in spring, and I can’t take a leisurely walk through the forest; the crispness in the air makes me want to run.” “You can get the smell of a place in the first 20 minutes. In many cases it’s the smell of downtown Calcutta in summer. The challenge is to create the smell of Fontainebleau in spring.” Bartlett and Ghoshal saw companies as portfolios of processes, and assigned three key roles to top management (equivalent to the CEO, as leader of the CEO system): stretching opportunity horizons and establishing performance standards; institutionalizing norms and values to support cooperation and trust; and creating an overarching purpose and ambition and challenging deep-seated assumptions. “Purpose isn’t strategizing,” Ghoshal emphasized, “it is sharpening the focus from the top, so strategy can emerge from the day-to-day actions of people … It provides energy, and a sense of excitement and direction. Strategy is emergent and induced.” An important consequence of the idea of companies as portfolios of processes, was the death of what Ghoshal and Bartlett called “the Russian doll model of management”; management as a neatly nested hierarchy of responsibilities. In the “individualized” corporation there are no generic managers; just individuals in different roles that require different abilities. This is getting quite close to my idea of the multi-agent business enterprise (MaBE). In the hands of Bartlett and Ghoshal the Mk. 3, individualized corporation becomes more like an integrated network than the Mk. 2 divisional hierarchy where horizontal relationships and information flow are swamped by the organization’s essentially vertical dynamics. But individualized companies have CEOs. “We do not see the virtual corporation,” said Ghoshal. “Some professional and high-tech firms will take that form, but our study suggests that there will almost always be a center. It may be small, but there has to be a primary engine to articulate, revise, and embed a sense of purpose. It is not about creating a bunch of cowboys and cowgirls. It is about an abiding faith in people.”

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Ghoshal and Bartlett put their fingers on a number of vital issues, and they made a strong business case for the kind of organization a reformed MuBE could become. The “individualized corporation” was, in a sense, a late 1990s entrepreneur-oriented development of Douglas McGregor’s Theory Y, which held that people can manage themselves and companies perform better when they trust their employees to make decisions.4 But Bartlett and Ghoshal weren’t interested in structure. For them beliefs, ambience, and “smell” were more important than shape. They saw the corporate form as an abstraction. It is not an abstraction. Structure and size help to determine the ambience and “smell of the place,” and a hierarchical shape, where all power is in the hands of a charismatic leader whose pockets bulge with options and restricted stock, precludes, whatever those CEOs might say, a style of management based on an abiding faith in the ability and entrepreneurial talents of frontline employees. Although for a brief time it looked as if it might, the appearance in our skies of Halley’s comet in 1986 didn’t herald the emergence of the “individualized” corporation and the realization of Douglas McGregor’s 30-year-old vision. It heralded, instead, the advent of shareholder value maximization as the primary strategic objective, the associated obsession with finance, the rise of the charismatic CEO and the executive pay explosion. The CEO system obstructed the emergence of the company Ghoshal and Bartlett described. It is the cause of most of the large company’s problems and weaknesses. Something has to be done about it.

The regents committee A CEO can get run over by a bus; get poached by a rival company or lured away by a government post; lose the confidence of investors; fall out with the chairman; get ousted in a boardroom coup; make a catastrophic decision; turn out to be incompetent; have a heart attack; decide to spend more time with the family; get caught with his or her hand in the till; or just quit for no apparent reason. Companies can lose their leaders unexpectedly at any time and they have to cope, one way or another. The chairman, or another C-level executive, often the chief financial officer, is appointed acting CEO, the nomination committee (NomCo) swings into action, head-hunters are briefed, and an urgent search for a replacement begins right away. It is

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a nervous period. The investment community, with its addiction to charismatic CEOs, worries about who’s minding the store and assumes that employees are rushing around like headless chickens. The strategy’s on hold, because no one knows who the new CEO will be, let alone what he or she will want to do. The agency of the business has gone. Nothing happens, because no one has the power to act and no one wants to pre-empt the new CEO for fear of starting off on the wrong foot with the new Grand Panjandrum. Losing a leader is an ever-present risk, with potentially damaging consequences during the interregnum. Boards are obliged, by their duty to shareholders, to mitigate all risk. One way for a board to discharge their duty to mitigate this particular risk would be to appoint what I call a “regents committee,” the stated task of which was to enable the company to operate effectively without a CEO for extended periods. Such a committee would be more like an executive committee, than a board sub-committee. It might have a non-executive chairman, but it would have no leader equivalent to a CEO, because such a person would probably be a candidate for the vacant CEO position and thus have a conflict of interest. Its membership could be chosen by the non-executive directors. It would shadow the CEO system by sending “observers” to strategy-formulation sessions and meetings with key external advisers – lawyers, consultants, investment bankers, and so on – establishing relationships with shareholders and the investment community, including investment analysts and the financial press; and, by these and whatever other means are deemed to be necessary, generally equip itself to assume the reins of power, should a need arise. During a regency a leaderless stand-by system would save money and equity dilution (from grants of options and restricted stock), and would also have many other advantages. It would reduce the urgency of the search for a new leader, which would have the added benefit of moderating the upward pressure on CEO pay. It would reduce the risk of boardroom bust-ups and, during the time of the regency at any rate, would reduce the sense of unfairness created by huge CEO pay packets. By enabling the board to dispense with their CEO with relative impunity, a leaderless stand-by system would also prevent a bad CEO from destroying too much shareholder value. Following the huge destruction of shareholder value in the banking sector over the past two years, the merits of this last advantage scarcely need emphasizing. It would be in accordance with Sir Karl Popper’s dictum that the most important question in politics (and in business, in

