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THE GOVERNANCE OF FIRMS CONTROLLED BY MORE THAN ONE BOARD:

THEORY DEVELOPMENT AND EXAMPLES


by
Shann Turnbull
A tbesis :.ubmittcd in fulfilment of the requirements
fonhe degree of Doctor of Philosophy
August 2000
1\-lacquaric Graduate School of ;'Vlanagcmcnt
1\lacquarie Sydney

TABLE OF CONTENTS
Table o.fContems
Lis! of Tables and Figures
Summary
Certljlcate of exdusivitp
Foreword
LO INTRODUCTION
1.1 Choice of research lopic
1.2. Aim of the study
L3 Relevance of the research
l ,4 Kt..'Y concepts
1.5 Rescan;h methods and outline of the thesis
1.6 Contributions to knowledge
1. 7 Assumptions and limitations
Page
ii
v
vi
Vll
VIII
I
3
4
6
10
13
16
2.0 CORPORATE GOVERNANCE AND RELATED RELEVANT LITERATURES 19
2. J Introduction
2.2 Definitions
2.3 Factors which affect the operations of firms
2.4 Different corporate govcmancc perspectives
2.5 Comparative studies and theories
2.6 Models and explanations of corporate governance
2.6. t The simple finance model
2.6.2 The stewardship model
2.6.3 The stakeholder modd
2.6.4 The political model
2.6.5 Culture
2.6.6 Power
2.6. 7 Biological model of the fim1
2. 7 Outstanding issues in corporate governance scholarship
2.7.1 Limited life
2.7.2 \Vorker ownership and control
2.7.3 Compound boards
2.7 .4 Information theory
2. 7.5 Networks
2.7.6 Holonic structures
2.7.7 Self-regulation and self-governance
2.8 Conclusions
3.0 THEORY DEVELOPMENT BASED ON BYTES AND CYBERNETICS
3.1 Introduction
3.2 Definitions
3.3 Human cooperation dependent upon transacting bytes
19
21
30
37
44
48
50
54
56
60
62
67
70
70
71
72
74
76
77
79
80
83
83
84
89
3.4 Methods of human communication and control 95
3.4.1 Sensory 97
3A2 Semiotic 97
3.4.3 Voice!word in hierarchies 98
3.4.4 Price/cost 100
3.5 Human behaviour and tbc tra..Jsaction of bytes t 01
3.6 The processes of human thinking and action I 07
3.7 Hierarchies: their control, regulation and sdfgovemancc 113
3.7.1 Information overload 120
3.8 The necessity for requisite variety in infonnation and control 123
3.8.1 Variety in decision making 124
3.8.2 Variety in infonnati-on channels 124
3.8.3 Variety of control channels 125
3.9 Cybernetic strategies for economising information 126
3.9.1 Amplifying control through supplementation 126
3.9.2 Economising bytes through the "Principle ofSubsidiary Function" 127
3.9.3 Economising bytes through a hierarchy ofholons 129
3.9.4 Economising bytes through tensegrity 134
3.10 The thesis and the structure of its defence 136
3.10.1 Originality 137
3.10.2 Theoretical utility 137
3.10.3 Evidence of compound boards and utility of the TBA framework 139
4.0 THE EVOLUTIO!'I OF CORPORATIONS AND COMPOUND BOARDS 141
4.1. Evolution of finn control structure
4.1, l Ownership and control taxonomy
4.1 .2 Management structures
4.2 D<!vdopmcnl: of corporate concepts
4.2. i English origins
4.2.2 Australian developments
4.2.3 US devdopments
4.3 Nutional ditlCrencc in control architecture
4.3.1 Anglo
4.3,2 Dutch and Indonesian
4.3.3 German
4.3.4 French
4.3.5 Japanese
4,3.6 Overview
5.0 INTERNAL COMPOUND BOARDS IN ANGLO NATIONS
5.1 Introduction
5.2 US case studies
5.2. 1 American plywood industry
5.2.2 The American Cast Iron and Plpc Company
5.3 United Kingdom case swdics
5.3.1 Scott Bader Commomvcalth
5.3.2 The John Le\vis Partnership
5.4 Review and conclusions
141
146
148
\50
ISO
157
159
160
t60
164
165
167
I 71
173
177
177
179
179
!84
186
186
190
194
6.0 STAKEHOLDER CONTROLLED FIRMS WITH COMPOUND BOARDS 199
6.1 Introduction
6.2 Corporncion Cooperativa
iii
199
200
6.3 The founder of MondragOn
6.4 Building Mondragon
6.5 The governance of MondragOn fim1s
6.5.1 \Vorkcr cooperatives
6.5.2 Distribution of cooperative profits
6.5.3 The Bank and other second order cooperatives
6.5A govcmancc
6.5.5 Holonic architecture
6.6 Japanese Keiretsu
6. i Rcviev .. -of compound boards with stakeholders
7.0 UTILITY OF TRANSACTION BYTE ANALYSIS
7.1 Introduction
7.2 TBA grounded in science
203
205
208
209
214
215
217
220
225
228
235
235
7.3 Application ofTBA in investigating MondragOn compound boards 239
7.3.1 Minimisi11g bytes and bounded rationality through holonic subsidiarity 239
7 .3.2 Identifying the operating advantages of a division of power 241
7 .3.3 Identifying the decomposition of decisiot1 making labour 243
7 .3.4 Evaluating sclf-govcmance 248
7.4 Relationship ofTBA with other theories 249
7 .4.1 TBA based on power model rather than efficiency model of the fim\ 249
7.4.2 TBA as a and extension ofTCE 251
7.4.3 Comparison \'lith TCE, resource and evolutionary theories of the firm 264
7.5 Propositions for testing TBA 268
7.6 \Vider implications ofTBA framl.!work 274
7. 7 Limitations ofTBA framework and areas for future research 280
7.8 Concluding remarks 283
REFEREtiCES 286
iv
Table No.
Table 2.1
Table 2.2
Table 2.3
Table 2.4
Table 2.5
Table 2.6
Table 3,1
Table 3.2
Table 3.3
Table 3.4
Table 3.5
Table 3.6
Table 3.7
Table 3.8
Table 4.1
Table 4.2
Table 4.3
Table 4.4
Table G.!
Table 7.1
Table 7.2
Table 7.3
Table 7.4
Figure No.
Figure 2.1
F
. ? 0
tgurc ....
Figure 4.1
Figure 4.2
Figure 4.3
Figure 4.4
Figure 5,1
Figure 5.2
Figure 5.3
Figure 5.4
Figure 6.1
6.2
Figure 6.3
Figure 7.1
Figure 7.2
FJgure 7.3
Figure 7.4
LIST OF TABLES AND FIGURES
Title Page
Stakeholders affecting the operations of publicly traded tlm1s: 31
Scope und diversity of corporate governance conccms 36
Characteristics of governing mechanisms 40-41
Models of corporate governance 45
Efficiency and power model oflhe tlm1 63
Comparison of biology with economics 68
Methods of communicution and their attributes 91
Characteristics of communication and control methods 96
Loss and distortion of information in a hierarchy 99
Difll:rcnccs between "economic" and "real" people 103
Human constraints in transacting bytes Ill
Corrupting powers of a unitary board 115
Evaluation of hierarchies to control, regulate or sc!f.govem ! ! 8
Holarchy: hierarchy ofholons l30
Ownership and control taxonomy of corporations !46
l'.'umber of listed "Anglo" companies 157
Nature of German and UK (rwncrship !67
Cultural differences in corporate ownership and control 174
Holon typology of MondragOn 221
Comparison ofTCE and TBA boundaries 255
An Organisa!ional Failures Framework 258
Comparison ofTBA with other theories of the fim1 266-267
Role of communication channels in governing society 276
Title Page
Investor view of a fim1 33
Stakeholder view of a finn 33
Management structures and control architecture of firms 149
Evolution of"Anglo" corporate control architecture 155
International comparison of control architecture 163
Anglo and Japanese dispersed ownership and control architecture 172
USA LabourOwncd plywood firms: lnfonnation and control architecture 181
ACIPC: Infom1ation and control architecture 185
Scott Bader Commonwealth: Information and control architecture 188
The John Lewis Partnership: Infonnation and control architecture 191
MondragOn Cooperative System: With dates of establishmcni 207
Information and control architecture of MondragOn cooperatives 210
Control network of MondragOn activities 218
Functions and activities of a unitary board 244
Functions and activities of MondragOn compound board 245
Y1ondrag6n -compound board compared with unitary board 245
of governance in political systems 277
v
SUMMARY
The contribution of this thesis is to present a framework to analyse firms controlled by more
than one board. The literature survey of Chapter 2 revealed that there is little recognition of
this phenomenon and no accepted way to investigate firms governed by multiple control
centres described as a "compound board". The framework is developed in Chapter 3. The
historical emergence of compound boards is outlined in Chapter 4 with examples of their
architecture described in Chapters 5 and 6. Chapter 7 shows how the framework provides
insights not available from other theories of the fim1 and how self-governance can be
furthered by utilising contrary human attributes of competition/co-operation, trust/suspicion
and self-interest/altruism.
The framework is described as transaction byte analysis (TBA) as it is based on the limited
and inconsistent ability of humans to transact units ofinfonnation described as "bytes". TBA
identifies cybernetic principles and strategies that can mitigate human limitations in
processing bytes. These provide organisational design criteria for finns to obtain operating
advantages. As infom1ation is a common clement in varies theories of the fim1, TBA relates
and subsumes them while allowing any type of organisation to be analysed.
Propositions arc presented in Chapter 7 for illustrating how TBA provides insights into
explaining: (i) why non-trivial employee owned industrial firms have more than one board;
(ii) why self-regulation and self-governance of non-trivial fim1s cannot be assured without a
compound board; (iii) how compound boards can simplify the role, knowledge, duties and
liabilities of directors; (iv) the competitive advantages of appropriate compound boards in
relation to unitary control systems; (v) how to compare and evaluate the relative advantages
and disadvantages of firms with different ownership and control structures; (vi) how to
compare the relative efficacy of hierarchical and non-hierarchical firms be they in the private
or public sector.
vi
CERTIFICATE OF EXCLUSIVITY
1 hereby certify that this work has not been submitted fOr a
higher degree to any other university or institution,
Shann Tumbull
FOREWORD
This thesis has its origins in my first published academic paper, 'Time Limited Corporations'
(Turnbull 1973a). This article was motivated by the need to find a way for Australia to attract
fOreign investment while at the same time eliminate long tcnn foreign ownership. I presented
the paper to the 45th Annual Congress of the Australian and New Zealand Association for the
Advancement of Science and it was subsequently also published by the Economic Society of
Australia and New Zealand (1973b). At that time I was a corporate raider and company
promoter who had learnt how to manipulate ownership and control rights for the profit of
individuals.
It became evident that the framework of analysis used by mainstream economists did not
provide a basis to understand my proposals for distributing property rights or analysing
distributed control into two or more control centres. Then, in 1974 I discovered that a US
lawyer, Louis Kelso ( 1967) was putting into practice an alternative proposal to my own for
distributing corporate ownership through Employee Share Ownership Plans (ESOPs). In
1975, I organised Kelso to visit Australia. In order to introduce both his ideas and my own to
the general public for his visit, I wrote Democrarising the Wealth ofNations (Turnbull l975a)
which was launched and reviewed by the fonner Deputy Prime Minister (Cairns 1976). I also
undertook consulting work to put the ideas of my book into practice in a number of
assignments for leading corporations, national and provincial govenunents.
Starting in I 976, the US Congress introduced a number of major tax incentives to promote
"Kelso Plans". In 1999, around 10% of the US work force had equity in their employers and
15% of the largest publicly owned corporations in the US were more than I 0% owned by
their employees (ESOP 1999). Kelso publicly debated his vision of "universal capitalism"
with leading US economists, which resulted in mutual ridicule. No refereed journal ever
published any work by Kelso.
VUJ
My own approach was to constructively engage with economists and other academics. This
became my principal vocation from 1991 when I re-wrote 'Time Limited Corporations' as 'Re-
inventing Corporations' (Turnbull 1991a). This and other articles published in refereed
journals since then have analysed both distributed ownership (Turnbull 1998a) and distributed
control (Turnbull 1997i). However, this thesis is restricted to analysing only distributed
control as it arises from firn1s controlled by more than one board whether or not the boards
arc internal or external to the firm.
The literature search for the thesis in Chapter 2 forn1cd the basis for 'Corporate Governance:
lts scope, concerns & theories', published as an invited contribution to mark the completion of
the first five years of publication of the first specialist corporate governance journal,
Corporate Governance: .An International Re\'iew (Turnbull 1997a). This survey was updated
and translated into French, as the lead article to launch the first Francophone academic journal
on corporate governance (Turnbull 2000a).
Transaction Byte Analysis (TBA) developed in Chapter 3 had its origins in a professional
assignment undertaken for the Australian Minister for Aboriginal Amlirs in 1977 to study the
impact of mining royalties on Aboriginal communities in the Northern TerritO!)'. The initial
clement of the methodology was published in my report fOr the Australian Parliament
(Turnbull 1978b: 5,51) and later used in 'Stakeholder Democracy: Redesigning the
governance of firms and bureaucracies', (Turnbull 1994d). Grounding of the methodology in
the theory of the finn was first undertaken in a paper, 'Beyond markets & hierarchies:
Extending the theory of the firm', presented to the Twenty-third Annual Conference of
Australian Economists (Turnbull 1994a). Additional grounding in the management literature
was included in an invited paper 'The application of cybernetic knowledge in governing
society', presented to an international conference on 'Knowledge, Economy and Society' held
at the University of MontrCal (Turnbull 1997j). The development of the methodology into
TBA, grounded in clements of physiology and the principles of cybernetics is a major
contribution of this thesis.
