Notes on the Theory of the Managed Firm

Notes on the Theory of the Managed
Firm (TFM)
J.-C. Spender
Working Paper Series
Nonaka Centre for Knowledge and Innovation
Number 1
November 2013
Colegio Universitario de Estudios Financieros (CUNEF)
C/ Serano Anguita 8, 28004 Madrid (Spain)
1
Editor´s Foreword
CUNEF´s Nonaka Centre for Knowledge and Innovation series publishes the work
of members of CUNEF and people associated with it. Papers may be of topical
interest or require presentation outside of the normal conventions of a journal
article. A formal editorial process ensures that standards of quality and objectivity
are maintained.
This paper follows a presentation titled “Innovation: Planning the better mouse
trap or responding to knowledge absences”, given at the BBVA Innovation
Centre to an audience of academics and practitioners in October 2012 by
Professor JC Spender, Visiting Professor at ESADE (Spain), Lund University
(Sweden), Cranfield University School of Management and Open University
Business School (UK).
In the present working paper “Notes on the Theory of the Managed Firm
(TMF)” Professor Spender addresses a critical question for management and
organization researchers: What is the firm? He argues that while every theory of
the firm is a reflection of the analyst´s purpose the TMF opens up dimensions of
analysis that are ignored by the mainly positivist discourse around micro
economics and organization and management theory. By focusing on the firm as a
politically, legally and socially legitimated apparatus for creating economic value
the TMF brings in the ethical and moral dimensions of managing. Spender
underlines the TMF is crucial step towards better understanding economic value
creation and how it hinges on the constrained, as opposed to free, exercise of
human judgment. While the debate is useful for management and organization
researches Spender gives some thoughts to politicians and entrepreneurship
researchers who are interested in fostering the dynamics of firm formation: he
reminds us that the constraint the entrepreneur must work within are often those
of society – political, legal and normative – rather than those occasioned by the
physical nature of the transformations the firm´s production function presumes or
the personal or psychological constraints to persuading collaborators.
Sylvia Rohlfer and Jorge Cruz-González
2
Notes on the Theory of the Managed
Firm (TMF)
J.-C. Spender
Background to the Theory of the Firm
The term ’theory of the firm’ is familiar to micro economists but may be less so
to management and organization researchers. Yet these too must have some entity
in mind as the ‘thing’ being managed. What, then, is the firm? Two concepts are
always necessary and axiomatic to thinking about managing the firm; (a) the firm
(or organization) as an entity in the analysis and (b) the human individual doing the
managing and, perhaps, being managed along with tangible resources and
intangible capabilities. Such concepts are generally brought into the analysis ‘by
assumption’ and seldom made explicit. When did we last see a definition of ‘the
organization’? Or ‘the individual’? We hear frequently, in critical tone, that our
discourse is over-formalized in presuming a rational or, as Simon suggested, an
‘intendedly rational’ individual --‐ manager, employee, customer, supplier, etc.
(Spender, 2013). Consequently the individual’s definition is often left implicit
since making it explicit threatens to narrow the scope of the analysis. Likewise the
assumptions about the firm as an entity are seldom spelt out or self--‐evident. Our A-‐journals presume we know what firms/organizations are.
They are not
problematized --‐ they merely need direction or their resources reallocated to
improve their performance. They are seen as production functions or machines for
transforming inputs into outputs as efficiently as possible. There are other ideas
about firms, of course, splendidly laid out in Morgan’s Images of Organization
(Morgan, 1997). Even when we have concepts of firms/organizations and people
in place, the research literature has made little of any necessary interplay or
isomorphism between them, such as the need to adopt a rational--‐man model of the
firm’s individuals if the firm itself is to be rational. Note that Simon was one of the
few to probe how a science of administration might work to create rational
organizations from boundedly rational beings.
3
There are two questions here. One concerns the literature’s variety of models
of individuals and firms and where they come from and how they can be fitted
together. Another is how a particular model of the individual might limit or extend
what the firm is capable of --‐ its capabilities. Those who define the firm as a bundle
of tangible resources will judge this question scarcely relevant, it is all about
resource allocation. Yet in the background are Coase’s unanswered questions about
the nature of the firm --‐ Why do firms exist? Why are their boundaries located
where they are? Why are their internal arrangements as they are? Why is their
performance so varied? (Coase, 1991). Clearly there is a gap between what Coase
had in mind and the institutionalized view that the firm or organization is
unproblematic or self--‐evident or simply its resources. Coase’s questions have yet
to be answered and some micro economists are prepared to admit this suggests an
‘academic scandal’. A post WW2 generation of micro economists, Williamson,
Demsetz, Fama, Klein, Hart, Masten, among others, has generated a portfolio of
possible ‘theories of the firm’ that have some potential to address Coase’s
questions. Their vigor and success (and Nobel Prizes) has led some to argue that
the territory of organizational theory and sociology is being ‘colonized’ by micro
economics (Fine & Green, 2000). Many academic jealousies and prizes at stake
but the matter is basically methodological. The micro economists achieved
considerable progress into the ‘black box’ of the firm by staying with their rational
model of the human being, keeping the discourse within economics. Their work is
clearly not neo--‐Simonian, for in spite of Simon’s Nobel no modification of rational
man is welcomed. At the same time neoclassical economics has been buttressed of
late by ‘behavioral economics’. Despite the hoopla, amplified by those interested
in brain science and MRIs, this development does not, in fact, abandon the core
axiom of rational man. Rather it saves the assumption of a universal rationality,
albeit one biased away from pure logic and homogenous information. Kahneman’s
Nobel implies his work has been welcomed by the economics establishment as a
new defense against the rising numbers of those attacking the axiom of rationality.
The not--‐fully--‐logical--‐but--‐still--‐rational man of behavioral economics universalizes
empirical evidence of our tendency to structure information systematically in ways
that logicians or analytic machines do not. But behavioral economics offers no
new answers to Coase’s questions.
In contrast, Simon was committed to human beings’ heterogeneity, to our
being different in ways that were crucial to the firm’s nature and administration.
He suspected, along with others such as Coase and Barnard, that firms arose only
as such individual differences were subordinated to or unified by the firm’s goals
(Barnard, 1968). All involved then showed practical commitment to something
‘beyond themselves’ rather than to themselves alone --‐ rational man’s focus. They
4
were ‘with the program’. Any mechanisms adopted to make such subordination
happen point to a non--‐microeconomic ‘theory of the firm’ that has yet to be fully
spelt out. Organization theorists have a portfolio of tentative non--‐rational man
theories.