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my view) isn’t “Who should rule?” but “How can we so organize political institutions that bad or incompetent rulers can be prevented from doing too much damage?”5 If regents committees made boards less reluctant to fire CEOs who were intent on making “strategic” acquisitions at recklessly high prices the alarmingly high M&A failure rate might be significantly reduced. I would not expect a proposal to establish a regents committee to be greeted with universal approval. The incumbent CEO, for one, is unlikely to relish the prospect of a group of subordinates looking over his or her (almost invariably his) shoulder, as he steers the corporate ship. Nor is his replacement likely to be sanguine about joining a company where he will be replacing, not the former CEO, but a group of executives who have been running the company pretty well during the interregnum, are well-connected with the company’s key constituencies, and will remain together as an alternative base of power and influence after his arrival. I say “running the company pretty well,” because there’s no reason to suppose a group of people who know the company well, are aware of its resources and strategic options, have inherited a system of management from the previous CEO and who are disinclined, in their caretaker role, to take great risks, will not do a reasonable job. The longest interregnum I can remember at a major U.K. company began when Martin Taylor resigned unexpectedly as CEO of Barclays Bank in November 1998. When Matt Barrett, the distinguished Canadian banker who eventually replaced him in October 1999, announced the group’s 1999 results a few months after his arrival, he revealed a 49 percent increase in operating profits to £2.9 billion. Not bad for a company that for most of 1999 had been operating with no CEO, under the nonexecutive chairman Sir Peter Middleton, and a group resembling an ad hoc version of a regents committee. Although it’s unlikely that either Taylor or Barrett, or any other incumbent or prospective CEO, would have welcomed the formation of a regents committee, shareholders should approve, for the reasons outlined above. The company’s employees should also take comfort from the knowledge that, in times of leaderless uncertainty, there are people they know, and who know them, at the helm. Some companies might find they perform better without a leader and decide they can dispense with charisma, give the money they save on CEO pay to shareholders, and assign the CEO job to the regents committee permanently. They might retain the name and maintain the fiction for a while that they were still looking for the right man or woman,

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if only to appease charisma-addicted investment analysts and journalists. But if they performed as well as, or better than, their CEO-led industry peers, the CEO position could remain vacant indefinitely. If a regents committee is to play more than a stand-by role, much thought will need to be given to its composition and constitution. How will its members be chosen? If, in its original incarnation as a risk management system, its members were appointed by the board, does that remain appropriate for its role as a CEO replacement, or should it be a “soviet” – a council of elected delegates? That word carries far too much baggage for a capitalist institution, but the idea of a gubernatorial committee of delegates or representatives (half of whom would, hopefully, be women) elected by the workforce and shareholders has a lot to commend it. How long would members serve? What would be the formal relationship between the committee and the board? What would be the formal, legal responsibilities of the committee collectively and its members individually? These are important questions, because the answers will become the model for the way that power is exercised and responsibilities are assigned throughout the organization. If the CEO is replaced by a committee of elected representatives, it’s inconceivable that old-style command and control management could survive beneath it. To many this is the nightmare scenario; a democratic plague sweeps through the organization, sapping its disciplines and rigor, and robbing it of direction and decisiveness. A company, once lean and hungry for shareholder value, becomes a mere debating club capable of producing nothing but hot air. Possibly. If so, the company will go bust and those who talked too much and did too little will be out of work. Competition will weed out corporate democracy experiments that fail.