The analysis of the weaknesses in undistributed control in Section 3.7 was developed as a
fOunding author of The Company Directors' Diploma Course (Turnbull l975b). This was the
first educational qualification developed for company directors. The analysis was later
published in refereed international journals (Turnbull l993b; Guthrie & Turnbull 1995;
Turnbull I995c,t).
Information on the history of the development of the corporate concept in Chapter 4 and the
examples of distributed control, through two or more boards, in Chapter 6 also had their
origins in material prepared by the author tOr The Company Directors' Diploma Course. The
case studies of distributed control in employee owned firms in Chapter 5 were researched for
the thesis as was the detailed analysis of the stakeholder-controlled cooperatives located
around the town of MondragOn in Spain published by Corporate Gmerna11ce: An
!nremational Review (Turnbull 1995d).
Dr. John Mathews, at the School of Industrial Relations & Organisational Behaviour
supervised my initial PhD work in 1993 at the University of New South Wales. In 1997, I
transferred my enrolment to the Macquarie University Graduate School of Management,
Sydney. Supervision of my work was taken over by Professor James Guthrie, who became
Deputy Dean of the Graduate School of Management and Director of Research. Dr. John
Mathews joined the staff of the Macquarie University Graduate School of Management,
Sydney in 1998 and took on the role of Director of Research in 2000. Both John and James
also guided me through my qualifying topics when they were at the University of New South
\Vales. I thank my supervisors, my various editors and many anonymous referees.
I also thank my wife, Pauline Markwell tOr her support and our three teenage children,
Karinya, Christopher and Melysha. Perhaps one day they may accept that one can facilitate
distributed control and democracy while not always practicing it in the home.
X
CHAPTER 1
INTRODt:CT!ON
1.1 Choice of research topic
The first three sections of this Chapter explain respectively: an explanation of how the
research toptc was seli.X:ted, the aim of the research, and why the research is important for
the analysis of firms controlled by more than one board. St.>ction lOur outlines the key
concepts of the analytical ffomework developed for investigating finns controlled by more
than a single board described as Transaction Byte Analysis (TBA). TI1e process of
developing TBA is outlined in Section l.5 and this aiso describes the structure of the
thesis. The following Section J ,6 describes the contribution to knowledge provided by the
thesis, The Chapter concludes with Section 1.7, which also reviews the assumptions and
limitations of the process by which the framework was developed.
The experience and interests of the author d e s c r ~ e d in the Fore-word motivated the
research topic. One of the most inrorcsting bur cha!knging concerns about inv..:stignting
tirms controlled by more than one board was that then: was little previous published work
into this phenomenon described as a "compound b-oard''.
The lack of previous published research into compound boards had been identified by the
author from his work in pioneering the study and teaching of comparative corporate
govcnumce as a foundation author of the Company Directors Diploma Course (Turnbull
1975b). ::vfotivation fOr researching the topic arose from the author's work with employee
owne-d finns \Vherc compound boards arc ubiquitous; also, from his experience in
establishing a two tiered control system fOr raising funds from the public for a large cotton
fam1 jn 1980 and tOr a new technology company h!! established in 1988.
There arc a number of empirical studies on the structure of unitary boards such as provided
by Monks & Minow {1995) and Tricker (1994}. There arc also many studies investigating
the rdationship of board variables to fim1 pcrfommncc (Blair 1995, Donaldson & Davis
INTRODUCTION
1994, Gordon & Pound 1991; Hawley & Williams 1996). In a number of instances
compound boards were involved but this was not recognised. Gertner & Kaplan ( 1998)
provide an example. The invisibility of two tiered boards might be explained from the
insights of Kuhn ( 1970: 24) that described "normal science" which does not "call forth
new sorts of phenomena: indeed those that will not fit the box are often not seen at all".
Compound boards arc not uncommon in Anglo cultures such as the USA, UK and
Australia. They arc created whenever one company controls another with outside
shareholders. Even in the Fortune 500 companies, around 20% of these arc controlled by a
dominant investor/shareholder (Zcy, 1999). Compound boards are even more common in
emerging economics where a family company of the founding entrepreneur, or a
multinational, typically controls publicly traded corporations (La Porta, Lopez-dc-Silancs
& Shlcifcr, 1999).
The functions and concerns of directors on a board controlled by another board, or by an
individual, who is the major shareholder, an:: substantially different from those mr.::mbers of
a board without a dominant or influential sharr.::holdr.::r. Thr.:: most important rolr.:: of a
unitary board is to appoint, direct, monitor, control, remunerate and when necessary, retirc
the chief executive. However, this role can become largely irrelevant if thc dominant
shareholder is also the Chief Executive officer (CEO), such as Bill Gates of Microsoft
Corporation (Microsoft, 2000) or Rupert Murdoch of News Limited (News, 2000).
Succession in their corporations may be detem1ined and/or maintained by their family
interests rather than the board directors who hold their position at the grace and favour of
the family.
The presence of a controlling shareholder also provides a way to resolve the most sensitive
and contentious conflicts of interest, which arc inherent in a unitary board in regards to
control of the auditor or the detem1ination of dircctor remuneration, nomination or
retirement. These conflicts involve the motivations of individuals and so people rather
than boards arc the focus of the investigation. The capability and integrity of individuals
2
C U P T E ~ I
in transacting infomnttion to fl.!rther thdr own interests provides a basis for investigating
compound boards. This h!(\ds to the development of a framework of analysis described in
Chapter 3 as TBA.
1.2 Aim of the study
The <lim of the research is to develop a framework to understand the operations of tinns
controlled by more than one board or control centre. Tbc original aim was to investigate
the operations and pcrfonnancc of corporations with two or mor.: boards, However, as the
literature research revealed that there was no accepted framework to further this initial aim,
it was decided to change the aim to making a theoretical contribution in developing: a
framework of analysis. This was originally limited to considering finns controlled by
more than one board withitr a fim1. However, this would have restricted the rdcvance of
theory development to worker owned finns and to non-Anglo corporations.
Many finns controlled by a uniiary board may also be con! rolled by a board of a dominant
shareholder or parent company external to the firm. 1l1is situation is quh.:: common
around th!.! world as documented by La Porta, Lopcz-de-Sil;:mcs & Schh;ifcr (1999). To
increase the relevance of the framework of analysis, the scope of the investigation was.
changed to consider "f!nns controlled by" rather than "firms controlled with" more than
one board. ln this way, centres of control exwrnal to the finn can be included with
internal boards and control centres.
By including both internal and external control centres in the definition of a compound
board, the utility of TBA can be illustrated by the insights revealed from investigating the
complex control relationships found both within and between the network of firms located
around the town of MondragOn in Spain. The complexity of their control system raises
questions as to rhe boundary between finns and the conglom<:rate they create. This
question is avoided by taking an inclusive approach ln defining a. compound board to
include both intcmal and external boards.
3
INTRODUCTION
However, many firn1s may not have a board such as with a joint venture, alliance or a
network fim1. Many publicly traded companies may be controlled by an individual rather
than by a board of a dominant shareholder or parent company. To allow these situations to
be included, the definition of a compound board includes a "control centre".
As noted in Chapter 7, this inclusive definition of a compound board means that TBA can
bt.! applit.!d to any type of social organisation or institution used for coordinating any social
activities. The origins of TBA arose in this general context as it is based on a
methodology developed by the author to investigate economic development of Aboriginal
communities in Australia (Turnbull 1978b: 5,52). The development of TBA was restricted
to firms to allow it be grounded in, and compared with, established theories of the fim1
articulated by Coase (1937), Williamson (1975), Ouchi (1980) and Nelson & Winter
(1982).
Both TBA developed in Chapter 3 and the case studies in Chaptt.!rs 5 and 6 make a partial
contribution to the original aim of explaining how compound boards operate and how they
can affect pcrfomnmce. TBA represents the revised aim of the rcsearch with examples of
its application presented in Chapter 7.
1.3 Relevance of the research
The research makes a contribution to the current stock of knowledge in at least five ways:
First, the research identifies a significant gap in the literature on corporate governance in
neglecting the study of compound boards. The thesis documents and analyses the
neglected and unrecognised phenomena in Anglo countries of compound boards. It
provides both an empirical and conct.:ptua\ foundation for other researchers to extend such
research and analysis. For researchers investigating unitary boards, it provides a basis for
re-interpreting their findings in the event they were investigating a board controlled by
family interests or one that was a component of some other more complex control system.
4
CHAPTER I
Second, the research provides a framework for comparing unitary boards with compound
boards. In this way it provides a foundation for studies in comparative systems of
corporate govcmance. This has practical and political importance as the European
Community is striving to harmonise company law in all the member states. Two and three
tier boards arc found in a number of member states. A proposal to mandate dual boards
was made but has currently been deferred (Skog 1994: 122). In Australia, as a direct result
of the contributions by the author, the Parliamentary Joint Standing Committee on
Corporations and Securities (JSCCS, 1998), invited public submissions into the
desirability of a "corporate governance board" being established by each publicly traded
company in Australia.
Third, the research grounds organisational analysis in the natural sciences of cybernetics
and human biology. The neurophysiological limits of individuals to process bytes
introduces criteria for designing organisational architecture to minimise the exposure of
people to transact bytes beyond their capabilities. Cybernetic principles provide design
criteria for minimising errors in communication and control and for organisations to
manage complexity. TBA offers a basis for developing "the elusive 'science of
organisation' to which Chester Bamard made reference fifty years ago" (Williamson,
199Ja: 12). Both Williamson (1990: xi) and Simon (1984: 40) saw the nc!.!d "f{)f
observing the phenomena at a higher level of resolution". Bytes provide an answer in this
regard and also answer the question raised by Williamson ( 1990: xi) "how micro is
micro'?"
Fourth, TBA provides a way to relate and compare various theories of the fim1 as they all
depend upon the communication of infonnation. A comparison of Transaction Cost
Economics (TCE), resource based theories of the finn and evolutionary theories arc
presented in Section 7 .4.3. As TBA can be applied to any type of institution it provides a
way to compare all types of integrating mechanisms found in society. Institutions can
become a variable rather than a given in the analysis of industria! organisation and
5
INTRODUCTION
organisations m general. TBA also provides a way to relate and compare the vanous
approaches to corporate governance identified in Chapter 2.
Fifth, the research relates the infonnation and control systems found in organisations to
those found in humans and those designed by engineers for complex machinery, devices
and computer software. In this way it provides a way to design organisations to most
efficiently and effectively match the capabilities of humans. TBA provides a perspective
for evaluating organisations and provides a tool tOr designing social institutions to fit their
purpose as proposed by Hirshleifer (1977: 366). This contribution could have profOund
implications for the role of both government and non-government institutions and so the
architecture of society as indicated in Chapter 7.
1.4 Key concepts
The key concepts on which TBA is based arc set out belo\v. Some of these concepts arc
not found in other theories of the finn. It is by applying concepts developed in related
disciplines to finns that TBA makes an original contribution for understanding the
operation of compound boards, complex firms and organisations in general. A unique
feature of TBA in organisational analysis is that it is based on units of infOrmation rather
than costs. As outlined in Chapter 3, TBA subsumes the economics of information by
being based on all types of infom1ation used in organising social action.
TBA is based on the fOllowing key concepts which arc explained in Chapter 3:
(a) Infom1ation quanta, in the form of bytes, are used as a unit of analysis;
(b) The governance of all social activities is dependent upon communicating
bytes;
(c) There are physical limits on the volume of bytes that can be transacted
within a person and between people;
(d) The transaction of bytes within and between people, fim1s and organisations
arc subject to the laws of cybernetics;
6
CHAPTER I
(c) People are variable. The way in which they transact bytes can vary, both
between people and with the same person at diftCrent times. People can
transact bytes in an inconsistent, contradictory manner;
(t) The transaction of bytes within and between people is subjected to errors;
As described in Chapter 3, TBA is so named to illustrate both its connection to, and
ditlCrcnce from Transaction Cost Economics (TCE). Infonnation represents the dominant
cost in governing transactions as noted by Coase (1937: 83). From the TBA perspective,
costs represents a proxy for bytes. It is argued that TBA subsumes TCE because bytes
represent a microelement of transaction costs. The five key clements of 'The
Organizational Failures Framework" of TCE identified by \Villiamson (1975: 20) arc
based on infonnation. The five clements arc (i) Bounded rationality; (ii)
Uncertainty/complexity; (iii) Opportunism; (iv) Small numbers and (v) Infonnation
impactcdncss.
The key concepts (c), (c) and (f) of TBA set out above explain causes of "bounded
rationality". Bounded rationality describes the limited ability of people to handle
infonnation. Williamson (1975: 21) explained that: "the physical limits take the fonn of
rate and storage limits on the powers of individuals to receive, store, retrieve ;;md process
inforn1ation without error." The need to limit the volume of bytes transacted by an
individual within his or her reasonably reliable operating capacity provides one of the most
important criteria for designing the infom1ation and control architecture of finns.
By economising the infom1ation required by individuals to coordinate their activities, the
cost of infOnnation to organise and/or govern transactions is also economised.
Economising information then cconomises costs consistent with TBA being a
microclement ofTCE. The economising of bytes also reduces the problem of complexity,
an clement on which the Williamson framework is based.
7
INTRODUCTION
However, "opportunism" and "small numbers" arc not key concepts in TBA because it
recognises that people arc variable and contradictory. People can also be altruistic even if
they arc in a superior bargaining position because of "small numbers". Likewise,
infonnation compactcdness is not a key concept fOr TBA although it can be recognised, as
it is dependent upon bytes being possessed by one party to a transaction but not available,
or available economically, to another party.