Bureaucratic theory presupposes that professionally qualified
individuals volunteer to be hired into roles in a rationally designed apparatus. In
contrast, political theorists see the exercise of superiors’ power as inducing the
subordination. Psychological theories see the need to belong to the group
overcoming individuation. Unfortunately these theories also fail to address
Coase’s questions. Especially the “Why do firms exist?” one. In bureaucratic
theory this question is pushed beyond the analysis; firms are simply the
instruments of the owners’ goals. In political theories of the firm, such as
stakeholder theory, there is no answer to why firms exist or are chosen as
instrument of policy; plus the boundary between the political activity within the
firm and outside it dissolves. The firm is merely a socio--‐political context in
which individuals do their political thing. There is no notion of the firm.
Likewise for the psychological theories of the firm; it is simply a psycho--‐social
context for individuals. There is no firm.
One way to address Coase’s questions lies through the notions of the
individual rather than of the firm. Those who look at the firm for answers are
simply looking in the wrong place. At the same time the post-WW2 micro
economists are beginning to question whether any viable theory of the firm --‐
beyond the ‘black box’ of a ‘firm--‐less’ production function --‐ can stand on rational
man assumptions. The attack on rational man is often mounted from notions of
emotion, ethics, social duty, and so on. The weakness here is that while rational
man gets soundly ‘dissed’, little is put in his place. The lack of a clear definition
of the individual means the resulting discussion lacks coherence --‐ all the right
words but what are they to mean in practice? What is the objective function, and
how is it reached? Writers seem to say IF the firm exists, THEN it should act
judiciously, ethically, or with attention to its social responsibilities. But why? Just
because individuals should act this way --‐ a debate about moral philosophy --‐ why
should firms? Were firms presumed to be individuals --‐ a highly contested issue --‐
then OK, it would follow. But can Coase’s questions then be rephrased as “Why
th
do individuals exist?” Obviously not. The 18 century Italian philosopher
Giambattista Vico suggested we could certainly ask why firms existed, because
they are our constructions, but that we could not ‘enter the mind of God’ to ask
why we existed (Croce, 2002). A similar point was made by Simon when he
argued that “Nothing is more fundamental in setting our research agenda and
informing our research methods than our view of the nature of the human beings
whose behavior we are studying” (Simon, 1985:303). If not Rational Man, then
5
what? Whatever the answer, the researcher’s choice delivers the resulting
discussion into a particular part of the overall study of economics, management,
and organizations, for any move away from rational man puts the discussion into a
different sub--‐field, beyond the reach of economists and sociologists of Rational
Man persuasion. The institutionalization of our publications reinforces this
separation, for our journals are closely tied into particular axiom sets - micro
economics presumes Rational Man, the Academy of Management Learning and
Education does not. At the same time we should appreciate no discipline’s set of
axioms lie beyond criticism. The history of natural science is less one of steady
progression on a single axiom--‐base, more a series of ‘scientific revolutions’ as
axiom sets are revised or tossed aside. In the social sciences there is less advance
by revolution and more a ‘circulation of elites’ as one axiom set achieves
rhetorical and disciplinary dominance in the academic journals and university
appointments.
Yet the irony is that there is widespread agreement about the limited practical
value of socio--‐ economic theories based on rational man --‐ and a growing suspicion
that the way towards more powerful theories of the firm lies through theorizing the
evident failures of rationalist approaches. For instance, one route lies through
‘market failures’, wherein firms might be responses to the market’s failure to be
fully rational. Unfortunately we have no theory of market failure, so it is not clear
how this insight can be translated into a theory of the firm. While failures clearly
occur, they are of many types and there is no general theory that can gather up all,
or even several of these. Rather we see the recent activity of this generation of
dissident micro economists as explorations of very narrowly specified types of
market failure --‐ for instance in principal--‐agent theory --‐ that then lead on to specific
but not general post--‐neoclassical theories of the firm. Likewise if firms are able to
produce at a better cost than the ruling market price then there is a rationale for
firms’ existence, and if the relative prices are known, the firm’s boundaries can be
established rationally. Unfortunately this analysis misses Coase’s existential
question because a firm must exist before it can discover its ability to out--‐price the
market. Nonetheless, there has been a steady accumulation of these ‘failure--‐based’
explorations. Unfortunately they fall into axiomatically separated silos which,
while clearly beyond the reach of neoclassical discourse, are not birds of a feather
that come together into a coherent discussion of non--‐rational--‐man theorizing,
precisely because their axiom sets or, more specifically their assumptions about
markets, differ. Note that rationality is still presumed of the individual actors, just
as principal and agent are both presumed to pursue their own interests.
6
Recovering an Old Route --‐ Judgment
A rather different route to a post--‐positivist theory of the firm lies through
theories based on models of non--‐rational--‐man individuals. There are many such
models, of course, for we have not yet arrived at a compelling or coherent universal
theory of ourselves or our condition. Merely mentioning this opens us to the whole
of philosophy, what can be rudely collapsed into the everlasting search to answers
to the existential question “What is Man?” While it seems obvious that researching
firms involves people and so connects us to philosophy there is some hope that
firms pose a simpler set of questions that lie on ‘our side’ of the more profound
philosophical ones --‐ for the reasons Vico suggested; firms are our constructions,
they are not ‘natural’ as we are. As soon as we stop presuming what firms are, our
analysis turns to the task of creating them, for we determine what they are. The
simplest level of answer to Coase’s question is ‘us’ --‐ we (or our failings) are why
firms exist and we give them their nature.
This is strategic work or
entrepreneurship, and rational--‐man axioms do not illuminate it well. The task is
creative, a practice not an idea and, as we know from Polanyi, real world practice
always requires the application of tacit (personal) knowledge because our world is
uncertain and our experience can never be fully grasped by rationalist notions
alone. Instead of stepping away from rational--‐man by supplementing the model
with emotions, moral scruples, or a sense of social duty, we can follow the
Enlightenment philosophers and propose an alternative model of the individual as
combining judgment with reason. This does more than supplement reason; it
reframes what we mean by reason. It puts our capacity to reason and imagine in
dialectical tension for we reason about our judgments. We do not know anything
for certain so we must always begin our reasoning by making judgments. Our
judgments come from us --‐ our imagination. We cannot begin by reasoning about
facts as if they came to us from elsewhere. As Descartes and Kant reminded us,
we have no knowledge of the world beyond us that is unmediated by our minds and
judgments.