Corporate democracy The Orpheus Chamber Orchestra’s experiment did not fail. Musicians and executives found a way to produce sublime, award-winning music year after year, without a conductor. When first rehearsing a piece of music, a “core team” consisting of the principal player, for that piece, from each instrument section decides musical elements, such as tempo, interpretation, phrasing, and bowing. The core team members are the “leaders,” chosen by the orchestra, for that particular piece. “No one owns a chair; no one owns a principal

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title” the executive director Graham Parker told Jennifer Higgs.6 A few hours after the core team has met the full orchestra assembles to rehearse. In “the executive,” board and orchestra members may have different roles – musicians may have administrative roles; staff members may sit on orchestra committees. “We try and mix it up as much as we can,” says Parker. Orpheus is tinkering constantly with its system. Richard Hackman, a Harvard Business School professor, was recently appointed to the board (see Chapter 6). He is working with Orpheus to improve integration, communications, and accountability. Hackman introduced Orpheus to the linking pin model where the team sits at the center of a horizontal and vertical matrix, and groups radiate from it. Orpheus is the 2008 award winner at WorldBlu Inc., a design studio founded by organizational democracy evangelist, Traci Fenton. The 25-strong, 2008 WorldBlu List of Most Democratic Workplaces also included a Fortune 500 group for the first time – DaVita, a leading U.S. supplier of dialysis services. A company much admired by Fenton and many other organizational democracy advocates is Semco Group, a Brazilian supplier of industrial machinery. It has a charismatic leader in Ricardo Semler, but the CEO is elected. As the principal architect of Semco’s democratic system, Semler thinks he has too much power. He spends as much time writing books and spreading the gospel at business schools and elsewhere, as he does at Semco. The company, which before the 2009 recession had recorded 14 years of uninterrupted, doubledigit growth, ran perfectly well without him for several months in early 2005 when he was recovering from a car crash (see box at the end of this chapter). The election of the company’s senior managers by employees, rather than shareholders, is the crucial democratizing step. There is no avoiding it. In The Democratic Enterprise, Professor Lynda Gratton follows former London Business School colleague, Sumantra Ghoshal, in assigning a key role to leaders in corporate reformations. She says that in the democratic enterprise “it is in the creation of a shared purpose that the role of the leadership is most vital,” and that without the containment of such a purpose people will “simply go their own way and the organization rapidly becomes an adhocracy … the leaders’ personal philosophy pervades the company and their sense of purpose articulates a common vision for the realization of freedom and choice.” Gratton’s book is an excellent survey of the business benefits of a democratic workplace, but she advocates benign tyranny, rather than democracy. She doesn’t acknowledge the possibility that leaders are the problem, not part of the solution.7

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In their book The End of Management and the Rise of Organizational Democracy,8 Kenneth Cloke and Joan Goldsmith take that crucial step and advocate the election of CEOs by employees. They also advocate the replacement of hierarchies by what they call “heterarchies” in which the employees “make decisions for themselves and one another horizontally.” I approve fully of the sentiment and the shape, but in English English, “heterarchy” means rule by an alien. Companies are already heterarchies, because in theory they’re ruled by their shareholders. Cloke and Goldsmith democratize leadership itself, by arguing that it is a quality required at every level and that companies should try to develop “ubiquitous, linking leadership.” This is similar to the “contextspecific” leadership developed by the Nhunggabarra in Australia tens of thousands of years ago (see Chapter 6). I have no quarrel with this kind of leadership, but it is not what most people understand by the word. If democracy is to come to the large modern company, the omnipotent CEO has to go. In the political world tyrannies can be overthrown by revolutions and replaced by democracies, but you cannot turn business tyrannies into democracies overnight. You have to take one step at a time as Ricardo Semler did at Semco. You have to nudge.

Numbers that nudge When I was doing my research on Gini coefficients for Chapter 4, it occurred to me that companies wishing to establish reputations for being fair organizations might consider publishing their own Gini coefficients. To save you leafing back let me remind you. The Gini coefficient is a measure of inequality. A coefficient of zero is perfect equality; everyone in the population measured has the same income. A coefficient of one is perfect inequality; one person has all the income. Insofar as able people think extremely high levels of executive pay are wrong, unfair, or merely unfashionable in this day and age, they will be attracted by a company with a Gini below the average for its sector. Numbers such as these can make a difference. If a graduate has two equally attractive job offers, he or she might choose the one from the company with the lower Gini. It would be easy to calculate the Semco Gini, because the pay of every employee, including Ricardo Semler’s, is an open book. This was part of the democratization of Semco; the opening up, the laying of cards on the table, an end to secrecy. Most writers on organizational democracy make much of the need for open-

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ness or “transparency” as the modern parlance has it. In conventional companies the possession of information is closely linked to power. The higher up the hierarchy you are, the more you are allowed to know, and vice versa. Giving everyone access to the important numbers is a vital step toward democracy.