TBA uses the Principle of Subsidiary Function, which is explained by Schumacher ( 1975:
203) who stated "that no higher order association should undertake any function, which
can be undertaken at a lower level". TBA also has two derivative, or second-order
concepts, which are based on the key concepts listed above. One is the concept of
"holonic architecture" which provides the basis for nature to create and manage
complexity. Mathews (1996a: 30) notes that holons allow a "prodigious reduction in data
transmission and in data complexity". They provide the most efficient way to construct
organisations to manage complexity to keep the transaction of bytes within the reliable
operating limits of individuals. A weak fonn of holonic architecture recognised by TCE is
the multi-divisional type finn, which reduces the intOnnation overload of head oflice
(\Villiamson 1985: 280). The Principle of Subsidiary Function can be utilised by a
hierarchy ofholons described by Koestler (1967) as a holarchy".
Another second order and original concept ofTBA is that ofsocial tenscgrity". The word
tensegrity is used to describe physically strong structures found in nature which can now
be engineered. These structures possess flexibility and stability to a degree greater than
their component parts which have contrary properties like their ability to withstand tension
or compressiOn. Likewise, social tenscgrity describes strong reliable relationships in
organisations that possess flexibility and stability to a degree greater than can be provided
by their component attributes with contrary properties such as
compel i ti veness/ cooperativeness. Love/hate, dam i nan t! su bm iss i ve, trusti ngl suspicious
relationships provide other examples. Trust provides an ctlicient basis fOr goveming
8
CHAPTER I
transactions in teams and organisations. But to survive, teams and organisations also need
processes fOr detecting and managing activities when trust is misplaced.
A compound board is relevant to both derivative concepts. Organisational holons require a
division of power to achieve their self-governing capabilities and a division of power
provides a basis to develop constructive tensions between individuals.
The key concepts (c), (c) and (f) of TBA recognise the limits and Jack of integrity in
transacting bytes to govern human activities as required by key concept (b). A unique
contribution of TBA is the key concept (c) that introduces instrumental rather than
nom1ative, empirical or descriptive principles to:
(i) Identify strategies for overcoming limited information processmg
capabilities of people and the existence of errors,
(ii) Explicate the informational and control advantages of different
organisational architectures and
(iii) Provide design criteria to create an organisational architecture, which best
matches the capabilities of members of a finn to its purpose.
Compound boards can provide a technique tOr decomposing decision making labour and
so a way to economise the information load on individuals. The division of infOrmation
and power inherent in compound boards introduces checks and balances on self-dealing
and agency costs. With sufficient plurality of infom1ation, control and processing
channels, the opportunity tOr self-dealing, communication biases, distortions, errors and
omissions can be reduced as much as desired. This statement is elaborated in the
cybernetic principles identified in Chapter 3.
Compound boards facilitate the usc of cybernetic principles by introducing a division of
power, decision making labour and multiple communication and control channels. A
division of power allows checks and balances to be introduced in organisations to provide
a basis for them to become self-governing as demonstrated with employee owned firms. It
9
INTRODUCTION
also reduces power differentials, introduces interdependencies and so establishes a rational
basis fbr developing trust in organisations.
Holonic architecture is of profOund significance. The complexity of life and the universe
is based on holonic architecture. Holonic organisational architecture provides a strategy
fbr individuals to \vork together to manage far greater complexity than they could
individually or by working through markets and/or hierarchies. It is by providing this
insight that TBA could indicate how to design changes in the role of govemment and non-
govemment institutions as the complexity of society increases.
1.5 Research methods and outline of the thesis
The research grew out of extensive and varied experiential knowledge obtained as
explained in the Foreword. This included work by the author as a corporate govemance
practitioner and educator. The theory development of Chapter 3 was based on the
literature survey of Chapter 2 and earlier consulting research described below. To
understand the t!volution of compound boards, research was carried out into the history of
corporate concepts and the dewlopment of companies with two or mon! boards as reported
in Chapter 4. Some field visits into contemporary firms with compound boards werl: used
to complement the research documented in Chapter 5. The case studies of Chapters 5 and
6 provided the basis for obtaining insights to illustrate the utility of TBA in Chapter 7.
Consideration of the utility of TBA in Chapter 7 was based on the literature research into
other theories of the firm identified in Chapter 2. Also, Chapter 7 considers the
implications of TBA tOr future research and its wider application for 1mprovmg the
govcmancc of society.
Chapter 2 presents a rev1ew of the corporate govemance and related literatures. It
identified a number of shortcomings in accepted theories of the firm by some of the
leading scholars working on the topic. No theoretical basis was discovered tOr analysing
fim1s that were controlled by more than one board. The theory of a firm was based on the
assumption that an entrepreneur or other type of centralised authority system controlled the
10
CHAPTER I
business. Even in the political science literature, Dienncier & Myerson (l999: 1185) state:
"there arc theoretical papers that probe the consequences of dividing legislators into
separate chambers which represent the same voters". To fill this gap. re:st':arch was
extended to the cybernetic and management literature and later to human evolutionary
biology to develop an approach utilised by the author in 1977 to undertake the first
economic study into !he economic development of Australian Aboriginals (Turnbull
197Sa: 95- l 02; 1978b: 52).
\Vhilc the 1977 methodology \vas based on the .. amount of information" utilised by
various "integrative mechanisms" in society" it was not based on either bytes or
transactions, However, it did provide a basis !Or comparing markets and hierarchies with
other ways of governing society as utilised by traditional Aboriginals, It was these
tbmi1y", "dan/community" and "associative" identified and defined by
Hollingsworth & Lindberg (1985) which are most relevant to the activities of boards.
Chapter 3 develops TBA ifom the 1977 methodology, which was re-published at the
bcginning of the current research work in 'Stakeholder Dcrnocracy: Redesigning the
goverrw.nce of firms und bureaucracies' {Turnbull, 1994d}. TBA devdoped h-om fOcussing
on the intOnnational dimt:nsion of the work ofCo<l.st, Williamson and other theorists. The
neurophysiological <"md psychological limitntlons of individuals to receive, process, store
and transmit bytes were investigated. The opportunities for biases, omissions, errors and
distortions in communicating infonnation were atso investigated. The relevance of
cybernetic principles to organisations was then considered. These provided a hasis to
identify organisational strategies for overcoming human limits in transacting bytes and
losses in tbc integrity of their information. Cybernetic principles required for seJf ..
regulation and were also used to identify the fundamental problems of
firms being controlled by a unitary board.
Chaprcr 4 reviewed the evolution of corporate concepts in early developing countries.
Changes in the institutional arrangements of corporate ownership and control in the
11
ll'TROIJUCTION
leading industrial countries was reviewed from the 16th century to the pn::sent. This
research identified how continental Europe and Japan took different evolutionnry paihs
from those taken in England and how in the last century this was also different from the
USA. This work provided a context in which to examine how firms controlled by more
than one boards evolved historically in Europe, but not in England and other Anglo
cuJlurcs except for employee owned finns.
Employee owned flnns provided a basis for investigating internal compound boards m
Anglo cultures. To both illustrate and explore the phenomena of compound boards m
greater detail, two employee owned firms based in England and two based in the USA arc
described as reported in Chapter 5.
A case study is presented in Chapter 6 of the complex system of stakeholder
controlled fim1s. with compound boards located around to\vn of MondragOn in
Northern Spain. The :V1ondmg6n system provided compelling evidence ibr applying
infbmmtion nnd control d1eory to the analysis of organisations because 1t reveals a number
of cyb.::mctic principl.::s, In particular the study showed ihc holonic architecture tlmnd
throughout the universe for creating and managing complexity. Chapter 6 atso idcntiticd
similaritie.s betwci.!:n MondragOn and the stukcholdcr-controllcd firms round in a Japanese
keiretsu, which are also controlled by compound bourds.
Chapter 7 consi-ders the utility of the TBA tfamework by comparing it with others such as:
TCE; the power model; resource based and evolutionary theories of the finn. Because
these other theories arc dcp;;:ndent upon the exchange of infomlation, TBA also provides a
way of comparing each theory. In this way TBA meets the tcsl used by Kuhn to describe a
"paradigm shitl" in that TBA represents a ''higher lcve) theory than those known before.
one that linked together a whole group of lower level theories without substantially
changing any" (Kuhn 1970: 95). The power and relevance ofTBA is illustrated by using it
to reveal novel insights into the structure of MondragOn firms. The architecture of
MondragOn illustrates derivative concepts ofTBA, auxiliary concerns and other principles
CIIAPTER l
ofTBA. This leads to the development o ~ t number of propositions for illustrating the usc
ofTBA.
Chapte-r 7 then considers the wtder implications of TBA in providing a basis fOr a deeper
and more rigorous understanding of institutional structures of society. This includes
consideration of the role of govcmn1cnt and markl.!ts. One conclusion is that cybernetic
principles require other governance mechanisms besides mmkc!s andlor hierarchies to
effectively regulate a complex society. The requisite variety required to managl.! a
complex society leads to a related conclusion that the usc of compound boards will
Increase as the complexity of society increases.
1.6 Contributions to knowledge
As noted above, TBA meets the test of being a paradigm shift as it presents what Kuhn
(1970: 95} described as a "higher level theory than those known before, one that linked
together a whole group of lower le\'d theories \Vitbout substantially changing any".
TBA provides a framework for identifying the components of"boundcd rationality" which
provides the foundation for leading theories of the tinn and a "rational economic order''
{\Villimnson !975: 5). Human physiology, neurology and psychology all place limits on
the volumt! and consistency of humans to transact bytes to create bounded rationality, ln
this way, TBA provides a common basis to link other theories of the finn and provide a
framework for integrating organisational analysis into physiology, neurology and
psychology. As any transaction of bytes require a change in physical state, TBA grounds
the study of firms, organisations and the architecture of society in the natural sciences.
Because TBA is not based on costs' or other social constructs, which do not have a
physical form, TBA can be applied quite generally to ali fonns of organisations whether or
not costs are involved. This provides a bas1s for directly comparing the intOmmtion and
control systems within and between individuals m1d organisations with those found in
l3
1:'\TI\OI)VCTION
nature and maclunc. Cybernetics was defined by its founder a'i "the science of control and
communication, in the animal and the machine" (\Viener 1948).
TBA provides a framework grounded in the natural sciences tbr comparing and
understanding empirical, normative and instnnnental theories of the fimL The application
ofTBA it not limited by culture, form or type of finn. It provides a basis for investigating
firms. independently of the number uf boards or control centres involved and so provides a
way to compare firms wlth unitary control to those that possess two or more boards or
control ccntn::s. As a result. TBA provides a basis lOr investigating comparative corporate
governance.
TBA grounds the study of corporate governance in cybcml!tics. The application of
cybernetics to corporate governance has not been undertaken bc!On: according to StaffOrd
Beer
1
, th!.! fOunder of management cybernetics.
TBA identifies cybcmetics principles and strategies as a basis for mitigating the problems
created by the limited quantity of bytes, which can be pmee:sscd by humans, n:nd the
variability in thcir processing. The prlnciplcs and strategies identify criteria for dcsignirlg
the infom1ution and controf architecture of finns, organism ions and the structure of society
to improve their operations.
The thesis makes a contribution to understanding in the following areas:
(a) The development of corporate governance pructiccs in diffCrcnt cultures
(Cimpter 4);
(b) The strengths and weaknesses of the infOrmation and control sys!Cms m
finns found in dift0rent countries (Chapters 3 & 4);
1
Stafford Be1.!'r {1959, !966. 1985. l987, !995a,h,c) has been a pioneering practitioner in management
cybernetics, scholar ;;:md pa_'>t PrL,;idc-nt of the World Organization of General Systems and Cylxmctics. In
Toronto, Augu:>t 3'
4
1996 he reviewed the m>lnuscript ofTumbull {l997i} and advised the author that lle
wat( not aware of cybernetics being applied to corporate governance. Beer's work involved communlcuiun;;
and con!rol uithitz fim1s cr bureaucr;u;iC$, :mC this was ba"'Xl on information rather than bytes. Pres idem
Allende Beer in 1971 to assist him in managing lhe Chilean
h::p:iiflh:mbc r.111:w;.gu y. n>nV mavdav !:::rvptn't.Typtn6U. htm I hnp :i 1 . vull.ac .bd :/CST!l INK. hl ml
14
CHAPTER 1
(c) The ability of the infonnation and control system of a t1rm to provide
operating advantages (Chapters 3 & 7);
{d) Why employee and/or stakeholder owned fim1s cannot be sustained with a
unitary board (Chapter 3);
(e) How intcmal compound boards can be introduced m Anglo cultures
(Chapter 5) without a change in the law;
(f) How and why stakeholder govemancc provides competitive advantages
(Chapter 6);
(g} Criteria for improving the self-regulation and sdt:govcmance of fim1s,
organisations, and other institutions of society (Chapters 3 & 7).
In investigating the phenomenon of compound boards it bccame evident rhat one of their
bcnetits was that they provided a technique tOr mitigating the problem of 'bounded
rationality through decomposing the labour of decision making, The research problem
becatnc one of finding a method for understanding and cvaluatmg the process of
decomposing decision making labour. TBA is pn.:semcd as a tool to b;; used in the
solution of this problem and a ffamcwork for identifying how to design the infOrmation
and control structur ... of organisations to manage complexity. TBA helps to identify
general guidelines on how individuals can be organis!.!d to mnnngc complexity beyond
their indi\idual cnpabilitics. In this way it provides the architectural design criteria tOr
dctem1ining how to establish effective relationships betwc:l.!n people in organisations to
cope with managing complexity.
Eight propositions arc presented in Section 7.5 to test the utility of the TBA tfamework.
The basic proposition of the thesis is:
The limited of individuals to transact bylf!s can be ameliomted by jinns being
governed by more than one board vd;ich rlu: principles of and control
science.