Embracing judgment and making it fundamental to how we know recovers a
mode of analysis that was familiar in the era before rationalism took over in the
th
19 century and pushed judgment out of the academic discourse and university
syllabi. Note judging is not a state that can be rationally determined, measured, or
explained, as the product of experience, for instance. The term is more a ‘place
holder’ for a human capability sensed but discovered as very different from our
ability to reason logically. It is our capability to arrive at conclusions in situations
that cannot be grasped by rational methods alone. John Locke wrote of: “the
faculty which God has given Man to supply the want of clear and certain
7
knowledge, in cases where it cannot be had, is judgment. The mind sometimes
exercises this out of necessity, where demonstrative proofs and certain knowledge
are not to be had; and sometimes out of laziness, unskillfulness, or haste, even
where demonstrative proofs are to be had” (Locke, 1928). The epistemological
point is that if we posit judgment as something that cannot be defined and brought
into causal models we may still be able to handle it as something we know from
our own experience --‐ which is to suggest that we can know things subjectively as
well as objectively. Indeed this distinction gives us some insight into tacit
knowledge, what we know about ourselves but remains unknown to others except
through demonstrations, for example, of bicycle riding. The shift is from
objectivist rational man modes of knowing about everything beyond herself/himself
a n d towards accepting a degree of personal knowledge that complements and
supports our objective knowledge.
This bi--‐capable model of the individual, one able to combine or synthesize
objective and subjective modes of knowing to guide her/his practice, can be
associated with (a) human action in the uncertain conditions Locke implied, and (b)
the intuition that the firm’s essential nature may be less to do with its extra-‐individual assets than with its human--‐sourced ability to cope with uncertainty and
asset--‐absences by bringing judgment to bear. Each of the market failure types
explored in the proposed micro economic theories of the firm calls for a specific
and corresponding type of judgment. Principal--‐agent theory presumes knowledge
and/or interest differences between two parties that are engaged in shared activity.
Transactions cost analysis --‐ a somewhat more complicated theory --‐ presumes
knowledge differences between the firm and the market. Behind this group of
theories lies the general notion of human judgment as the capability that can be
marshaled to deal with the specific uncertainties real situations inevitabl y
present. Likewise principal and agent overcome their knowledge differences and
generate trust. Firms and markets overcome their differences by moving
transactions within or outside firms. These moves turn out to be matters of
entrepreneurial judgment that are not rigorously solvable. In which case a second
concept of management is needed to complement the rational--‐man notion that
underpins neoclassical economics and its view of management as rational resource
allocation as well as organization theory with its view of the organization as a
rationally designed and operated mechanism. This second notion is the
management of the actor’s judgment, complementing managing the participating
individuals’ reasoning. This is tricky because judgment cannot be determined and
so brought into a causal model, the normal command and control approach; but it
may well be shaped by others much as a gardener shapes fruit trees into espalier or
a marijuana grower uses LED lights to encourage his crop. Control is displaced by
8
the notion of management as husbandry --‐ hinging on respect for those being
shaped.
The subtler switch implied by this new route towards a theory of the firm is
from the language that works for rational man and towards one grounded in
practice and skill. The causal model that lies behind command and control
management is an exercise in abstraction --‐ that must then be transformed into the
reality of practice as enactment. Rational--‐man based theorizing presumes a perfect
relationship between the abstraction and the practice, and so excises the judgment
necessary to deal with Murphy’s Law and those other unanticipated matters that
always get in the way of practice. In contrast, judgment is always specific to a
situation, indexical. It cannot be theorized precisely because it cannot be
universalized or separated from the instant of its exercise. There is no universal
notion or theory of judgment that can be meshed with the universals of causal
modeling, the firm is a concept that belongs in a different epistemology, an
epistemology of practice. Practice is a puzzle, of course, simply because it is
indexical, not general. Polanyi’s work is interesting, as is Bourdieu’s (Bourdieu,
1990; Polanyi, 1962). Grounded theory is a not very successful attempt to
prioritize practice (Glaser, 1993). It may be that a theory of practice is a
contradiction in terms, that practice cannot ever be adequately seized by language
and analyzed. It can only be fully understood in experiencing it. Instead we might
focus more on what can be said about firms, shifting the focus from practice to the
judgments that bring thoughtfulness into the realm of practice.
What can be said about instances of judgment or managing --‐ since language
itself is constructed with generalizations? Von Clausewitz articulated a way
around this roadblock, one commonly appreciated a century ago (Sumida, 2008).
At that time many writers quipped the best sign of intelligence is the ability to hold
two or more contrary ideas in mind and still function. Rational Man fails this test,
of course; but humans may sometimes pass it. So we can suggest the actor’s
judgment lies asleep in the interstices between the contrary ideas held but wakes at
the moment of action as the actor bears these ideas in mind but contrives to
synthesize or balance their implications to find a ’sweet spot’ between them. A
sense of appropriateness is key --‐ which is why a number of scholars are bringing
the Greek notion of phronesis back into the discussion (Flyvbjerg, Landman, &
Schram, 2012; Kinsella & Pitman, 2012; Nonaka & Toyama, 2007). Judgment is
the essence of phronesis, implied by our need to find a balanced and appropriate
way through the maze the contrary ideas or constraints even as judgment itself can
never be identified as a specific thing or quality.