Open-book management

Giving everyone access to the critical numbers is called open-book management (OBM). Ricardo Semler was an OBM pioneer. So was Jack Stack, CEO of Springfield ReManufacturing Corporation. The idea is that a company performs better when everyone involved knows how it is performing. It is also in tune with demands for openness in our institutions, and a dislike of secrecy and obfuscation. People are less willing to be pawns in other people’s games and stories, and are more financially sophisticated these days. They have more skin in the business game and have become more interested in the wealth creation process. The OBM evangelists argue that, if that interest is satisfied by opening the books, employees will understand how their work contributes to wealth creation, and more wealth will be created. But you can’t stop there. “Opening the books” is opening Pandora’s box. It unleashes a host of new desires, hopes, and anxieties that can initiate changes so profound the OBM company could soon become unrecognizable. In The Open-book Management Experience John Case tells the tale of Jack Stack’s experiment at Springfield ReManufacturing and of many other companies that have implemented OBM.9 He reaches three main conclusions. The first is that it is pointless to tell people the whole, unvarnished truth in a language that’s foreign to them. It follows from this that OBM implies an obligation to educate and explain, so that the critical numbers disclosed are understood. Since the goal is to get people to work more effectively, and make better decisions, OBM also requires a strong form of empowerment, because it would be fruitless to help people understand how they contribute without giving them responsibility for, and the freedom to increase, their contributions. Case’s second conclusion is that OBM companies are “companies of businesspeople.” Transparent companies, employing “businesspeople” are risksharing companies, because employees who see the critical numbers “moving south” know they will have to tighten their belts. Their know

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ledge restrains them but, in return for their restraint in hard times, they will feel entitled to more rewards when the numbers tell them the good times have returned. This is Case’s third conclusion. OBM requires employees to have “a stake in success,” because they will not feel they own the critical numbers unless they own some of the value they measure. Case sees bonuses as “an integral part of the whole management system [which are] expected, not only to motivate employees, but to help them learn.” He says bonus plans should be “fair, generous and comprehensible” and designed by employees. But surely an employeedesigned bonus scheme would favor employees, at the expense of shareholders? Apparently not. “For reasons I don’t entirely understand,” Case reported, “the opposite is more common.” This is indeed puzzling, until one learns that most of the open-book companies Case studied are owned in whole or in part by their employees. When employees are owners a miserly, employee-designed bonus scheme reflects people’s preferred mix of income and capital appreciation. Employee ownership or part ownership is an implicit destination of OBM, because equity can be seen as the capitalization of income from bonus schemes. In large companies in which employees cannot, in the short term at any rate, own a significant proportion of the equity, and the contribution of an individual has only a marginal impact on overall performance, the performance benefits of OBM are likely to be less evident than in small companies. But insofar as OBM does improve performance, there are two implications for large companies. The first is that small and medium-sized companies that adopt OBM will outperform their larger rivals, and so become more attractive to able people. The second is that large companies that seek the benefits of OBM should review their bonus schemes. OBM bonus schemes are “fair, generous and comprehensible.” Schemes that are confined to senior executives are unfair, they’re usually extremely generous, but only to senior executives, and their blend of salary-based bonuses and grants of options and restricted stock make them incomprehensible to the average employee. It is an axiom of OBM that everyone contributes to company performance. The bonus schemes at most large companies implicitly deny this obvious fact, and imply instead that only top executives, particularly the chief executive, create value. A significant step toward democracy, and to a fairer distribution of valued added, would be to put everyone on the same bonus scheme and, as far as possible, to base the bonus of each employee on the economic value he or she adds.

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Measuring CEO performance

It’s often said that you can’t measure the economic value added by CEOs, because they’re members of the staff function, and the staff function’s job is to consume value (and how!) supporting the line function. All you can do is ensure that the interests of the staff are aligned as closely as possible with those of shareholders. An implication of this argument is that if the value added by a CEO personally, rather than employees collectively, could be measured, she or he would not have to be paid so much (unless of course, she or he was adding enormous, and measurable amounts of value. Were I a shareholder, I would be willing to take my chances on that). I’m not aware of any attempt to measure CEO value added. For their part, CEOs are unlikely to see it as in their interests to partake in such a study. But, given the potential savings, it would surely be in the interests of shareholders to explore the possibility. The obvious approach is to apply the activity-based costing method that has revolutionized management accounting and ask each area of the business – manufacturing, marketing, distribution, public and investor relations, accounting, human resources, and so on – touched by the CEO how much it would be willing to pay for the services he or she has rendered. Negative figures would be acceptable. Some value could be added to the total for strategic moves and balance-sheet transactions such as acquisitions, but only insofar as they can be shown subsequently to have created value. It would be useful for assessing the value added by the CEO in the company’s strategic and other balance-sheet moves, and appropriate in a company committed to openness and candor, if the board, the board committees, and the executive committee were all required to publish the minutes of their meetings. It wouldn’t be easy to calculate CEO value added and the result of such a calculation would not be precise, but precision wouldn’t be necessary. A ballpark figure would do. The objective is to bring some proportion and clarity to CEO pay, so that both employees and shareholders can be confident that taking as much as possible into account, the CEO’s pay packet is reasonable. It’s entirely possible, of course, that an activity-based analysis of the CEO’s value added will produce such a small number that the company will decide it can do without a CEO.