15
Ii'TRODUCTION
1.7 Assumptions and limitations
The contributions to knowledge set out above arc based on some basic assumptions and
limitations considered below. Chapter 2 identifies how accepted theories of the finn and
organisations have many culturally embedded assumptions. Some of the most important
may not be made explicit especially in regard to human behaviour.
Many theories of the firm assume people arc homogeneous "agents" whereas TBA
assumes the characteristics of people arc variable between and with each individual. The
specific assumptions made by TBA are considered in Chapter 3 as set out below:
(a) Individuals have a limited ability to handle infom1ation;
(b) Individuals reduce, condense and summarise infom1ation;
(c) The behaviour of individuals may be neither logical nor consistent;
(d) Differences between individuals arc significant and important;
(c) The behaviour of individuals can be changed by the infom1ation they
obtain;
(f) Individuals can be both sdf-sl!rving agents and/or self-less stewards; and
(g) Individuals can bl: both competitive and/or cooperative, tmsting/distmsting.
Cybernetic principles provide strategies for overcoming the variability and unreliability of
infOnnation processing. The most fundamental assumption of TBA is that cybernetics
principles arc just as valid with social systems as they arc in nature and machines.
Specifically, the following six cybernetic principles are identified in Chapter 3 and utilised
in analysing fim1s with compound boards and developing the propositions in Chapter 6 as
listed in the previous section:
(a) Errors in processing infom1ation with unreliable components (i.e.
individuals) can be reduced as much as requin:d by employing sufficient
number of components/individuals;
(b) Errors in communicating information can be made as small as required by
using a suflicicnt number of infOrmation channels;
(c) The control of many variables requires a requisite variety of controllers;
16
CHAPTER I
(d) Infonnation is economised by utilising controllers that arc most directly
connected to the variables;
(c) Regulation cannot be amplified without supplementation;
(f) components provide the most eflicient way to create
complex organisations and for managing complex variables.
Other assumptions on which TBA is based arc:
(a) Information is required to establish coordination between individuals;
(b) Information is the principal cost in organising economic transactions;
(c) Economising the bytes required to coordinate activities reduces costs;
(d) The transaction of bytes is required to establish trust between individuals or
groups;
(c) Trust economises the bytes required to govem transactions;
(t) Trust is improved as individuals or groups become more interdependent;
(g) Trust is reduced by power differentials between individuals or groups;
(h) The ability of individuals to trust others is limited to about 150 people.
A basic limitation of the current research was the limited choicc: of case studies and their
limited variety. However, the selected cast: studies were considerc:d sufficient to illustrate
the phenomena under investigation and to indicate how TBA could provide a useful
fi-amework for validation. The limited number of case studies considered in this thesis
means that there is much work" (Kuhn 1970: 24) that can and should be
undertaken to work out the finer details of TBA. An important dimension that requires
development is to take much greater cognisance of the qualitative dimension of bytes.
\Vhile TBA recognises the differences in the "richness" of information transacted through
the various modes of governance, this needs to be developed much further both within and
between modes.
All six case studies in this thesis involved stakeholder ownership without any external
investors. All case studies were based on compound boards created within the fim1.
17
11"\TRODUCTIO!"\
However, external control existed with MondragOn firms fforn their banker and/or their
relationship group. MondragOn also involved compound boards external to the fim1.
External control and compound boards also exist in a keiretsu and VISA International.
There remains much work to be undertaken in the many compound boards created but not
noticed, when one company becomes the dominant investor in another to obtain the
influence or power to take over some of the activities of its board.
18
CHAPTER2
CORPORATE GOVERNANCE AND RELATED RELEVANT LITERATURES
2.1 Introduction
The purpose of this chapter is to review the various literatures that have relevance to corporate
governance and theories of the firm. Also reviewed arc elements of infonnation and control
theory in which TBA is later grounded. Definitions of specialist words used in the literatures
arc presented to explain how they may vary and to establish ngour in integrating the
contributions of the disciplines.
The scope of corporate governance is then considered and a critique made of two corporate
governance surveys to illustrate the variety and limitations of their different perspectives.
Some additional perspectives arc identified and gaps in the cmvoratc governance literature
reviewed arc identified. The Chapter concludes by identifYing the facts relevant to
investigating fim1s controlled by two or more boards and the theoretical gaps which might be
filled by TBA.
Corporate governance literature intersects with several of disciplines such as microeconomics,
organisational economics, organisational theory, information theory, law, accounting, finance,
management, psychology, sociology and politics. Each may view corporate governance in a
different way.
To encompass most perspectives an inclusive definition of 'corporate governance' is
introduced in section 2.2 to include all types of organisations and other institutional
arrangements involved in productive activities. To assist in integrating the knowledge of the
19
C1IAPTER2
various disciplines some common language is suggested, The word 'finn' is used to describe
aU organisations involved in productive activities. Section 2.2 defines various key words that
may have various meanings within, and between, disciplines.
Section 2,3 identifies a diversity of agents who are involved in influencing, controlling,
regulating and managing fim1st productive networks and associations, Again, an inclusive
approach is used to encompass the diversity of ways in which leading scholars in the field
dct1nc the topic of corporate govemance.
Section 2.4 considers diffcn.:nt corporate governance perspectives and these arc related to the
discipline and professional affiliations of various w r t ~ r s in the fic:ld. This section also
considers how well theories of the firm: tit the various perspectives and how governance
practices differ between cultures,
Section 2.5 details shortcomings in the th..::or)' of firm as identific:d by scholars who
contributed to its dcvdopmcnt in thl! USA. In addition, the ctlmoccntric mlturc of the theory
of the fim1 developed in the USA is identified. The Section describes how leading scholars
sec the need fOr further developing the theory of the finn as well as for establishing a
framework tOr analysing and comparing the different fom1s of corporate governance found
within and between in nations.
Section 2.6 uses the broad perspective of corporate governance identified in Scclion 2.2 to
analyse a corporate governance survey by Hawley & Williams (l 996) prepared for the OECD
and another survey undertaken by Shleifer & Vishny (1996). Hawley & Williarns present
four viewpoints: (i) Simple finance model; (ii) Stewardship theory; (iii) Smkeholder theory
and (iv) The politics of shareholder control at the micro level of the firm. The more extensive
20
CORPORATE GOVERNANCE AND RELATED RELEVANT LITERATURES
Shleifcr & Vishny survey is based on the narrow financial viewpoint of economists who base
much of their analyse on transaction costs and agency theory. Three additional viewpoints
based on culture, power and biology are considered to provide seven different viewpoints of a
finn.
Section 2.7 identifies gaps in corporate govemance scholarship such as: (i) Limited life
enterprises; (ii) Worker ownership and control; (iii) Compound boards with two, three and
more control centres; (iv) Information theory; (v) Network forms; (vi) Holonic structures; and
(vii) Self-regulation and self-govemance. The Chapter concludes with Section 2.8
summarising the findings of tht: literaturt: review and gaps in corporate govemance
scholarship in relation to the analysis of compound boards.
2.2 Definitions
The literature on the theory of the firm, economics, organisational behaviour, management,
COI]Jorate govcmancc and infonnation theory attributes different meanings and nuances to a
number of words in common usage. To avoid ambiguities some general words and concepts
are defined below.
Some scholars use the word 'organisation' to refer to a particular type of institution such as
a corporation, club or govcmment department. In this thesis the word 'organisation' and
'institution' will be interchangeable to refer to any network of people who become associated
for a common purpose. Firms then represent a sub-set of organisations and corporations
become a sub-set of finns that can include unincorporated enterprises.
The tcnn 'corporate governance' is used to includes all the influences affecting the
institutional processes for appointing and regulating the individuals involved in organising the
21
CHAPTER 2
production and sales of goods and services. Described in this way, corporate governance
applies to all types of firn1s whether or not they arc incorporated under civil law. In Chapter
7, TBA is applied to the governance of any type of organisation/institution.
Finns can exist as either common or civil law companies, partnership, joint ventures, limited
liability partnerships, cooperatives, mutual associations, building societies, friendly societies
or trading trusts. Fama & Jensen (1983b: 293-4) even considered churches. However,
organisations like churches, not engaged in the production and sale of goods and services, do
not meet the generally accepted description of a finn.
Firms may be publicly traded, privately held, for profit or not-for-profit. Much of the
literature on corporate governance implicitly assumes that only publicly traded fim1s arc the
subjects of analysis (e.g. Blair 1995: 3, and Zingales 2000). This would limit the topic to less
than 60,000 finns worldwide and involve only a fraction of all economic activity in even the
most advanced market societies (FIBV 1999). Restricting the study of corporate governance
to publicly traded corporations would deny investigation of compound boards in employee
owned finns and leveraged buy-out (LBO's) finns which Jensen ( 1993: 869) states represent
"a proven model of governance structure".
If finns include all social institutions engaged in the production and sale of goods and
services, then both public and private sector organisations such as schools, hospitals, clubs
and societies need to be included. With firms defined in this way, the scope of corporate
governance includes nearly all the economic activity of a nation. It was by asking the
question, "Why is not all production carried on by one big finn?" that Coase (1937: 86) laid
the foundations for developing what is referred to as a 'theory of the finn'.
22
CORPORATE AND RELATED LITERATURES
Couse (1937: 94) considered the existence of a "master and servant relationship" or an
"employer and employee relationship" as a defining feature of a fim1. However, this
condition would exclude activities carried out by teams, partners, joint venturers, strategic
alliances, associations and networks. This led Alchian & Demsctz (1972: 137) to ask the
question, "what is meant by a fim1?" They concluded," the tenn fim1 as commonly used is so
turgid of meaning that we can not hope to explain every entity to which the name is attached
in common or even technical literature".
However, Coasc (1937: 82) also stated "the distinguishing mark of the finn is the
supersession of the price mechanism". This proposition avoids the problem of identifying the
institutional fom1 of a fim1. It docs not necessarily avoid the problem of identifying the
boundaries of a finn (Barney & Ouchi 1986: 78). The boundary problem emerges when
analysing joint ventures, strategic alliances, associations and networks which some scholars
treat as "economic entities which have a coherence, a structure and an individuality of their
own" (Mathews J996b: 116). Ambiguous boundaric.::s arc found with MondragOn firms, their
relationship groups and their systems, as pointed out by Turnbull ( 1995d:
174).
The need to identify fim1s and their boundaries may not be required to develop the most
efficacious institutional arrangements for organising productive activities in society. The
problem of defining fim1s or their boundaries is avoided by defining corporate governance as
proposed at the beginning of this
In discussing systems of corporate control, economists frequently usc the word 'capital' in
different ways. Shleifer & Vishny ( 1996) used the word in four different ways in their survey
of corporate governance. The word was used to indicate: (i) "the means of production" (p.6);
23
CIIAPTER2
(ii) an investment which may not be represented by the means of production (p.3); (iii)
"finance" (p.2) and "external capital" (p.6); or even (iv) just credit created by contract, ("bank
debt" and "junk bonds").
The problem introduced by such ambiguity is illustrated by their reference to "the people who
sink the capital" (p.3). It is not clear if these "people" are: (i) investors subscribing for new
shares; (ii) shareholders purchasing existing shares from others; (iii) bankers lending money;
or (iv) the managers/"entrcprcneurs" purchasing the means of production or what Moulton
(1935: 7) describes as "procreative assets". The agency costs, benefits and risk change
according to the various meanings of the word 'capital'.
Clarity of the Shleifer & Vishny statement is fUndamental for their survey as they define
corporate governance as "the ways in which suppliers of finance to corporations assure
themselves of getting a return on their investment" (p. 2). \Vith this perspective of
considering the moral and other hazards of investors obtaining satisfactory returns, Shkifer &
Vishny (1996) provide a comprehensive literature review of their perspective. But their
definition is limited to corporate entities that attract investment and so exclude corporate
entities which do not provide returns to investors as found in the non-profit sector, fim1s not
incorporated and other types of organisations in the public and private sector. Accountants
usc the word 'capital' with other meanings. So in an interdisciplinary topic like corporate
governance, it is safer to avoid the usc of the word 'capital'
The tenn stakeholder is used and defined in various ways as noted by Donaldson & Preston
(1995). Freeman (1984) defined stakeholder as "any group or individual who can affect or is
affected by the achievement of the finn's objectives". Clarkson (1994) points out some
problems in this definition and suggests a "risk based model". This defines stakeholders as
24
CORPORATE GOVERNANCE AND RELATED RELEVANT LITERATURES
those who arc exposed to costs or gains from the operations or activities of a finn. Risks can
be assumed on a voluntary basis by employees, customers and suppliers or on an involuntary
basis such as when tinns cxternalise its costs. Clarkson ( 1994: 8) states:
A corporation will be both responsible and successful when its relationships
with its stake holders arc managed in such a \vay that: (i) Its stake holders
an! reasonably satisfied with the gain in value, or the anticipation of gain, of
their stakes; and (ii) Risks and potential harm to involuntary stake holders
resulting from the corporation's activities and operations arc minimized and
the potential costs of such risks arc internalized.
Clarkson ( 1994: 8) includes stockholders as part of the "core group of primary stake holders
essential for its survival". However, this statement is not relevant for common ownership
fim1s considered in Chapters 5 and 6, mutual organisations and for public sector enterprises.
Indeed, investors may not be requirt.!d in many mature publicly traded firn1s which become, or
can become, financing as demonstrated by LBO's and firms which unde11akc stock buy-
backs and/or do not make any share issues to raise additional cash. Stockholders may not
always meet the test of being essential for the past and/or continued existence of a fim1. So,
this thesis identifies a of stakeholders, "Strategic stakeholders" as described above to
distinguish them from the more general definition of stakeholders presented below.