9
Engineers are familiar with one version of this --‐ dynamic programming. It
posits a field of potential actions with several constraints. An aircraft has what
engineers call an ‘operating envelope’ defined in terms of maximum altitude,
maximum and minimum flying speeds, maximum carrying load, maximum
distance flown, and so on. The ‘space in the middle’ between these constraints is
under--‐determined. The aircraft can fly higher or lower so long as it is below its
maximum, it also has some choice of airspeed, and so on. The space inside the
operating envelope identifies the pilot’s options --‐ the place into which the pilot’s
judgment is ‘thrown’ (Heidegger’s term) or enacted (Weick’s term), for without
the pilot’s choosing the airplane cannot occupy any of the options within the
operating envelope. It needs the pilot. The flight envelope limits the pilot’s
choices whenever the airplane is flying, so the pilot is in a symbiotic relationship
with the envelope --‐ s/he enacts or realizes one or other of the practical solutions
available within the envelope. The aircraft designer shapes the envelope but
leaves a finite number of options open for the pilot. In a similar manner a manager
can open up a space for a subordinate’s practice but still shape it by putting
constraints in place. For instance, an employee might be charged to sell so many
widgets in such and such a time period but also be left free to negotiate price and
delivery --‐ within certain limits --‐ and so be invited to make judgments. The
operator of a machine that is not fully under the control of a computer has choices
about how to work it, inviting his judgment. Business is clearly better thought of
as a space of judgments among practice options than as a mechanism for executing
rules and decisions. At this point it is useful to see how Coase, pondering answers
to his own questions, surmised the essential nature of the firm was something to
do with how employees were subordinated --‐ within certain limits (Coase,
1991:21).
The bottom line here is that we cannot ever identify judgment specifically,
only by the space it moves into and occupies as practice. We must speak about it
indirectly for it is the evanescent and indexical creature of an instant of a specific
human action, not something general and so matched with language. But we may
be able to generalize about the space into which it is thrown by marking it out
with persisting ideas that do not then determine the manner in which it should be
occupied on any specific occasion. For instance we drive into the supermarket’s
parking area. There are seldom any hard and fast rules about how cars, trucks,
and individuals (some in wheel--‐chairs) are to maneuver around each other. OK,
we can build a list of appropriate ideas but many of these are generally
contradictory and the actual maneuvers we make are indicative of our choices
about how to occupy or inhabit the precise situation. But note how the
maneuvers we choose also reveal us --‐ as aggressive drivers, patient or impatient,
10
greedy for a good spot or polite, and so on. Thus action in the opportunity space -‐ in--‐the--‐world (as Heidegger might say) --‐ calls forth the manner (technically
known as ‘style’) in which we occupy it. We are how we act under the
uncertainties that characterize our personally lived world. When we say “So and
so has good judgment” we verbalize a personal conclusion, perhaps arrived at
inductively. But it is our personal conclusion nonetheless and does not identify
any enduring quality of the actor observed --‐ who may well act in a quite
surprisingly ‘bad judgment’ way in the next situation. The point about our
agency is that it is not determined so it captures the way we can always choose
differently. It is an echo of the free will and determinism debate --‐ asserting we
have choices in life and these demonstrate or manifest our judgment. Since we
cannot generalize judgment or seize it in language, especially scientific language,
Von Clausewitz’s ‘trick’ was to identify the constraints to the exercise of
judgment. There is also an interesting exploration of this approach in Goldratt’s
work, well known among consultants but almost unknown to academics
(Goldratt, 1990). He carried some dynamic programming ideas into the
management arena; though there are problems with this. In the next section the
theory of managed firm (TMF) begins to emerge --‐ as the constrained exercise of
a managing individual’s judgment. The constraints are all that can be known,
never the judgment that directs the practice that occupies the option space
between them.
The Constraints to Managerial Judgment
It is unfortunate that we have become so inured to (a) treating the firm as an
unproblematic ‘thing’, like a truck that needs driving, with (b) an ‘inside’ and an
‘outside’ (what follows from our giving it an object--‐like nature) that (c) must
respond to external forces as if it were a billiard--‐ball (defining the driver’s role).
This way of looking at firms can be labeled the external--‐internal--‐fit (EIF)
paradigm and it is endemic to our literature. Managers are supposed to enact the
EIF, especially so if we read mainstream strategy texts. But what are we to make
of those managers, numerous in number, who strategize to change their world
rather than accept it passively as it is? Henry Ford willed a brand new world into
being populated with new needs and threats, as did Steve Jobs, as did Jeff Bezos,
and many politicians too. The conventional positivistic assumption is that all
causes are external and that managers are passive fact--‐followers and have no
choice --‐ both ridiculous and insulting. It also denies the relevance of Coase’s
questions. Our literature has little to say about exploring the limits to
entrepreneurial choice (agency). A branch of sociology deals with the structure-‐agency relationship but it turns on how sociological structures shape social life
and does not tell us much about the limits to the entrepreneur’s choices.
11
The TMF is a ‘theory of the firm’ that makes active (agentic) human
judgment axiomatic, placed at its core in lieu of a rational analysis of resources,
scarce, valuable, or otherwise. First, every firm exists because someone willed
it. We cannot say much about Will, but we can say the firm exists because a
person saw or made an opportunity space in the world that was (a) constrained to
be small enough to be occupy--‐able, and then (b) occupied as a matter of practice.
The question is not “Why did this entrepreneur will this firm into being?” but
rather “What obstacles did this entrepreneur overcome to construct this firm?”
Knightian uncertainty is a collective label for these obstacles (Knight, 2006).
Note they cannot be priced. Things price--‐able, like an office for the firm or a
programmer, are not obstacles of uncertainty; they are costs. The entrepreneur’s
opportunity space is bounded by the limits to what s/he can do. Beyond these
limits the possibility of action becomes uncertain. The entrepreneur can make
something happen on his side of the boundary, but probably not beyond it.
Someone can get 12 bottles of wine into the cardboard box, but probably not 15.
She can get the filled case to the party 2 miles away in 15 minutes but not in 3.
All human action is bounded in this way. The boundaries express the limits to
our knowledge and practice. In fact we only know the world in terms of how it
limits what we can translate from imagination into practice.
Some constraints to entrepreneurial practice seem obvious, such as those set by
‘the science’. Engineers know the Second Law of Thermodynamics ensures no
real process can avoid a degree of waste --‐ why we cannot build perpetual motion
machines. Whenever an entrepreneur needs energy to enact a firm, s/he has to
th
confront this scientific fact; one of the reasons why 19 century spinning mills
were built as close to cube--‐form as possible, minimizing the losses while
transferring energy by belts and pulleys from the engine house to the looms. The
adoption of electrical power, with much lower losses over distance, changed the
physical shape of factories, just as outsourcing has changed the physical nature of
much of business too. Similarly brewers are bound by the facts of their mixing and
fermentation processes.