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Redeeming the corporation The dramatic events of the past two years or so in banking and in business at large, offer an unprecedented and, hopefully, never to be repeated opportunity, which should not be wasted, to take stock of our economic arrangements and institutions. The large listed joint stock company is an enormously powerful and successful institution and is, in large part, the creator of the modern world. If things had turned out differently, other forms of enterprise might have done a better job, and might still do so in future, but the corporation as we know it today has been and will continue to be for the foreseeable future the main engine of world economic development. But although its achievements are all around us and its strengths are formidable, it has serious weaknesses. I have argued in this book that it has recently become a liability for liberal capitalism, because the huge sums of money it pays its top executives, which are not required for the efficient conduct of modern business, are eroding the consensus on which the liberal capitalist system depends. Excessive executive pay was tolerated before the crash because the system seemed to be working. Now that those highly paid executives running the system have turned out collectively to be reckless and incompetent the trust invested in them has dissipated and the myth of business leadership has been dispelled. As shown by the furor over the $165 million worth of bonuses that were to be paid to executives of U.S. insurance giant AIG, after it received $152 billion of bailout cash, people are angry. They feel badly let down. The least that they, as the ultimate owners of big business (through pension funds and savings) had a right to expect from such well-paid servants was prudence and competence. They got neither, because as the past two years have made abundantly clear, the CEO-led system of corporate governance doesn’t select for such qualities. The danger, in these times of turbulence and anger, is that deeply disillusioned and resentful voters will insist that the commanding heights of their economies be taken into state ownership, and that the liberal capitalist experiment be abandoned. To pre-empt such a backlash, the large listed company must reform itself. It must become freer, fairer, more open, more reasonable in its dealings with its various constituencies, and more decent. In its shape, governance, and distributions of power and rewards, it must come to resemble more closely the political system we call liberal democracy to which it owes its freedoms.

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State ownership of our large companies is too drastic a remedy for what ails big business. Its poor record disqualifies it. It would cost too much in lost efficiency, dynamism, and the disciplines of competition. My prescription is decapitation; the removal of the institution’s head; of the position of CEO. The CEO-led system, in the power it gives to individuals (untested during their climbs to the top for prudence and competence), and the inequalities within companies and society at large it creates, is the source of almost all the company’s own problems and of the problems it creates. In this chapter I have suggested how such a decapitation might be executed, so to speak, and proposed other steps companies can take to make themselves more democratic. Democratic companies will be driven, not by the dreams and visions of omnipotent CEOs, but by the interactions of self-interested and selfconfident employees empowered to make decisions and motivated by fair rewards and their hunger for self-esteem, to be innovative and entrepreneurial. They will perform better than unreformed CEO-led companies, because they will find it far easier to attract and keep able people who want work to be, not a price they have to pay to be themselves outside work, but an interesting, challenging, and deeply satisfying part of their lives. We must move away from the current system, which John Rawls called the “capitalist welfare state,” because it concentrates too much power, wealth, and story in the hands of a small elite to allow the full flowering of liberal principles. We must create a new kind of liberal capitalism. Rawls proposed a “property owning democracy,” in which ownership of wealth and productive assets is spread more widely, or a “liberal socialist regime” in which political power is widely shared and economic power is dispersed within companies, as when, for instance, employees elect managers and own a significant proportion of their company’s shares.10 Ordinary people in search of self-respect will be the sculptors of the reformed system. They will seek out organizations and forms of association that don’t retain power, wealth, and story in the hands of a small elite and, instead, allow each contributor to feel that he or she is being fairly rewarded and is the author of his or her own story. There’s no reason why people should continue to be mere “extras” in the stories of superstar CEOs. They can be the authors of their own work narratives and play significant roles in stories of enterprise with beginnings, middles, and ends.