Donaldson & Preston (1995: 85) state: "Stakeholders arc identified through the actual or
potential banns and benefits that they experience or anticipate experiencing as a result of the
firm's actions or inactions". Donaldson & Preston organised a network of scholars to
establish a consensus statement on the meaning of "stakeholder" which is accepted by this
thesis. Rede..flning !he corpora/ion ( 1999) stated:
25
CHAPTR2
Stakeholders participate in wealth-creation by contributing inputs, incurring
costs and experiencing inconveniences or hanns. They correspondingly
have som!!thing at risk in the the risk that benet!rs will be less, or
costs or harms greater. than anticipated or appropriate.
The Stanford Research Institute (SRI) in 1963 as stakeholders,
11
those groups without
whose support the organisation would cease to exist" (Freeman 1984: 31). Tumbull (l997h;i)
describes these types of stakeholders as 'strategic stakeho-lders' as stmtegic issues concern
the ability of a linn to exist. Strategic issues transcend discounted cash flow analysis based
on a relative performance measure of un 'opportunity rate of return'. No finn can exist
without suppliersj employees and customers so they must be strategic stakeholders tOr all
firms. However, ns by definition all viable fim1s must become self-financing, stockholders of
viable firms must loose their status of being a strategic stakcholdt:r after the time horizon of
their investors (Turnbull 1997i: 8}. The term :strategic stakeholder is used in this thesis in
accordance with the SRI definition,
The \Vord board' will be used to describe one or more people who have fom1a!ly been given
power by the constitutional members of an organisation to control and/or advise on aspects of
its administration. The organisation could be an unincorporated body. In the case of a finn it
ml!ans that the power to control advise hns been defined by the owners. The owners
may be partners, investors or shareholders. The fonnal instrument of their would
respectively be a partnership- agreement, joint venture agn.>::cJnent or corporate constitution in
the form of articles of association and/or corporate by-laws. These instruments could in tum
delegate powe-r to non-0\vncrs !O establish boards that could be in the form of a committee,
COUllCil, assembly, forum, panel, senate etc. All these terms will generically be refern::d to as
"boards1'.
26
CORPORATE GOVERNANCE AND RELATE I) RELEVANT LITERA TliRES
However, such delegated control centres will not be considered to represent a separate board
unless parties other than those who have the delegated power to create them detennine their
membership. In other words, sub-committees of a board would not constitute a separate
control centre or "board" because its member, their tenure and role is at thl! grace and favour
of the board of directors. Likewise, the auditor would not be considered a separate board if he
or she was nominated or could be retired at the grace and favour of the board of directors.
Howevl!r, a separate board is created when a company makes provision for its shareholders to
appoint a "watchdog board" or for its other stakeholders to elect a customer forum, employee
council or supplier assembly. The test of the existl!nce of a separate board is in a separation
of powers in both the appointment of members and their role.
The term 'compound board' will be used to describe the existence of two or more control
centres whether or not they arc required by law, the constitution of the firm or arc created by
relationships external to the firm. Compound boards arc commonly found in Anglo cultures
although they may not be recognised as such. Publicly traded corporations controlled by a
parent company, control group, rdationship investor or family shareholder creates a
compound board. Two and three tiered boards may be required by law in Europe (Analytica
1992: 86, 104-5) and may exist in Japanese firms where the shareholders elect 'statutory
auditors' to oversee the conformance role of the board described as kansayaku (Charkam
1994: 93). When a Japanese finn is a member of a keiretsu, then the keiretsu council creates
another centre of control.
A board may be a single individual. The constitution of some corporations may make
provision for the board to appoint a managing director (chief executive officer- CEO) and
other officers. But if the terms of appointment arc at the discretion of the board it represents a
27
CHAPTER 2
delegation of the powers of the board rather than the establishment of a different board. The
same argument applies to wholly owned subsidiaries. The appointment of the subsidiary
board is an extension of the powers of the principal board. However, as soon as there arc
other shareholders, the delegation of power is not likely to be absolute and so a compound
board may be created. This is also likely to be the case when it is the shareholder(s) who
appoint the CEO rather than the board. The existence of board sub-committees, such as for
audit, nomination and remuneration, fail the test of being a compound board as they arc
created by the board rather than through the constitution of the company. They also usually
fail the test of having different roles and accountability.
\Vhile a European supervisory board described in Chapter 4 may have the power to appoint
all the members of the executive board, this is different from a parent company appointing
members of a subsidiary board. This is because the powers of the executive board arc defined
by the corporate constitution that is controlled by the equity holders. This separation of
powers had its origin in the need to provide the nominators and monitors on the supervisory
board with limited liability. To achieve this objective they could not be involved in
management. European supervisory boards typically specify that no individual can be a
member of both boards.
In somewhat an analogous fashion, shareholders' agreement to limit the power of directors of
a private company creates a compound board when there is more than a single shareholder.
These types of compound boards arc commonly found where shareholders of private
companies have entered into an agreement with one or more professional investors to attract
their funds as with venture capital fim1s. Compound boards arc created by LBOs when an
association of investors supcnriscs the operating board of employees. However, the existence
28
CORPORATE COVERNA:\CE ANO RELAT0 RELEVANT LITERATURES
of compound boards is not recognised in either practice or the litt!r.ature, as it is a term coined
by this thesis.
The existence of a compound hoard could be indeterminate anclior changeable. This could
arise from changes in corporate eonstitutions or the size of the investment one company has in
other. The ability of a dominant shareholder to undertake the role of being a supervisory
board would reduce as it reduced the size of investment in a company. However, TBA ust:s
individuals and infonnation ao;; the fundamental units of analysis and so transcends the need to
identitY if one or more boards exist
The term 'bolon' describes an "almost self-governing component" of an organisation which
can itself be a holon. Smuts (1926) coined the word "holism" to explain how the compkxity
of the universe arose from assembling simpler components that together as a whole (hol)
crl.!ated JitTercnt properties from themselYcs so that the wbotc was more ihan the sum of the
parts. Koestler (1967) coined the word "holo-n' to describe th.; components of complex
systems, which produced properties difTcrcnt from
Simon ( 1962) did not usc the tcm1 "holon" in his lecture on the 'Architecture of Complexity'
but he was describing them when referring to components of complexity being ''sub
assemblies", .. stable intenncdiate fom1s" or "nearly decomposable systems, in which the
interactions umong the arc weak, but not negligible". Beer (1985: 117) refers to
them as a "viable system" and describes a number of their attributes. The paradoxical
pluralistic characteristics of organisational holons described by Mathews (1996a: 414) are
discussed in Chapter 3. These attributes led another writer (Hock 1994: 1) to coin the word
11
chaord!J to describe them by combining the words "chaos" and "order". Hock was the
founding CEO of VISA International Inc. when it "reconceived" its organisational fonn to
29
CHAPTERZ
adopt holonic architecture with over a hundred boards. In the context of organisational
analysis, this paper will also refer to holons or chaords as "almost self-governing
components" as this describes one of their most relevant characteristics for corporate
govemance research. A compound board is an inherent feature of holonic organisations as
explained in Chapter 3.
Koestler ( 1967) coined the word 'holarchy' to describe the hierarchy of complexity described
by Smuts ( 1926) and Simon ( 1962) in tenns of holons. Atomic particles represent holons,
which create atoms with different characteristics. Likewise, atoms represent holons, which
create molecules with different characteristics from their components. (A hierarchy of
ho1onic components creating a "holarchy" is illustrated in Tables 3.8 and 6.l.)
2.3 Factors which affect the operations of firms
The definition of corporate governance is based on "all the influences affecting the
institutional processes for appointing and regulating the individuals". Firms whose securities
arc publicly traded generally have more external influences on their operations than other
firms do. One way of determining the scope of corporate governance is to consider the more
obvious influences, which can af!Cct the operations of publicly traded firms as indicated in
Table 2.1, 'Stakeholders affCcting the operations ofpubliclv traded finns' .. The Table lists
private and public sector Stakeholders who influence the individuals who control and/or
manage a finn.
The multitudc of stakeholders listed in Table 2.1 is consistent with the definitions of corporate
governance provided by a number of authorities in the field. Demb & Neubauer (l992a: 9;
1992b: 187) state that, "Corporate governance is the process by which corporations arc made
responsive to the rights and wishes of stakeholders". Monks & Minow (1995: l) wrote that,
~ ~
:This process is illustrated in Table 3.8 of Chapter 3.
30
CORPORATE GOVERNANCE AND RELATED R E L E V ~ T LITERATURES
"It is the relationship among vanous participants 111 detern1ining the direction and
performance of corporations". \Vhile Tricker (1994: xi) states, "Corporate governance
addresses the issues facing boards of directors, such as the interaction \Vith top management
and relationships with the owners and others interested in the affairs of the company,
including creditors, debt financiers, analysts, auditors and corporate regulators".
Table 2.1, Stakeholders affecting the operations of publicly traded firms
Private sector Public Sector
Customers Trade practice laws
Competitors Anti-monopoly laws
Shareholders Securities laws
Employees Labour & Equal Opportunity laws
Unions Arbitration courts, etc.
Suppliers Fair trading laws
Bankers & financiers Cr!.!dit & bankruptcy laws
Auditors Corporate law
Stock Exchange rules Federal/State/Local taxes
Market for shares Health & safety laws
Media Environmentalla\vs
ProfCssional associations Quality standards
Trade associations Building regulations
Directors & Advisers Community
However, other writers like Sternberg ( 1996) do not accept that publicly traded corporations
should be "responsive to the rights and wishes of stakeholders" as proposed by Demb &
Neubauer ( l992a: 9). Sternberg ( 1996: 17) states that, "stakeholder theory is both misguided
and mistaken", and that, "stakeholder theory of accountability is unjustified" (12), it
"undermines private property, agency and wealth" (15), "is incompatible with business" (7)
and "with corporate governance" (9).
Even before the contribution by Sternberg, the diversity of views about corporate governance
led Pound (1993b: 1004) to state, "the lack of a broad defining paradigm has created a sense
of intelkctual vertigo in the increasingly intense debate over corporate governance reforms".
3!
CHAPTER 2
An objective of the rest of this Chuptcr is to provide orientation to the diverse views on the
topic,
2.4 Different corporate governance persp-l.'ctivcs
One reason why diverse views can exist is that different scholars investigate finns from
different disciplines, Donaldson & Preston (1995: 68} point out that a tirm \VHS viewed by
Adam Smilh (1937) and by contemporary investors as an organisation which obtained
resources from ils investors, employees and suppliers to produce goods and services for its
customers. Marxists, financial economists and Sternberg, view a finn as an organisation that
obtains resources from its employees and suppliers, with cashtlows contributed by its
customers to service its owners. In other words. Marxists and others view finns n.s servicing
their owners rather than their employees and suppliers. In defining "Stakeholder
Theory", Clarkson ( 1994: 8) states:
"The firm" is a system of stake holders opcrnting willoin the !arger sysiem of
the host society that provides the legal and market infrastructure
for the linn's activitil.!s. The purpose of the fim1 is to cr.::atc wealth or value
for lts stak\! holders by converting their smkcs into goods and services.
Figures 2.1, 'Investor view of a tirm and 2.2, 'Stakeholder view of a fi1111' were used by
Preston (1996: 7-8} to illustrate the difference between an investor view of a firm and a
stakeholder view. The arrows arc used to indicate the direction of contributions made by
various stakeholders from the various vic'>vpoints" As noted by Kay (1996: 29), the legal
obligation of directors is to investors rather than to customers (i.e. it follows the viC\\'pojnt of
1V1arxisEs and financial cconomisrs).
CORPORATE GOVERNANCE AND RELATED RELEVANT LITERATURES
Figure 2.1, Investor view of a firm
lnvc>tors
Suppliers FIRM
Customers
Employees
Figure 2.2, Stakeholder view of a firm
Government
Suppliers
Trade Assoc-
iations
FIRi\'1
0
mployccs
Source: Preston (1996)
33
l\llitical
r o u p ~
Customers
Unions
CIJAPTER2
The stakcholdcr vic\v recognises that fim1s do not exist in isolation. Both their cxistencl.! and
their operating discretions are subject to other .agents in society. Society creates the laws,
which allows fimls to exist and operate. The various perspectives on corporntc governance
can also be n.:latt.'"<.l to different cultural contexts, intellectual backgrounds and interests of
scholars. \Vorkers in the field come from diffcn:n! academic disciplines. There is often little
or incomplete. integration between the various disciplines. The overlap of corporate
governance with other disciplines is rarely articulated or even recognised. To indicate how
different viewpoints arise and to provide an overview of the topic, some examples arc
considered.
Blair ( 1995: 3) states that, "the phrase corporate governnncc is often applied narrowly to questions
about the structure and fUnctioning_ of boards of din..-..:tors". This \h.;w is fotmd mnong>;l some business
school scholars ::md management consull<m\s. Donaldson ( t 990: 376) defin\.'d corporate gov.::mancc as
"the stmcturc whereby mrmagcrs at the organizational apex arc controlled th:ough lhc boa:d of
directors. its associated stn1cturcs, cxccutivl! incentive and other schemes of monitoring and bondir.g",
I lis colleague, a fonncr lvkKinsey consultant, in the book r r i c r ~ ~ /Jnardroom (Hilmer l99J),
rdJcctcd this narrow view.
The definition of corporate governance quoted above by Tricker (1994: xi) in Section 2.3 is
focussed on the boardroom but extends the scope to include "owners and otht::rs interested in
the affairs of the company, including creditors. debt financiers, analysts. auditors and
corporate regulators". Such wider concerns reflect the audience for company financial
reports, consistent with both Trickers' accounting background and the target audience for his
publication.
Monks & Minow ( 1995) have an interest in 'relationship investing' as described by Monks
(1994). Their definition of corporate governance is based on "relationships" as quoted in
CORPORATE GOVERNANCE AND RELATED RELEVANT LITERATURES
Section 2.3. Monks & Minow formed a commercial mutual fund which they called 'Lens' to
focus on corporations. As active shareholders they seck to add value to
companies by relating to the boards of their in vestee companies as owners.