Explosives manufacturers must accept the organic
chemistry of their trade. There are many non--‐scientific constraints. Some are
regulatory --‐ for instance, minimum age for workers, or the provision of health
services or safety. An entrepreneur cannot build a firm without taking such
constraints into account --‐ and many more besides. But the constraints the
entrepreneur must consider are never given, they must be selected --‐ for the list of
possible constraints is infinitely long precisely because we lack an overall theory of
the socio--‐ economic universe, a theory of the ‘external’ world. To think it no more
than a collection of objective facts lying around ready to be retrieved and presented
12
to the strategist as ‘facts of the situation’ is to abandon the world managers inhabit
and disappear into the world imagined by uncertainty--‐denying academics. Hence
the reality--‐grounded condition Simon suggested by ‘bounded rationality’. We can
never grasp more than part of any real situation. But which part to attend to and
which to ignore? Judgment is inescapable.
First, judgment is a necessary part of selecting the constraints used to bound
and engage the entrepreneur’s chosen opportunity space. Second, the possibility
of saying something interesting about these constraints --‐ so instantiating a TMF --‐
lies in categorizing them, not merely identifying them but also considering their
implications for the entrepreneur. We cannot say much about the acts of
judgment that led the entrepreneur to select the constraints engaged. In spite of
the plethora of advice about writing business plans, we have no theory of the
viable firm. So any writer’s presumption of a universal check--‐list simply
obscures the fundamentally judgment--‐based nature of the entrepreneurial task.
The selection is driven by the entrepreneur’s intuition of possibility and grasp of
the situation’s constraints and processes, not by an abstract universalist theory.
But we can say something interesting about how the constraints chosen must be
brought together to define an opportunity space. The challenge is to illuminate
the nature of the judgments made if the firm is to exist --‐ we can look for this in
the interstices between the constraints, between what is known. The next section
will examine this synthesis in action and thereby suggest the TMF as a
synthesizing practice --‐ not as an analytic practice driven by theory in the
deterministic sense we generally think of theory. Note that before science began
th
its rise in the 18 century theorizing used to mean taking a thoughtful attitude to
human affairs. It was more of an aesthetic than a method nor prescription.
Today theorizing means something more prescriptive and is often conflated with
rigorous causal modeling. But if the phenomena of interest is not amenable to
such deterministic notions we have to step into an alternative epistemology. As
we do that the meaning of the term theorizing changes. Thus I see theorizing
from the point of view of purposive practice, thoughtful action in space/time
bounded situations towards chosen goals. Weick uses the term ‘mindful’ but it
underplays the significance of the tacit and moral understandings we garner by
engaging the world as a lived practice, which are essential to grasping real
situations (Weick, Sutcliffe, & Obstfeld, 2005).
Admitting the notion of tacit understanding --‐ not original with Polanyi of course
--‐ implies we can know things in several different ways. The positivist way of
knowing is that all knowledge is a representation, perhaps approximate, of the
objective Truth that lies beyond us, for instance, in Nature. Positivism asserts there
13
is only one way of knowing. It has reigned supreme in many areas of the social
sciences for some decades but is under increasing criticism on account of its
inability to address increasingly pressing questions about leadership, innovation,
entrepreneurship, endogenous growth, and so on. A more workable epistemology
can be developed by distinguishing three modes of human knowing --‐ as data, as
meaning, and as skilled practice. The emphasis is then on how we know rather
than on the nature of the thing known or the knowledge itself as another kind of
thing (such as an intangible resource). When we know something as data it is
because we presume the objectivity of the universe of what is known, as in the
positivist approach. The object of attention can be measured. But since we know
nothing for certain, everything known is actually of our construction; the measures
are never entirely objective. So the resulting knowledge is a human (possibly
social) construction and attribute, within and of us, not a feature of what lies
beyond us. It is a matter of our opinion, meanings or cognitions that we attach to
sense--‐data or to our imaginings. Meanings are subjective superimpositions onto
our impressions of the world we feel lies beyond us that nonetheless stimulates
our senses. In which case we also feel there is a complementary and separate inner
world lying within us to which we also attach meanings. Meanings are contested
because they come from within us. We have differing views because we live
without (a) insight into each others’ inner worlds and (b) any certain knowledge of
the world beyond us that we might use as a test of the truth of our opinions.
We synthesize our data and meaning modes of knowing into ‘information’,
presuming it has impact on our lives. Information inhabits our thinking and
contrasts with our action in the world as we exert force, consume energy, and
change the state of the world. Tacit knowledge presumes that since we are
physically present in a physical world we can also act on it using a mode of
knowing that lies beyond thought. Not thought--‐less action so much as action
unrelated to or regulated by the presence or absence of thought. Simon explored
the concept of habit, practices that became so familiar they did not require one to
engage the conscious mind in the execution of the action. They offer economy of
thinking work. He also presumed an unconscious mind as capable of thinking
(processing habit) as the conscious mind --‐ an untestable hypothesis. Polanyi’s
notions are not quite the same, though it is clear that riding a bicycle can also
become habitual. He posited a third categorically distinct mode of human knowing,
demonstrated as skillful practice, different unlike knowing in a thinking way, even
subconscious - though the differences from Simon’s assumptions about the
unconscious are unverifiable. Others argue for a form of intelligence located in the
gut rather than the mind. Wittgenstein explored the relationship between modes of
thinking knowing and practical knowing, concluding that all human thought is
14
grounded in our practices --‐ or rather, he prioritized practical knowing, seeing
thinking knowing as a distillation or abstraction from practical knowing.
Philosophers will always be pursuing better answers to these puzzles.
But for the more mundane task of thinking about organizational life and
entrepreneurship the three-mode epistemology o f d a t a , m e a n i n g , a n d
p r a c t i c e opens up questions very different from those opened in positivist
epistemology --‐ including those related to human creativity that are pushed aside in
a discourse framed by positivist causal analysis. Human creativity and agency
break the causal chain. If the breaks are presumed random, unexplained and
unexplainable, the enquiry stops. But if the breaks are not random they can be
captured as a consequence of human agency or judgment by treating that as cause.