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Semco’s steps to democracy Ricardo Semler’s guru and principal ally in the democratization of Semco was Clóvis da Silva Bojikian, a radical educator and admirer of A. S. Neil’s Summerhill school in England. They took it slowly. The first step was to respond to complaints about the cafeteria by asking employees to help improve it. A group of employees ended up running it. It was a small step from there to let employees choose the color of their uniforms and the paint on factory walls. The São Paulo rush hour is notorious – Semco employees spent hours in traffic jams travelling to and from work. No problem. They can set their own hours, and travel at non-peak times. Skeptics within Semco’s management warned of disaster, but it worked fine, because employees sorted out schedules that suited them and the factory. It was another small step from setting their own hours, to setting their own pay. Benchmarks based on pay at 35 comparable companies were established and 10 percent was added to help reduce employee turnover. Everyone’s pay, including Semler’s, is published. Peer pressure produces differentials that are seen as fair. It was not a huge step from there to allow subordinates to appoint and review their supervisors and ultimately for employees as a whole to elect the senior executives. It was not as easy as all that, of course. There were problems and arguments along the way and the whole democratization process took nearly five years. But the results, in terms of performance, speak for themselves. Source: “Ricardo Semler Won’t Take Control,” by Lawrence Fisher, Strategy + Business, issue 41, January 2006.

References 1 2

Managing Across Borders: The Transnational Solution, Harvard Business Press, 2002. The Individualized Corporation: A Fundamentally New Approach to Management, HarperCollins, 1997. 3 The Organization Man, Simon & Schuster, 1956. 4 The Human Side of Enterprise, McGraw Hill, 1960. 5 The Open Society and its Enemies, Routledge, 1945. 6 Orpheus Chamber Orchestra embodies democratic principles. Self-governing orchestra empowers musicians, by Jennifer Higgs, Axiom News, October 28, 2008. 7 The Democratic Enterprise, Prentice Hall, 2005. 8 Jossey-Bass, 2002. 9 The Open-book Management Experience: Lessons from Over 100 Companies that Have Transformed Themselves, Nicholas Brealey Publishing, London, 1998. 10 Justice as Fairness: A Restatement, Belknap Press, 2001.

Index

A

business schools 60, 61, 102, 107, 109, 113, 186 Buttrick, John 58

Accenture 166 Acorn Computers 167–8 activity-based costing 59, 190 administrative coordination 52–5, 60 agency costs 10, 38, 45, 53, 54, 65, 81, 94, 97, 98, 111, 112, 117, 119 AIG 191 Andersen Consulting See Accenture Apache Software Foundation 138 ARM Holdings 167–70 Armstrong, Lord 67 artificial life 169 asset-skimming 92–5, 98 A. T. Kearney 167

C Canonical 137 capitalism entrepreneurial 62, 63, 66, 67, 131 family 62, 63, 67 financial 62, 63 investor 63, 99 managerial 60, 62, 63, 66, 67, 99, 131, 175 Case, John 188, 189 Catalyst 150 Catcher in the Rye 143 CEO -led company 8, 11, 17, 29, 120, 123, 124, 127, 135, 138, 139, 148, 163–7, 170, 171, 174, 175, 176, 185, 191, 192 pay, pay packet 1, 5, 6, 7, 10, 24, 45, 54, 63, 67, 69, 72, 78–86, 88–98, 100, 102, 104, 106, 110, 114, 117, 119, 143, 148, 159, 165, 174, 175, 182, 183, 184, 187, 190, 191 system 61, 105, 109–11, 113, 114, 117, 119, 132–5, 142, 149, 177, 181–3

B Barclays Bank 184 Barnevik, Percy 179 Barrett, Matt 184 Bartlett, Christopher 178–82 Berle, Adolf 37, 62 Black-Scholes 84, 85, 95 Booz-Allen & Hamilton 166, 167 Branson, Sir Richard 26, 63, 90 Brimm, Michael 26–8 Broughton, Philip Delves 61 B-schools See business schools 194

195

INDEX

Chambers, John 26 Chandler, Alfred 43, 44, 48, 51–6, 58, 60–7, 69, 71, 99, 124, 125, 127, 131, 163, 179 chief executive officer See CEO Chrysler 99, 162, 163 Clapham, Sir John 57 Clive, Robert 38, 42 Cloke, Kenneth 187 cloud computing 137 Coase, Ronald 52, 53, complex adaptive systems 132, 133, 142, 170 coping classes See Woods, Judith corporate community 148, 149, corporate purpose 96, 133, 145, 146, 147, 181, 186 corporate social responsibility See CSR corporate soul 148, 149 Cranfield University 150 Crystal, Graef 82, 85 CSR 147, 148, 150, 155

D Dawkins, Richard 34 Deering, Anne 170, 171, 173, 174 Deloitte 123 Deming, Edwards 163 democracy 3, 9, 11, 17, 18, 20, 29, 48, 69, 71, 90, 118, 131, 149, 185–9, 191, 192, 193 democratization 20, 187, 193 de Quincey, Thomas 41 difference principle See Rawls, John distributive justice 24, 70, 71, 145