In making recommendations to change tht: pattern of ownership and control of USA firms to
make them more competitive, Porter ( 1992: 16-17) targeted policy makers, investors and
corporations. He identified the need to involve strategic stakeholders such as employees,
customers, suppliers and members of the host community, in the ownership and control of
corporations, to make them internationally competitive.
The rejection by Sternberg ( 1996) of such stakeholder involvement was made in the context
of the author being based in England where intense political interest arose in the nature of a
'Stakeholder Economy'
3
The then li.!adcr of the parliamentary opposition party (Tony Blair
1996) raised this tcrn1 year be fori.! a gcnt.:ral l.!lection that elected him as Prime Minister.
Table 2.2, 'Scope and diversitv of con1oratc governance concerns', lists the authors discussed
earlier, and those bdow, \vith their concerns, to indicate the scopl.! of interests involved in the
study of how productive activities arc governed. The interests of each of the scholars listed
could be far greater than those particularly noted. For example, the scope of the inquiry
chaired by Sir Adrian Cadbury into "The Financial Aspects of Corporate Governance" was
limited by the tcm1s of reference of the committee. The City of London established the
committee fOllowing some high profile failures of publicly traded corporations (Cadbury
1992).
3
Counter arguments to those presented by Stemberg were published in the same edition of the journal by
Turnbull ( l997i) who was motivated as a founder and fom1er President of the Australian Employee Ownership
Association by having a commitment to stakeholders. The counter arguments were based on the cybernetic
viewpoint developed in Chapter 3.
35
CHAPTER 2
Table 2.2, Scope and diversity of corporate governance concerns
Authors (date order) Subject of analysis Concern
Simon 1962 Infonnation Managing complexity
Turnbull 1975b; 1993c Directors' responsibilities Managing conflicts
Jensen & Meckling, 1976 Agency costs Financial structure
Williamson 1985 Transaction costs Industrial organisation
Hollingsworth & Lindberg 1985 Four modes of govemance Social organisation
Monks & Minow 1991/5/6 Board accountability Relationship investing
Demb & Neubauer 1992a;b Stakeholders Finn responsiveness
Cadbury 1992 Financial aspects Board conformance
Porter 1992 Nature of ownership Finn competitiveness
Hilmer 1993 Boardroom Finn perfom1ance
Pound !993b Politics of ownership Economic etliciency
Jensen 1993 Publicly traded finns Failure in control systems
Bosch 1995; AlMA 1995 Directors' duties Code of conduct
Sternberg 1996 Stakeholder appropriation Shareholder value
Hawley & Williams 1996 Fiduciary capitalism Corporate perfomumcc
Shleifer & Vishny, 1996 Moral hazards Investment returns
Persson, ct. aL 1996 Separation of powers Welfare of stakeholders
Aoki 1998 Infonnation Comparative governance
Dienneier & Myerson 1999 Bicameralism Internal organisation
Turnbull 1997c;c;t; 1998a;c Cybernetic architecture Operating advantages
Similar failures occurred in Australia during the 1980's when Bosch (1995) chaired the
National Corporations and Securities Commission. The contribution by Turnbull ( 1975b) was
part of the first educational qualification for company directors and arose ffom concern over
earlier corporate t:'lilures in Australia and from his activities as a corporate raider, company
promoter and chaimmn of publicly traded companies. Corporate failures in the USA during
the 1980s led Jensen (1993) to analyse "the failure of corporate internal control systems" and
Pound (1992; 1993a;b) to review the politics of corporate control and Porter (1992) to
compare the USA system of corporate governance with those found in Japan and Gem1any.
Aoki (1998) uses "an infom1ation theoretic approach" as a basis for comparing different
forms of corporate governance without considering cybernetic aspects or the limitations of
individuals to process bytes. DiemlCicr & Myerson ( 1999: 1182) state that
modelling can be applied to political competition as well as market competition" along the
36
CORPORATE GOVE!t_'IA;<o;CE A.:'iD RELATED RELEVANT LITERATURES
Jlncs used by Persson, ct al (1996). While cybernetic principles ore mostly neglected in the
anaiysts and concerns noted above, they could be used to build upon the diversity of
approaches and concerns listed in Table 2.2 as considered in Chapter 3.
2.5 Comparative studies and theories
Research into the theory and practice of corporate governance ha.:; been heavily focussed on
English speaking countries and the USA in particular. All scholars listed in Table 2.2 arc
from 'Anglo' countries, Shleifcr and Vishny (l996: 6) state, "most of the available empirical
evidence in the English language comes tfom the USA". Hol!ingsworthj Schmitter & Strecck
( 1994: 4) indicated the reason for this in their statement:
ln the I 950s and 1960s, hardly anyone disagreed with the assumption that
the more traditional and, therefore, backward economies like Japan,
Germany or Europe as a \vhole would have !o adopt American patterns of
indust1'ial organisation.
The lack of research in comparing different systems of corporate control was only recognised
in the USA in the early 1990s. Gilson ( 1994: 132) cxpla!ncd this neglect by noting that:
The American system seemed to represent the evolutionary pinnack: of
corporate governance; so otha systems were either k:ss H1r along the
Darwinist path or evolutionai}' deadcnds; neither lagards nor neanderthals
made interesting objects of study.
This view was exacerbated by the USA being tbe most powerful economy in the world, the
'citadel of capitalism', and a widely recognised role model for other countries seeking to better
themselves. The importance of Porter's ( 1-992) study is that it provided a counter view for
academics and policy makers. The USA has also dominated the development of the theory of
37
CHAPTEH. 2
the firm which was based on the assumption, that "in the beginning there were markets''
(Williamson 1975: 20) and that fim1s exist because markets fail as proposed by Coase ( 1937:
82) who explained the existence of finns as the "supersession of the price mechanism",
US scholars developed the theory of the tim1 during the height of the ideological contest
between capitalism and communism. It would have been unpatriotic for them to entertain the
pm;sibility that markets were not the natural order of a free society, The of
communism has reinforced the hegemony of marker ideology with widespread political
interest in privatisation based on the US model of a finn. The problems of using this model in
the USA arc identified by Jensen (1993), in Russia by Biasi & Gasaway (1993) and in
Australia by Turnbull (I 993b; 1995a;c;f). The problems of the US model in dthcr the US or
former socialist economics nrc outlined by Shlcifer & Vishny (1996). Htlwcvcr, failh by
political ideologues in replicating the dominant, but t1awcd US governaacc model, has so tfir
been little inhibited by scholarly research, empirical evidence or the success of other
approaches.
The assumption that in the beginning there wen; markets is not supported by the evidence of
hi>tory a> noted by Bcn-Poralil (!978), North (1985: 558), Tumbull (l978h: 52; 1994a: 328)
and others. in the beginning, economic transactions \vcre governed by social relationships
rather than hy markets, hierarchy or even what Williamson (1990: x) refers to as "hybrid
modes of organisation" combining both markets and hierarchy. Hollingsworth & Lindberg,
( 1985: 221-2) slate that there arc "four distinctive tbrms of governance ... market, hierarchies,
the clan or community and associations". Each form rdics on a different type of infomtation
and control channel as set out in a typology described by Tumbull (1978b: 6; 1994d: 328).
of these additional forms of governance arc outside the discipline of economics and so
beyond the field of vision and analysis by economists. The question asked by Coase ( 1937)
3S
CORPORATE GOVERi\A;o.,'CE AND RELATED RELEVANT trfRATVRES
as to why economic transactions nre organised through the "authority system" of a firm rather
than through the market needs to be to take into account tht!sc two additional
ways of governing transactions.
Each of the four institutional modes for integrating human activities have "a separate logic of
coHcctive action and social order'
1
as set out by Strccck & Schmitter {1985: ll) in a tabu!ar
form, which is reproduced as Table 2.3, 'Characteristics of governing mcdu.uxhtnts'. Each of
these four governing mechanisms has different mixes of infOrmation channels and methods of
control. The ditlCrent methads--1 of control are indicated in row seven, which identifies the
"'superordinate" and the "subordinate" actors.
The important point of Table 2.3 is to provide cvidenct:: of the existence of tOur rather than
two institutional modes of organising human cooperation. This means that theories of the
finn enunciated by US scholars arc incomp!cte as most t:.niy recognise markets and
hierarchies, \Vith only some scholars recognising govcmancc by associative relations
(Turnbull l994a}. rt docs not necessarily mean thm US based theories of the finn arc
incorrect, only that they may hav-e limited application, in an anaiDgous way to Newtonian
'faws of motion' providing correct answers \Vhen the effects of relativity are not In
other words, the theory of the firm becomes more relevant in cultures like the USA. Cultures
committed to competition with strong laws and large scaic impersonal publicly
traded firms without related party transactions and arc not strongly bonded through cultural,
clan, trade, industry, vocational or other associations, including strong interlocking
directorships.
4
The mclhods are analy,;cd in greater de1ai! in Chapter 3 which also analyi'cs the difference"' in the nnturc of the
information channels of mode of governance fi!l:d the implications that both these differences have on
1rar.sac1ing bytes in governing human acltvitks.
39
"'
t;
"'
"
"'
;;;
'l,
" :...;:.;::
~ 0
, '
;<;::
~
ttl:..;:
"'
z
0

~
~
~
g
~
(:;
"

5
<
v
c
>
;;.:
v
~
' c
,
'
'
"
:E
"
I 2.,
,,
s
' ~
" s
u
-
:2:
"'
"'
~ ,
~
: :;,
~ itL
0
i
e
~
.,
"
=
0
~
r:: ...
>--
,:,:
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-

. ~
:;
=
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"' =
'"
=
= ~
;::
"'
=
:s
E
c
~
.:::
v
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.2::
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40
Table 2.3 continued
'
l'n""P"IIJicU'IUN J<UL!c'(') consent, !'anty rcprcscntatl{)n, proportiOnal <ldJUS\Illcnt, _tormat __ Lonsumcr pre terence
unantmous agreement concurrent adjud1eal1on, tmpera!lvc
certification
"
." .c.o.UJ .. vv.u. Soltdansuc goods Lmegonc goods LolleC!IVC goods l'nvate goods
produced and d1stnbutcd
!U
C!"'"P'.'.I Ll"\ V hide
Natives \'S. torctgncrs n. assocla\1{1!1<11 leaders vs. {state) vs. ruled, . vs. ouyer1part1es vs.
Other CLLA \ AGLS 111terlocutors Supenors vs. subordmates voters
Clan rivalries, generation In-cluded \'S. excluded (soeialmovemcll!s) Overlap ofjurisdictlon Capital \'S. labour
gaps, connict over turf". Well org;mizcd vs. less well organized Connicts between levels of
inheritance claims, and Established vs. rival associations govemment, interstate
personal dispute. Over- vs. under-represented fivalries, etc.
Majority \'S. mim1rity segments
National vs. regional vs. local interest (parties,
maverick emerpriscs. community
rcprcscntati\cs, local notables)
"
mant , 1_ 1_ ,, :- 1 Lustomal)' practiCes 1/C/(J Sl//1{ Sl'/"1'(//lt a. reeoom 01 assocm11on orma_1 aummtstratt\'e roperty ng 1ts, cons\ltutlona
LEGAL FOUNDATION procedures guarantees
-
nnc1pa1 rn r-vn{:,) a ICCtlOil, .css c cxp o1tat1on; more :xtcrna secunty, equ1t;t01C !\l(llcna prosperlly, Clllzcn
collccti\c identity di:;tribution of benefits: greater prcd icabil ity and and predicable trc;llment, accountability
stabi I ity of socio-economic outcomes efficient mobilization of
peace) resources
Source: Strccck & Schmitter ( 1985; l *Terms used by Hollingsworth & Lindberg ( 1985; 221-267)
CHAPTER 2
Theories of the firm enunciated by US scholars become less relevant when economic
transactions are mediated by cultural priorities; business related associutions, trade, and
vocational, fnmily. social and political networks. These are more prominent in continental
Europe, Japan and other Asian countries (Hollingsworth & Lindberg 1985; Analytica 1992;
HoHingswonh, Schmitter & Strecck 1994: Hollingsworth & Boyer 1997). However, "the
social governance of markets" in the USA is not insignificant as detailed by Bruyn ( 1991 ).
The operating advantages of a greater reiiancc on associations and networks in the govcmancc
of lim>S has been reported hy Franks & Mayer (1993). Gilson & Roc (1993). Kester (1992),
and Turnbull (1995d). Blair (1995), Fukao (1995: 74,77-8), and Porter (1992: 167) also
recommend tbat tinns in the US.t\ establish stakeholder as:socimions and networks.
However, it would seem that scholars intcrest<!d in theories of the tinn or corporate
governance have overlooked the contributions by Strceck & Schmitter (1985: I) und
Hollingsworth & Lindberg {1985: 221) who have provide a much richer basis for
understanding fimu;. or governance systems '-vithin and between cultures, Hollingsworth,
Sclunittcr & Strceck {1994; 5) state that, "Contemporary m,ainstrcam economics postulates
essentially t"\\i{) mechanisms of governance: markets and corporate hierarchies." They go on
to say
1
"ln the limited institutional repertory envisaged by mainstream economics, corpom!c
hierarchies are the prc!Crred and in fact, tht.! only 'i:conomic', alternative to markets".