But instead of looking for what, in turn, causes judgment we can see agentic
activity as an event, an irruption of judgment into the lived world. If data,
meaning, and practice are categorically distinct we can make their relationship a
matter of judgment in the instant of practice, suggesting judgment appears as the
various modes of knowing are synthesized in thoughtful action, the synthesizing
process being the application of judgment. Judgment resolves the uncertainties
that lie in the interstices between what is known as the actor’s judgment is realized
as thoughtful practice. Or we might say that every thoughtful practice requires the
actor to resolve uncertainties as an act of judgment--‐shaped practice. To repeat; we
imply three modes of human knowing. Data presumes a knowable world beyond
us. Expanding this requires discovery of this world --‐ we explore, go look and
record what we find. The different notion of meaning suggests that beyond
looking for the things that are immediately understandable, another river or
another aircraft taking off from the airport, we may do well to change our meaning
inventory to include something different --‐ a geyser or a helicopter taking off. The
scientific method is primarily directed at probing new meanings via the method of
hypothesis and empirical test, checking whether this or that meaning seems
supported. Note that it is neither a method of generating hypotheses nor devoted
towards the discovery of more skillful practice for scientific practice is always
subordinated to the integration of data and meaning --‐ to be fully comprehended and
not left in the tacit domain. Polanyi was reacting against logical positivist
philosophizing about science, noting the central place of tacit knowledge in the
conduct of real experiments. Another way of putting this is that the hypothesis-‐test method writes out tacit knowledge and pushes into ceteris paribus clauses.
The three different modes of advancing our knowing reflect differing natures
thereby allowed to the thing known. The scheduled arrival of a specific flight is
something of which one can be ignorant, but a moment’s work on the Internet
15
will reveal it a knowable, resolving ignorance of data. But Jane is not simply
ignorant of what Harry is going to do when she tells him she is dating William.
In bilateral human situations, such as are imagined in principal--‐agent theory, the
outcome is only rarely forecast-able. Game theory explores this and, as we
know, sometimes the outcome can be forecast --‐ because each player’s range of
options and preferences is known, as in tic--‐tac--‐toe, but not in chess. Human
situations are more serious than games. Jane is ignorant of Harry’s response
because Harry does not know either --‐ she has not told him yet. The situation is
indeterminate. To advance knowledge in such indeterminate situations it is
sometimes possible to surface the different meanings the players attach to the
situation --‐ perhaps by anticipating and discussing them in the course of
negotiating an agreement to cover the various possibilities. Contracts set limits
to wrongs and remedies that have not yet occurred. When it comes to advancing
skilled practice there is experimentation, bricolage, or just trying something.
Interesting progress has been made in modeling situations to help agents develop
practical judgment --‐ flight trainers or video war--‐games. This moves the
experimentation into a less threatening or consequential context. The plane
crashes and you pop out of the simulator to get a coffee. To our national cost we
know flight simulators work pretty well.
Since the nature of anything known can differ so the nature of the constraints to
judgment can differ too. Much more important, there can be specific understanding
of how a particular constraint might be moved, changed, or displaced. Few
constraints are as fixed as the Second Law of Thermodynamics seems to be. Most
of the constraints to an entrepreneur’s judgment are malleable to a useful extent.
The wages of the programmer being interviewed may turn out to be highly
negotiable because he is under pressure and out of work. Practice may not make
perfect but will often advance skill. All of which shows there can be no exercise of
judgment in a vacuum of total knowledge--‐absence. Judgment is always with
respect to something specific, indexical. It is always projected towards a specific
knowledge--‐absence framed by or in the interstices between knowledge--‐ presences,
things known. Thus at least three things must be known before judgment can be
brought into play. In earlier empirical research I concluded the structure of most
business executives’ knowings can be encompassed by around a dozen situationally
specific constraints (Spender, 1989). Their knowledge of each constraint can be
improved by probing the nature of knowledge, the manner in which the thing is
known. Ultimately the entrepreneur has to operate in a space framed by data,
meaning, and skilled practice but whose framing is amenable to action.
16
Language
The outcome of the application of judgment is thoughtful or ‘mindful’
practice that draws on tacit understanding. But the private firm also captures and
operationalizes the insights of Adam Smith and many others in centuries before
who saw how effective collaboration across a division of labor lies at the core of
wealth generation. This is very familiar to us, but in the light of the preceding
sections we see a distinction between labor that can be managed through the
exercise of reason --‐ in the manner of a bureaucracy --‐ and the labor of innovation
and creativity that calls for managed judgment. In fact bureaucratic instruction is
almost never sufficient for the practice it is supposed to determine, there are
always differences between the situation the instructor/planner imagined and that
which the operative meets in practice. What has been tidied away into
assumptions and ceteris paribus clause pokes through into reality in the manner
of Murphy’s Law --‐ that if anything can go wrong, it will. Synthesizing across the
other interstices between planning, instructing, and operationalizing calls for
further judgment.
The TMF proposes that both the operative’s reasoning and her/his judging
must be managed. Organization theory tells us a great deal about managing
employees’ and others’ reasoning with instructions, performance measures, and
incentives. These, together with the terms that identify the objects and practices
relevant to the operative comprise a language of local rationality, or rather a
language whose meaning hinges on the presupposition of the operative’s self-‐interest. The managers identifies task X --‐ which may call for some training --‐ and
instructs operatives who perform it because it is their interest to do so. Their
judgment is called for when the task cannot be fully and unambiguously
specified, perhaps because the instructor does not know how to do it himself.
Do this --‐ even though I do not know how. This is the typical consequence of the
division of labor and the trend towards increasing specialization,
professionalization, and productivity. New equipment calls forth new skills. In
Caxton’s era type setting was very much hand--‐work. Today the columnist sits at
a keyboard and the printed word arrives on the reader’s screen. Air--‐conditioning
engineers and house electricians need certification. Pilots are in a symbiotic
relationship with machines and when ‘flying by wire’ their interactions are
completely mediated by computers. The airline’s CEO can say “take off at 8:32
am and fly this 747 to Delhi” without any idea of what that involves for pilot,
ground crew, customs officials, and air--‐traffic controllers --‐ all of whom have to
deal with a continuous stream of unscripted situations that call for their
‘professional judgment’.
17
But how is the flow of operative’s judgment to be ‘managed’? Training helps
operatives appreciate the options available, but still their choices must be directed.