E Eagly, Alice et al. 154

Economic Policy Institute (EPI) 95, 96 economies of scale 162 English East India Company (EEIC), the 37, 38, 53 environment of evolutionary adaptedness See EEA 8, 10, 43, 44, 52, 54, 55

F Fels, Anna 153 Female FTSE Report, The 150 Fenton, Traci 186 Fink, Albert 125, 126 fitness landscape 129, 130 Follett, Mary Parker 154–6, 160, 165 Frank, Barney 81 Free Software Foundation 135, 136, 139 Frenier, Carol 156 Fukuyama, Francis 17, 18, 63

G Gates, Bill 26, 90, 175 GE 96, 100, 101, 105, 114 Gekko, Gordon 89 General Electric See GE Gent, Sir Christopher 94 Gerstner, Louis 106, 126 Ghoshal, Sumantra 178, 179, 180, 181, 182, 186 Gilligan, Carol 159 Gini coefficient 72, 73, 74, 76, 187 in China 73–4 in the UK 75–7, 82 in the US 75, 82 Gini, Corrado 72 GNU 135, 136, 142 GPL 135, 137, 138

196

GNUpedia 139 golden parachute 2, 24, 80, 81, 82, 83, 114 Goldsmith, Joan 187 Gould, Jay 126 Gould, Stephen Jay 44, 49 Graham, Jacey 150 Graham, Pauline 155 Granovetter, Mark et al. 126 Gratton, Lynda 186 greed 5, 6, 10, 86, 88, 89, 90, 91, 98, 108

H Hackman, Richard 110, 186 Hamel, Gary 133 Harvard Business School 59, 60, 61, 63, 71, 98, 116, 186 Harvey-Jones, Sir John 101 Hastings, Warren 38 Hayek, Friedrich von 84 Hegel, Georg W. F. 18 hierarchy-climbing 47, 59, 111, 152, 153 Hirsch, Fred 29 Hobbes, Thomas 18 Hudson’s Bay Company 39, 48, 49

I Iacocca, Lee 99, 100, 101, 102 Ibbotson, Piers 143 IBM 106, 126, 136, 138, 139, 162, 163 ICI 100, 101 Industrial Revolution 4, 39, 41, 42, 57 information costs 52, 53 inside contracting 58 Institute for Fiscal Studies (IFS) 76, 77 Interstate Commerce Act 125, 126

INDEX

J JIT 163 JLP 155 John Lewis Partnership See JLP Johnson, Thomas 58 Johnson, William 82 joint stock company CEO-led 8, 11, 17, 29, 120, 123, 124, 127, 135, 138, 139, 148, 163–7, 170, 171, 174, 175, 176, 185, 191, 192 company as a state 22, 23, company as a people 22, 23 “nice” company, the 25, 146 justice as fairness 18, 69, 70

K Kaplan, Robert 58, 59 Kauffman, Stuart 55, 127, 128, 129, 130, 131, 134, 135 Keynes, J. M. 3 Keynesian 64 Khurana, Rakesh 63, 98, 99, 115, 124 Kingfisher 94 Kotter, John 59, 60, 61 KPMG 123 Kuznets, Simon 73–5

L Landes, David 34 Lazear, Edward 46 Lewis, John Spedan 155 liberal capitalism 1, 2, 3, 4, 6, 10, 11, 70, 71, 78, 84, 86, 88, 102, 119, 191, 192 consensus 3, 6, 10, 11, 70, 72, 77, 78, 83, 86, 88–90, 102, 119, 143, 145, 160, 177, 191

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INDEX

liberal democracy 9, 11, 17, 18, 20, 29, 48, 69, 71, 90, 191 liberal socialist regime 71, 192 line-and-staff organization 51 Linux 11, 56, 126, 135–8, 142, 143, 163, 170 London Business School 178, 181, 186

M Machiavelli, Niccolò 18 managerial hierarchy 51, 54, 55, 57, 63 Marx, Karl 2, 40, 41 Masefield, John 40 MBA 60, 61, 71, 106 McGregor, Douglas 182 Means, Gardiner 37, 62 meme 34 mercantilism 36, 39, 40, 41 mergers and acquisitions (M&A) 7, 22, 54, 65, 93, 94, 105, 114, 162, 184, 190 Microsoft 4, 135, 136, 138, 139, 163 Mulcahy, Sir Geoff 94 multi-agent business enterprise (MaBE) 11, 126, 138, 139, 143, 163, 164, 166, 171, 175, 176, 181 multi-agent system 134, 135, 138 multi-unit business enterprise (MuBE) 43, 44, 48, 52–67, 69, 71, 123, 124, 125, 126, 127, 130, 138, 139, 163, 175, 176, 179, 182 Murdoch, Rupert 63 Murphy, Anne 170, 171, 173, 174