Failure by many e<:onomists to rl.!cognisc thal there arc modes nf organising transactions
outside markets and hierarchy and the hegemony of market ideology has rcsult(;d in there
being no theoretical framework for comparing systems of corporate govcmancc
wlthin or between cultures (Dcmb & Neubauer 1992b). Radner (t 992: 1384) goes further to
state, "I know no theoretical research to dmc that compares the relative efficiency of
hierarchical and non-hierarchical organizations within a common model". More generally,
42
CORPORATE AI'\ I) RELATED RELEVANT LITERATURES
Jensen (1993: 873) observed that "we're facing the problem of developing a viable theory of
organizations". This problem has been identified by a number of other leading workers in the
field. In relation to existing theories, Zingales (2000) states that, "they seem to bc quite
incffectivc in helping us cope with the ncw typc offinns that arc emerging".
Coasc (1991 b: 72) saw the need for "a more comprehensive theory" and stated that "theory is
outrunning our knowledge of the facts in the study of industrial organization and that more
empirical work is required if we arc to make progress" (l99la: 451). North (1985: 572) noted
that there is an "additional dimension currently missing in the discipline of economics".
\Villiamson (1990: xi) sees the need for "observing the phenomena at a higher level of
resolution". \Villiamson (199la: 10) noted that "In Demsctz's judgment, however, recent
work---of team theory (Alchian and Demsetz, 1972), agency theory (Jensen and Meckling,
1976) and transaction cost kinds- has not gone far enough". Demsctz (1991: !59) stated
that "a more complete theory of the firm must give greater weight to infonnation cost than is
given either in Coase's theory or in theories based on shirking and opportunism which have
not gone far enough". To overcome the shortcomings listed above on the theory of the firm as
well as providing a framework for analysing fim1s with more than one board, Chapter 3
develops TBA based on economising the infonnation processing required by individuals.
The lack of a generally accepted framework for comparing different systems of corporate
governance across countries has resulted in comparative corporate governance research being
more based on describing and analysing the ditTerences between nations. Notable
contributions to this relatively recent field of comparative corporate governance have come
from scholars outside the USA such as those of Analytica (1992), Demb & Neubauer (1992b),
Franks & Mayer (1993), lsaksson & Skog (1994), Charkham (1994), Gonc1w (1994), Tricker
(1994), Wymecrsch (1994), Garrett (1996) and Turnbull (1975b; !995a;b;c;d;t; !997a;d). US
43
CHAPTER 2
contributions have focused on Japan or Germany such <Is those by Kester ( 1991; 1992), Porter
( 1992). Roc ( 1993), Gilson & Roc ( 1993) and Aoki ( 1993 ), with other countries considered
by Black & Cotlcc (1993), Blasi & Gasaway (1993), Monks & Minow (1995), Fukao (1995)
and Preston (1996).
2.6 Models and explanations of corporate governance
This Section reviews two surveys of the corporate governance literature by US scholars. Both
the Hawley & Williams (1996) and ShleitCr & Vishny (l996) surveys illustrate the
ethnocentricity of US scholarship as discussed in the previous section. Both surveys and are
reviewed from the perspective of the inclusive definition of corporate governance described in
Sub-section 2.2.
Hawky & \Vi !Hams (l996) undertook a literature review of corporate governance in the USA
m; n background paper fOr !he Organisation for Economic Cooperation and Dewlopmcnt
{OECD)" They identified tOur models of corporate control: (i) simple finance model; (ii)
Sh..'\vardshlp m o e l ~ (iii) stakeholder model; and (iv), political model. While the Sun'ey of
Corporate Gowmumce by Shh::ifcr & Vislmy (1996) for the US bast'd National Bureau of
Economic Research was not rcstrict<:d to the CSA, its s-cope was limited to the finance modd
consistent \Vlth the specialised definition of corporate governance adopted by the authors
quoted above, Four other ways of considering corporate governance arc then considered in
this Section based on culture, power, efficiency and biology respectively. Th..:: cybcmetic
perspective developed in the next Chapter provides a basis for relating all eight models as
notl.':d in Table 2.4, 'Models of como rate govenmnce'.
Both the US based surveys contoin some unstated culturally detem1incd boundai)' conditions
44
CORPORATE GOVERNANCE AND RELATED RELEVANT LITER-\TURES
Table 2.4, i\'lodcls of corporate governance
Model Governance principally determined by:
I Finance Managers being self-serving agents monitored by investors
2 Stewardship Managers being self-less stewards for anybody
3 I Stakeholder Firms dependent upon stakeholders for their existence
4 Political How legal framework allocates power to stakeholders
5 Cultural Social conditioning of managers
6 Pmver Stakeholders fom1ing power coalitions
7 Efficiency Need to maximise profit for investors (closely related to Finance model)
8 Biological Managers being cooperative, competitive, selfish and/or unselfish
9 Cybernetic Managers possessing limited capability to process bytes and all above
and assumed that the US context provides a universal reference. Shleifer & Vishny (1996: 6)
explicitly state that, "While we pay some attention to cooperatives, we do not fOcus on a
broad variety of non-capitalist ownership patterns, such as worker ownership and non-profit
organizations". Nor arc these types of finns considered by Hawley & Williams who do not
state their boundary conditions. Tricker ( 1996: 31) states:
Stewardship theory, stakeholder theory and agency theories arc all
essentially ethnocl!ntric. Although the underlying ideological paradigms are
seldom articulated, the essential ideas arc derived from Western thought,
with its perceptions and expectations of the respective roles of individual,
enterprise and the state and of the relationships between them.
Neither, Hawley & \Vi !Iiams nor Shleifer & Vishny defines the type of "capitalistic" firms
subject to their survey. Nor do they describe the basis, if any, that the securities of fim1s are
publicly traded and the characteristics of the securities that exert some controlling, influence
on the firm. In the tradition of US scholarly corporate governance research, their national
legal!politicallregulatory system and the division of power between directors and
shareholders, as set out in corporate constitutions, is mostly implicitly accepted as the given
'state of the world'. There arc, however, important variations within the USA (Monks 1996;
45
CHAPTER 2
Gordon 1993), between Anglo cultures (Black & Coffee 1993) and between other cultures
(Analytica 1992, Porter 1992, Fukao 1995, and Charkham 1994).
For example, publicly traded firms in Europe may have two or three tiered boards (Analytica,
1992). Between and within Europe and the USA there are different ways of publicly trading
the securities of firms. Different stock exchanges have different rules governing the powers
of directors in relation to their shareholders. These introduce different regulatory rt.:gimcs to
produce significant differences in the management discretions of the firm, (e.g. a requirement
to have audit, remuneration and nomination committees; methods of electing or appointing
directors; shareholder approval to pay directors, new share issues, establishing employee
share plans, changing auditors, merging with another fim1 or changing the corporate charter
or place of incorporation to name a few). The voting rights of shares and the percentage
required to achieve changes in control, capitalisation or corporate charters may also vary
according to each fim1, stock exchangl..!, place of incorporation or national laws and
regulations.
The Hawley & Williams survey is implicitly limited to corporations that have their shares
publicly traded and explicitly limited to US based firms. Not being limited to either US firms
or the "simple finance model" of Hawley & \Villiams, Shleifcr & Vishny consider additional
dimensions of the finance model. Consistent with their concern of how financiers "assure
themselves of getting a return on their investment", they also survey how corporate control is
influenced by debt securities and bankers.
Implicit assumptions of both surveys seem to be that all publicly traded tinns have: (i) rights
ofpcrpctual succession; (ii) limited liability; (iii) unitary boards; (iv) management hierarchies
without related party transactions, strategic alliances or networks as found in non-Anglo
46
CORPORATE GOVER:'\A:"'CE RELATED RELEVANT LITERATURES
finns; and (v), unambiguous boundaries. Exceptions to all these <t'isumptions exist in
practice.
\Vhilc companies without the perpetual succession arc fOund in European countries and their
forrner colonies, this can also be found in Anglo countries. Ventum capital invcstmunt
corporations may be crt!atcd on the basis of being subjected to voluntary liquidation to release
the value of their investments. Mutual funds arc fOnncd as unlimited liability corpomtions in
Australia to allow their shares to be redeemed without court approvaL Dominant shardmldcrs
with related party transactions arc commonly found throughout the world, according to a
survcy of corporate ownership by Porta, Lopcz.de.Silanes, & SchlcitC:r ( 1999).
Companies with two or more hoards are found in European countries like Germany, France,
Holland and Spain and in their tbm1er colonies like Indonesia and in South America. The
fCdCratkm Intcmationalc des Bourses de Valcurs (FIBV !999) n:pons that in I99S then: were
29)274 domestic publicly traded companies in developed market e:.:onomics and 21,106 ln
"emerging" market economies. European countries in order of the numbcr of publicly traded
companies are Luxembourg with 1,957. Spain 1.122, France 914 and Gcnnany, 74!. This
compares with the 8,535 in the Unites States, 5,860 in India. 3,109 in Japan, 2,768 in Canada
and in Australia.
\Vhilc compound boards within finns are in the minority of publicly traded cornpanir.::s, they
arc common between companies as reported by Porta, Lopcz-de.SHanes, & Schleifer ( l999).
However, this point is n.:glectcd with the other t1ve implicit assumptions identified above in
the models of corporate gov..:-rmmcc used in the surveys by Hawley & \Villiams { 1996) and
Shlcifcr & Vishny (1996). Each of the models considered by these surveys and the additional
ones listed in Table 2.4 arc next consJdcred.
CHAPTER2
2.6.1. The simp:lg model
Tho first model of corporate governance considered by Hawley & \Villiams ( i 996: 21) is
described as the simple. finance model. They state, "in the finance view, the central problem
in corporate governance is to construct rules and inccn!lvcs {that is
1
implicit or explicit
'contracts') to l.!tTectivcly align the behaviour of managers (agents) with !he desires of
principals (owners)". However, the "rules" and "incentives" considered, arc generally only
those within the existing US system of publicly traded fim1s with unitary boards. The rules
and incentives in the finance model refer to those established by the firm rather than to the
legal/political/regulatory system and culture of the host economy or the nature of the owncrs
5

lt is the nature of the owners which cxnccrhatcs corporate control problems found in Anglo
countries iike th!.! USA, O:m::lda, UK and Australia. In each of these countries, institutional
investors own the majority of the shares in most the largest publicly firms unlike in
continental Europe and Japan (Analytica 1992). Institutional investors, such as pension and
mutual funds, colkctivdy owned more than 57% of the !Op US I ,000 firms in 1994 (Haw!t:y
& \Villiams 1996: 8). The problem with institutional ov:ncrship is that their investment
managers are fiduciary agents of the beneficial owners and so the situation created is one in
which agents represent agents as noted by Stiglitz ( 1999). Hence the tcnn "fiduciary
capitalism" or what Peter Drucker (1976) more provocatively described as "pension fund
socialism".
5
Tl:c financ>:: view a sub-sct:tion of the political model of corpomte govcmam:c. The po!i!ica! modeL
considered in Section 2.6.4, takes inio a-ccount the lcgnJ:political!rcgulatory which in tun1 is affected by
the cult>Jral context. The finance model also bccom.-::s a sub-section of the 'cultural' and 'power' models
discussed in SL-ctions 2.6.5, and 2.6J'} rc.spoctin'!ly. TBA developed in the next Chapt<:r provides a w.ay of
building on the insight'i of all thc:.c nHxh:ls nm.l so a basis for relating them to each other ns considered in
Chapter7.
48
CORPORATE GOVERNANCE Al\'D RELATED RELEVANT LITERATURES
A problem of agents being n::sponsible to agents is that it compounds the agency costs
identified by Jensen & Meckling (1976). A basic assumption is that managers will act
opportunistically to further their own interests before shareholders. Jensen & Meckling
showed how investors in publicly traded corporations incur costs in monitoring and bonding
managers in best serving shardwldcrs. They defined agency costs as being the sum of the
cost of monitoring management (the agent); bonding the agent to the principal
(stockholder/"residual claimant"); and residual losses. Their analysis showed amongst other
things: why fim1s usc a mixture of debt and equity; why it is rational for managers not to
maximise the value of a fim1; why it is still possible to raise equity; why accounting reports
arc provided voluntarily and auditors employed by the company; and why monitoring by
security analysts can be productive even if they do not increase portfolio returns to investors.
A basic conclusion of agency theory is that the value of a fim1 cannot be maximised because
managers possess discretions that al!ow them to expropriate value to themselves. In an ideal
world, managers \vould sign a complete contract that specifics exactly what they could do
under all states of the world and how profits would be allocated. Shlcifcr & Vishny (1996: 7)
state, "The trouble is that most future contingencies arc too hard to describe and foresee, and
as a result, complete contracts are technologically infeasible".
As a result, managers obtain the right to make decisions that arc not defined or anticipated in
the contract under which debt or equity finance is contributed (Grossman & Hart 1986; Hart
& Moore 1990). This raises the 'principal's problem' (Ross 1973) and 'agency problem' (Fama
& Jensen 1983a; b). How can publicly traded fim1s with such incomplete contracts with their
managers be effective in efficiently raising funds?
49
CHAPTER 2
The 'agency problem' is particularly acute in Anglo cultures with dispersed ownership where
corporations do not have a supervisory board or what Monks ( 1994) describes as a
urclationship investor". When all shareholders own small minority interests to create diverse
ownership it is not rational for any investor to spend time and incur costs to supervise
management as this provides a 'free ride' for other investors. In any event, small sharcholdas
may lack the power and influence to extract information that could reveal expropriation or
mismanagement.
In many Anglo countries, the law may limit the ability of shareholders to become associated
together to fonn a voting block to influence or change management unless they make a public
offer to all shareholders
6
Insider trading laws may also inhibit or prohibit shareholders from
obtaining the necessary information to monitor and supervise management.
2.6.2 The stewardship model
The second model of corporate governance discussed by Hawley & Williams is basc:d on the
concept of stewardship. Donaldson & Davis (1994: 159) describe the stewardship mode! by
stating that, "managers are good stewards of the corporations and diligently work to attain
high levels of corporate profit and shareholders retums"
7
.