Principal--‐agent theory models this situation, presuming the principal and agent
differ in their knowledge of the situation. Micro economists surmise there is some
mix of incentives and monitoring that can minimize the principal’s loss. But on
closer examination this turns out to be a mistake. Jensen & Meckling’s proposed
solution turns on the presence of perfect markets to supply the information
necessary to the solution they propose (Jensen & Meckling, 1976). Yet when
perfect markets pertain there is no space in the analysis for the agent, for in perfect
markets all actors are principals. Jensen & Meckling mis--‐specified the principal-‐agent model. In contrast Fama’s specification is better and allows the principal
and agent to experience each other as they work together, leading to ‘trust’ --‐ which
is a mutuality of judgment arrived at in the shared interest of continuing the
collaborative practice (Fama, 1980). But is collaborative experience the only way
to manage another’s judgment?
An alternative, which underpins the possibility of education, is language
(Morris, 2007). Some language is narrowly rational --‐ geometry proofs, for
instance. Technically such rational languages are ‘formal’. They stand on specific
axioms and the universe of language then created is that of all statements that can
be derived from those axioms. Yet we talk in ‘natural’ language. This is not based
on rigorous derivation from known axioms. Rather it is a hodgepodge of sounds
and ideas that ends up being inconsistent and inconclusive, but can illuminate the
human condition and its uncertainties. One kind of natural language is discourse
about our emotions or moral challenges. There are no secure axioms here, we are
not sure of the relevance of our beliefs about the world or our values. Perhaps the
seven virtues really do shape the quality of human life, perhaps not. Perhaps the
urge to survive is written into our genes, perhaps not. Perhaps love is the supreme
human experience, perhaps not. The inconsistencies here have the curious but
hugely important consequence of making it possible for us to communicate
thoughts and feelings that seem to go beyond any natural language’s logical limits.
I can say “I have the ‘flu and feel sick”, nothing complicated about that. In
contrast, poets work our language’s contradictions to project feelings that can be
‘trapped’ between the meanings we normally attach to words. Thus Blake’s lines
“Tiger, tiger, burning bright, in the forests of the night …” make no logical sense,
but begin one of the most powerful poems in the English language. Adept use of
natural language can shape listener’s judgment as well as introduce them to moral
possibilities and to the nature of love. Religious talk or the language of novels is
the antithesis of formal speech. As we define the firm as comprising individuals
18
who bring their faculties of reason and judgment to bear on its practices we realize
natural language can be used to shape them. While the individuals bring their
capacity to make judgments with them, the management challenge is to ensure they
act in the firm’s interest, towards the firm’s goals, rather than towards their own --‐
the principal--‐agent situation. Rather than presume a set of incentives and
monitoring costs, and aside from relying on mutual experience, shared natural
language provides a possibility of harnessing others to the firm’s objectives.
Rhetoric is the study of these. While the management of others’ reasoning can
veer towards the formal, presuming the self--‐ interest of the listener
(employee/agent), the management of their judgment calls for skilled rhetorical
practice.
Fortunately a great deal is known about rhetoric (Conley, 1990). Since before
the time of Ancient Greece societies have appreciated the need to educate their
leaders to create social order through language. The Greeks formalized rhetoric
into three basic categories that are somewhat like data, meaning, and practice in
that they presume three fundamental modes of human communication or
persuasion: logos, ethos, and pathos. Logos is the appeal to reason, logical if--‐then
arguments. Ethos is the appeal to the social situation that links speaker and
listener. Most Americans listened to Colin Powell’s 2003 speech at the UN --‐
urging war --‐ because he was a respected national figure with the Presidency in his
grasp. Ethos addresses the question “Why should you listen to me?” Pathos is the
appeal to the listener’s emotions, for the Greeks believed emotion was the real spur
to human action. We may agree with the logic and respect the speaker, but we
only act when roused emotionally --‐ to the barricades! Rhetoric indicates a mode of
management complementary to instruction and incentives. In the background is
the use or threat of force. Sociologists point to three modes of creating social
order --‐ coercion, calculation, and acculturation. The modern firm offers little
place for managers to use force. This leaves the interplay of calculation and
acculturation - incentives versus persuasion. As the knowledge--‐intensity of
modern work deepens, the knowledge gaps between managers and operatives
expand relentlessly. So the management emphasis shifts from calculation to
persuasion and they say ‘our people are our most valuable asset’. As a result many
organization theorists are exploring more ‘open’ modes of managing. But few of
them note the distinction at the center of the TMF which, because it adopts a bi-‐capable model of the individual, calls for two complementary modes of managing.
Over the last three millennia the study of rhetoric has not produced a theory --‐
rather it has generated a set of heuristics or ‘best rhetorical practices’. These are
expressed (a) in its ‘canons’ and (b) in ‘question theory’. The canons relate
19
seemingly logical sequences of speaking practice. The simplest of these is that a
story has a beginning, middle, and end. More fully spelled out, a speech or story
is contextualized and demands attention to subject, audience, purpose, and
occasion. The formal characterization of rhetoric’s canons is of invention,
arrangement, choice of style, memorization, and delivery. Every business person
does well to have some knowledge of rhetorical practice precisely because
business is a talking game (Leith, 2011). Question theory turns the analysis
around. Instead of focusing on preparing and delivering persuasively it sees an
audience listening for answers to the specific questions that concern them.
Rhetoric is a practice not a theory. It is always indexical, situated in a social
context and sometimes defined as the search for the best means of persuasion is a
specific situation. Theory, as we now understand that term, is generalization and
there are few generalizations in rhetorical practice. The canons are limited
generalizations and mean little until contextualized. Invention and arrangement
begin with ‘reading’ the audience and judging what it is able to hear about one’s
purposes. Plus it is always specific, and with specific questions. The viability of
the speech is contingent on addressing these questions. ‘Stasis theory’ is a formal
characterization of these because the audience is not a blank slate awaiting
inscription by the speaker (rhetor); to the contrary, it is already immersed in the
social context (ethos) and fully aware of what appears problematic about it. Thus
managers speaking to employees are dealing with people who already know a
great deal about what is going on and they are as cynical as the rest of us. A new
mission statement proposing attention to customers and respect for each other
may well be greeting with sardonic laughter. Managing the judgment of others is
a leader’s most fundamental challenge. It is central to the TMF and any other
social activity in situations that are uncertain and incompletely understood.