N nabob (nawab) 38, 42, 53 National Association of Pension Funds 94

netbook 137, 138 Nhunggabarra 118, 119, 187 niceness 146, 148 Nietzsche, Friedrich 18 Nupedia 140, 142

O Obama, Barack 84 O’Neal, Stanley 79, 81 open-book management 188, 189 original situation 19 Orpheus Chamber Orchestra 110, 185, 186 Ousterhout, John 138, 142 outsourcing 9, 53, 54, 170

P parasite strategy 169 Parker, David 133, 134 Parker, Graham 186 Peter, Laurence 133 Peters, Tom 133 physiocrats 32, 40, 41 Pickett, Kate 76 Popper, Sir Karl 3, 30, 96, 183 Porter, Michael 133 powers of sovereignty 16, 22, 24, 26, 30, 117 Prahalad, C. K. 133 PricewaterhouseCoopers 123 primary good 9, 17, 18, 28, 70, 127 Prince, Charles (Chuck) 78, 79, 81 procedural justice 21 property owning democracy 71, 192 psychological contract 9, 17, 145, 148

Q/R Quesnay, François 40, 41

198

Rappaport, Alfred 96, 97 Rawls, John 9, 18, 19, 22, 24, 30, 69, 70, 71, 78, 81, 117, 127, 192 Ray, Thomas 169, 170 regents committee 182–5 regulated companies 36 RemCo 83, 84, 85, 93, 98, 104 Remuneration Committee See RemCo reputational assets 25, 147, 148, 154 restricted stock 92, 93, 148, 182, 183, 189 Ricardo, David 34 Ridley, Matt 33, 112, 151, 152, 153 RISC 167, 168, 169 Rousseau, Jean-Jacques 18

S Salinger, J. D. 143 Sanger, Larry 140, 142 Sarbanes-Oxley Act 4, 111, 112, 158 Saxby, Sir Robin 168 Scarman, Lord 76 self-organization 132, 133, 134, 141, 142, 170 self-respect 7, 9, 11, 15, 17, 18, 20, 21, 24, 26, 28, 29, 30, 31, 48, 70, 127, 131, 145, 149, 159, 176, 177, 192 Semco 186, 187, 193 Semler, Ricardo 186, 187, 188, 193 Senge, Peter 133 shareholder value maximization See SVM Shuttleworth, Mark 137 Skuthorpe, Tex 33, 118 Smith, Adam 32, 33, 35, 36, 37, 39, 40, 41, 49, 58, 62, 66, 123, 131

INDEX

social construction 99, 104, 123, 124, 126, 127 Stacey, Ralph 133, 134 Stack, Jack 188 stakeholders 21, 96, 146, 156 Stallman, Richard 135, 136, 139, 142 Stern, Joel 97 Stern Stewart 97, 114 Sternberg, Elaine 147 stock options 5, 32, 46, 63, 79, 84, 85, 92, 93, 95, 97, 114, 148, 182, 183, 189 Sveiby, Karl-Erik 33, 57, 118 SVM 96, 97, 146, 147

T TARP 79–82, 112 Tawney, R. H. 35 Taylor, Frederick W. 57, 179 Taylor, Martin 184 telegraph 43, 56, 126 Thomson, Peninah 150 Tierra 169, 170 Torvalds, Linus 136, 137, 142 tournament theory 46, 47, 72, 97 TQM 163 transaction costs 52, 53 Troubled Asset Relief Program See TARP Tyler, Carlotta 155–7

U/V Ubuntu 137 value-added reseller 166 value-adding partnership 166 Vanderbilt, Cornelius 126 veil of ignorance 19, 30 Vickers-Armstrongs 62, 64, 67–8 Vodafone 94

199

INDEX

W Wales, Jimmy 140, 142 Wall, Larry 138, 142 war for talent 7, 24, 59, 150 Weber, Max 33, 89, 99 Welch, Jack 26, 96, 100, 102, 105, 179 Western Railroad 34, 43, 51, 56, 126, 179 Whyte, William 180 Wikipedia 11, 139–41, 142, 143, 163

Wilkinson, Richard 76 Williamson, Oliver 53 Windows 4, 136, 137, 138 Woods, Judith 77 work–life balance 7, 17 work-related stress 17 WorldBlu 186 Wyclif, John 35, 36

Y Yir Yoront 33, 34

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