Summary
The theory of the managed firm (TMF) presupposes the possibility of
thoughtful imaginative practice in uncertain situations, and of managing the
thoughtful imaginative practice of others. The human experience of uncertainty is
fundamental to the possibility of using the imagination. Such practice is also the
source of added value for action in certain situations cannot add value - it simply
reallocates it. The TMF adopts a bi--‐capable model of the individual --‐
complementing reason with judgment. The firm comprises collaborative practice,
only existing in the instants of its practice. It has no other ontology and is best
modeled and analyzed as the specific language used to persuade those involved to
act collaboratively towards the firm’s specific objectives. This language is always
20
specific and contextualized, the result of the entrepreneur’s strategic work. We
might also call this the ‘business model’, for it invokes a world that the firm is to
inhabit with its practices. It is a natural language. Formal models excise the firm’s
value--‐creating capacity --‐ which may be fine for some purposes but is ironic if the
researcher is trying to analyze the entrepreneur’s work and discover how firms are
the ‘engines of the economy’. The TMF opens up dimensions of analysis that are
ignored by the positivist discourse around micro economics and organization and
management theory. Aside from bringing in uncertainty and added value, it
implies the ethical and moral dimensions of managing. Reason is not subject to
ethical or moral constraint, judgment is. Hence the TMF provides a basis for
discussing the social control of the context of business activity, the social and
political management of the boundary between the private and public sectors,
lifting one of Coase’s questions to a higher level. Instead of asking “Why do firms
exist?” we can ask “Why does the private sector exist?” The constraints the
entrepreneur must work within are often those of society --‐ political, legal, and
normative --‐ rather than those occasioned by the physical nature of the
transformations the firm’s production function presumes or the personal or
psychological constraints to persuading collaborators. The TMF reflects Barnard’s
concept of the firm and its executives’ function as they synthesized the three social,
physical, and psychological subsystems into an ‘organizational system’.
Every theory of the firm is a reflection of the analyst’s purpose. The
bureaucratic theory of the firm is focused on maximizing command and control.
Micro economic theories of the firm probe whether firms help or hinder the most
economically efficient allocation of resources in an economy. The TMF is very
different; it focuses on the firm as a politically, legally and socially legitimated
apparatus for creating economic value. As such it is crucial to our notions of
democratic capitalism. Micro economists sometimes imply perfect markets are a
viable replacement for democratic capitalism, that the less government is the better.
Regrettably this shows little sensitivity to what we might learn from history or
insight into how the private sector actually works. The TMF is a step towards
better understanding economic value creation and how it hinges on the constrained,
as opposed to free, exercise of human judgment.
Bibliography
Barnard, Chester I. (1968). The Functions of the Executive (30th Anniversary ed.).
Cambridge MA: Harvard University Press.
21
Bourdieu, Pierre. (1990). The Logic of Practice. Stanford: Stanford University
Press.
Coase, Ronald H. (1991). The Nature of the Firm (1937). In Oliver E. Williamson
& Sidney G. Winter (Eds.), The Nature of the Firm; Origins, Evolution and
Development (pp. 18-33). New York: Oxford University Press.
Conley, Thomas M. (1990). Rhetoric in the European Tradition. Chicago IL:
University of Chicago Press.
Croce, Benedetto. (2002). The Philosophy of Giambattista Vico. New Brunswick
NJ: Transaction Publishers.
Fama, Eugene F. (1980). Agency Problems and the Theory of the Firm. Journal of
Political Economy, 88, 288-307.
Fine, Ben, & Green, Francis. (2000). Economics, Social Capital, and the
Colonization of the Social Sciences. In Stephen Baron, John Field & Tom Schuller
(Eds.), Social Capital: Critical Perspectives (pp. 78-93). Oxford: Oxford
University Press.
Flyvbjerg, Bent, Landman, Todd, & Schram, Sanford (Eds.). (2012). Real Social
Science: Applied Phronesis. Cambridge: Cambridge University Press.
Glaser, Barney G. (1993). Examples of Grounded Theory: A Reader. Mill Valley
CA: Sociology Press.
Goldratt, Eliyahu M. (1990). What is this thing called Theory of Constraints and
how should it be implemented? Great Barrington MA: North River Press.
Jensen, Michael C., & Meckling, William H. (1976). Theory of the Firm:
Managerial Behavior, Agency Costs, and Ownership Structure. Journal of Financial
Economics, 3(4), 305-360.
Kinsella, Elizabeth Anne, & Pitman, Allan (Eds.). (2012). Phronesis as
professional Knowledge: Practical Wisdom in the Professions. Rotterdam: Sense
Publishers.
Knight, Frank Hyneman. (2006). Risk, Uncertainty and Profit. Mineola NY: Dover
Publications.
Leith, Sam. (2011). You Talkin' to Me? Rhetoric from Aristotle to Obama. London:
Profile Books. Locke, John (1928). Selections. N ew York: Scribner's.
Morgan, Gareth. (1997). Images of Organization (New ed.). Thousand Oaks CA:
Sage.
Morris, Michael. (2007). Introduction to the Philosophy of Language.
Cambridge: Cambridge University Press.
Nonaka, Ikujiro, & Toyama, Ryoko. (2007). Strategic Management as
Distributed Practical Wisdom (Phronesis). Industrial and Corporate Change,
16(3), 371-394.
Polanyi, Michael. (1962). Personal Knowledge: Towards a Post-Critical
Philosophy (Corrected ed.). Chicago IL: University of Chicago Press.
Simon, Herbert A. (1985). Human Nature in Politics: The Dialogue of Psychology
with Political Science. The American Political Science Review, 79(2), 293-304.
Spender, J.-C. (1989). Industry Recipes: The Nature and Sources of Managerial
Judgement. Oxford: Blackwell.
Spender, J.-C. (2013). Herbert Alexander Simon: Philosopher of the
Organizational Life-World. In Morgen Witzel & Malcolm Warner (Eds.), Oxford
Handbook of Management Thinkers (pp. 297-357). Oxford: Oxford University
Press.
22
Sumida, Jon Tetsuro. (2008). Decoding Clausewitz: A New Approach to On War.
Lawrence KS: University Press of Kansas.
Weick , Karl E, Sutcliffe, Kathleen M, & Obstfeld, David. (2005). Organizing and
the Process of Sensemaking. Organization Science, 16(4), 409-421.
23