Donaldson & Davis go on to note that "managers are principally motivated by achievement
and responsibility needs" (159) and "given the needs of managers for responsible, self
directed work, organisations may be better served to free managers from subservience to non
cxecutiw director dominated boards" (159). According to Donaldson & Davis (153), "most
researchers into boards have had as their prior belief the notion that independent boards an!
h r-.lonks (1996), an Assistant Secretary of Labour in the Rcag:m Administration describes how US managers
have influenced law making to protect themselves from shareholder interventions.
1
This view is consistent with the self-image of many executives and those interested in becoming managers such
as the students attending gr.Jduatc business schools where Donaldson and Davis teach.
50
CORPORATE AND RELATED LITERATURES
good" and "so eventually produce the expected findings" (155). There an;: influential and
powerful sources who recommend the need for independent non-executive directors such as
the Council of Institutional Investors in the USA, Cadbury ( 1992) in the UK, Australian
Institutional investors (AlMA 1995), existing professional directors and all those would like
to become non-executive directors.
However, supporting stewardship theory arc the individuals who contribute their own money
and other resources to non-profit organisations to become directors. In analysing the welfare
distributed to stakeholders through introducing a division of powers, Persson, Roland &
Tabellini (1996) had provision in their equations to include the welfare contributed by
controllers.
In commenting on stewardship theory, Hawley & Williams ( 1996: 29) state that, "the logical
extension is either towards an executive-dominated board or towards no board at all".
Donaldson & Davis point out, "the nmH:xecutivc board of directors is, by its design, an
ineffective control device" ( 157) and cite evidence to support the view that "the whole
rationale for having a board becomes suspect" (155). Brewer (1996: I) rep011ed that, "one of
Canada's best-known business leaders suggested last month that boards of directors should be
abolished and replaced by a formal committee of advisers". This view arose from the
businessman in question being sued as a director of an insurance company for over a billion
dollars from actions taken by management.
Boards can become redundant when there is a dominant active shareholder, especially when
the major shareholder is a family or government. However, research by Pfeffer ( 1972) has
shown that the value of external directors is not so much how they influence managers, but
how they influence constituencies of the finn. He found that the more regulated an industry
51
CUAPTER2
the more outsiders were present on the board to reassure the regulators, bankers and other
interest groups.
Tricker ( 1996: 29) points out, "underpinning company lnw is the requirement that directors
show a fiduciary duty towards the .shareholders of the company". Inherent in the idc::t of
directors having a fiduciary duty is that they can be trusted and will act as stewards over the
resources of tht: company, Thus in Anglo law, directors duties arc bused on stewardship
theory. This duty is higher than that of an agent as the person must act ns if he or she were
the principal rather than a representative.
Many writers, and especially the proponents of stewardship and agency theory, see each
theory contradicting the other. Donaldson & Davis raised th0 possibility that thcr0 is: som0
deficiency in the methodologies of the numerous studies they cite \vhich provide support tt1r
both theories. Some possibilities arc tllat the studies did not separate out the affect of tirms
being in a regulated industry as analys..:d by Pfctl'ct (1972) or possessing a dommant
shar!.!holder acting as a supervisory board or 'relationship investor'. Bhagat & Black (1997:
12) point out that, "many studies of the ro!e of directors don't control fOr stock ownership",
The existence of an influential supervisory investor is not uncommon in Anglo cultures
(Porta, & Schleifer 1999) and it is the rule rather than the exception m
other cultures (Anaiytica 1992; Tricker 1994; Tumbull l995c;d;f).
Ghosal & Moran (I996: 14) raise the possibility that the assumption ofopponunism on which
agency theory is based,
1
'can become a sdf.fulfilling propht:cy whereby opportunistic
bt":haviour wiU increase with the sanctions and incentives imposed to curtail il, thus crem:ing
52
CORPORATE GOVERNANCE RELATED RELEVANT LITERATURES
the need fOr even stronger and more elaborate sanctions and incentives", Likewise,
stewardship theory could also become
This leads one to view that the inclination of individuals to act as stewards or
agenis may he contingent upon the institutional context If this is the case, then both theories
can be valid as indicated by the empirical evidence. Stewardship theory, like agency theory,
would then be seen as a sub-set of political and other broader models of corporate
governance. Psychological analysis supports both theories. \Vcaring (!973), a professor of
psychology. states that, "differences between individuals are significant and important"; the
need fOr money and approval, is "determined :md by the necessity of maintaining the
organism in a state of dynamic cqut!ibrium": people stand "in an interactive cybernetic
relationship to his/her community and environment and is changed as a result of any
intl!ractionn and individuals are usomctimes: sometimes collaborative: usually
"
both"-.
The inclination of individuals to act as sellkss s!cwards may be culturaHy contingent. The
'company man' in Japan may place his employer before family. The voluntary rl!slgnation of
executives is not tmcomnwn when a finn is disgraced and instances of suicide nrc still
reported.
>'<ould appear the $ilualion in arouwJ MondragOn which h:IVC no cxtcma! directors. All board
members arc ciihcr execu:ives or swlcholders as Lktaikd in Chapter 6. However, each fiml and each group of
finm in the MondragOn SJ'Stem is comrolled by 1llrcc or more boarclsJ;;ouncils or control centres which
introduce$ a division of pmver with checks and balance!'. This makes executives inten::lcpcndcnl to proviJc a
rationale basis for trust as dixu:<!'ed in Chapter 3.
') The:>c arc cktbor<Jtcd in the next Chapter and S11mmari::cd in T;"!b!c 3.4 10 provide a baiis: for
grounding TBA in human psychology.
5)
CHAPTER 2
2.6.3 The stakeholder model
The third model of corporate govemanee considered by Hawley & Williams is the
stakeholder view. In Section 2.4, Clarkson (1994: 8) describes "the finn as a system of stake
holders" as illustrated in Figure 2.2. Blair (1995: 322) supports this view and states:
the goal of directors and management should be maximizing total wealth
creation by the firm. The key to achieving this is to enhance the voice of
and provide ownership-like incentives to those participants in the fim1 who
contribute or control critical, specialized inputs (firm specific human
capital) and to align the interests of these critical stakeholders with the
interests of outside, passive shareholders.
Consistent with this v1ew by Blair to provide "voice" and "ownership-like incentives"' to
"critical stakeholders", Porter ( 1992: 16-7) recommended to USA policy makers that they
should "encourage long-term employee ownership" and "encourage board representation by
significant customers, suppliers, financial advisers, employees and community
representatives". Porter ( 1992: 17) also recommended that corporations "seck long-term
owners and g1ve them a direct VO!Ce m governance" (i.e. relationship investors) and to
"nominate significant owners, customers, suppliers, employees and community
representatives to the board of directors".
The rcason for thesc recommendations was to help establish the sort of business alliances,
trade related networks and strategic associations which Hollingsworth and Lindberg (1985)
noted had not evolved as much in the USA, as they had in continental Europe and Japan. In
other words, Porter is suggesting that competitiveness can be improved by using all four
institutional modes for goveming transactions rather than just markets and hicrarchy
10
.
10
The strengths :md weaknesses of each mode arc considered in next Chapter in developing TBA which
establishes a basis for analysing the recommendations of Porter.
54
CORI'ORATE GOVERNANCE AND RELATED RELEVANT LITERATURES
However, the recommendations of Porter to have various stakeholder constituencies appoint
representatives to a unitary board \Vould be counter-productive for the reasons identified by
Williamson (1985: 300), Guthrie & Turnbull (1995) and Turnbull (1994d; 1995b).
\Villiamson ( 1985: 308) states, "Membership of the board, if it occurs at all, should be
restricted to infOrmational participation". Such infOmmtion participation is achieved in Japan
through a keiretsu council and in continental Europe through works council and supervisory
boards. These provide a model tOr "stakeholder councils" as described by Guthrie & Turnbull
( 1995) and Turnbull (1994d; 1995c; 1997h;i).
Hill & Jones (1992) have built on the work of Jensen & Meckling ( 1976) to recognise both
the implicit and explicit contractual relationships in a fim1 to develop "Stakeholder-Agency
Theory". The interdependence between a finn and its strategic stakeholders is recognised by
the American Law Institute (1992: 72), which states, "The modern corporation by its nature
creates interdependences with a variety of groups with whom tbc corporation has a legitimate
concern, SLICh as employee, customers, suppliers, and members of the communities in which
the corporation operates".
Both stakeholder voice and ownership, as suggested by Porter ( 1992) and Blair ( 1995), could
be provided by 're-inventing' the concept of a firm as proposed by Turnbull (1973a;b; 1975a;
199la; 1994d; 1997i). The proposal is based on tax incentives providing higher short-tem1
profits to investors in exchange tOr them gradually relinquishing their property rights in
HIVour of strategic stakeholders. Control of the firm is like\vise shared between investors and
stakeholders through multiple boards to manage conflicts of interest and agency costs in a
manner similar to that found in continental Europe and especially in MondragOn. Details of
55
CHAPTER2
European control systems arc outlined m Chapter 4 and the c:1sc study of MondragOn
described in Chapter 6.
1.6.4 The political model
The political model of corporate governance was the last model considered by Hawley &
\Villiams in their corporate governance survey. This model recognises that the allocation of
corporate power. privileges and profits between owners, managers and other stakeholders is
dctennined by how governments favour their various. constituencies. The ability of corporate
stakeholders to influence allocations between themselves at the micro level is subject ro the
mccro ffamcwork, which is intcmctivity subjected to the influence of the corporate sector.
According to Hawley & Williams (1996: 29), "The political model of corporate governance
has had immense influence on corporate governance developments in the last five to :;even
years", However. Hawley & \:Villimns lOcus their discussion only on the micro of
how shareholders can influence tlnns. Finns have ulso bee-n intlucntial in moulding the LiS
political/legal/regulatory system ova the last few According to Justict!' Felix
Frankflma of the US Supreme Court. the history of US constitutional hw-' is "the history of
the impact of the modern corporation upon the American scene", quoted in Miller (1968: I)"
Roc (1994) provides an elaborati-on of the historical evolution of the political model and like
Black (1990) and others, argues tbat the finance model's nearly exclusive reliance on the
market for corporate control was primarily the result of the political traditions of
federalismldL"<:Cntralisation dating back to the Ameriean Revolution, However, these
tmditions have been subject to substantial changes.
56
CORPORATE GOVERNANCE A!'OD RELATED RELEVANT LITERATURES
After the American Revolution, there was concern that newly won political freedoms could be
lost through foreigners gaining control of corporations (Grossman & Adams 1993: 6). As a
result, the lives of all corporate charters were limited to 50 years or Jess up until after the Civil
\Var. Nor did these charters provide limited liability for the owners. Most states adopted a
t e n ~ y e r sunset clause for bank charters and sometimes they were as short as three years
(Grossman & Adams 1993: 9). Grossman & Adams (1993: l) state, "Early state legislators
wrote charter laws and actual charters to limit corporate authority and to ensure that when a
corporation caused hann, they could revoke the charter". However, "During the late 19th
century, corporations subverted state governments" {p: I) and according to Friedman ( 1973:
456), corporations "bought and sold governments".
ln 1886, the US Supreme Court ruled that a private corporation was a natural person under the
US Constitution, sheltered by the Bill of Rights and the 14th Amendment. Grossman &
Adams (1993: 21) state, "Led by New Jersey and Delaware, legislators watered down or
removed citizen authority clauses. They limited the liability of emvorate owners and
managers, then started handing out charters that literally lasted forever". And, "Political
power began flowing to absentee owners intent upon dominating people and nature" (p.l5).
Grossman & Adams went on to say, "No corporation should exist fOrever" (p.26).
As a reaction to the corporate power extant at the end of the 19th century, a number Statt.:s
introduced cumulative voting to allow minority interests to elect directors (Gordon 1993).
Gordon describes how this initiative was subverted by competition between states to attract
corporate registrations or what Nader, Green & Seligman ( 1976: 44) describes as
"chartermongcring". Monks ( 1996: 19) describes this as "the race to the bottom" and explains
how contemporary corporations arc influencing the detem1ination of accounting and legal
doctrines and promoting a management friendly politicalllcgallregulatory environment.
57
CHAPTER2
Monks (1996: 20) went on to observe that, "The hegemony of the: BRT (Business Round
Table) i;.; not a sustainable basis fOr corporate governance in America".
During the beginning of the 20th century, at the federal lcvd, laws \vcrc introduced in the
USA to limit bank ownership of corporations and related party transactions between
corporations. This forced both the pattern -of -ownership and control of US finns and !he
p;:tUcrn of trading relationships to diverge from that found in continental Eumpc and Japan.
Kester { 1992) describes the latter patterns as contmctual governance as an.alysed by Coas..: and
Williatn$0n while limiting the term corporate governance to the problem of coordination and
control as analysed by Jensen & Meckling (1976) and Berk and Means (1932),
Hawley & Williams ( 1996: 29) focused on the micro level oft he political model as articulated
by Gundfest ( t 990), and Pound ( 1993b-: 3) \vho defined the ''political mod!.! I of governmtce"
as an approach,",., in which active investors seck to change corporale policy by devdoplng
voting support frt)m dispersed shareholders, rather than by simply purchasing voting power or
controL.". Pound (1992: 83) also stated, "this new 10ml of govcnumcc basl.!d on politi..::s
rather than finance will provide a means of oversight that is both far more cflCctive and far
less expensive !han the takeovers of the 1980s",
GundiCst (1993) points out that, "an understanding of the political marketplace is essential to
appreciate the role that capitairnarket mechanisms can ... play in corporate For
example, Gordon & Pound (l99l) showed that corporations with ti::wcr anti-takeover
provisions in their constitutions out perfOrmed those with anti-takeover measures in place.
\Vhilc the political form of governance is a neglected area tOr scholars in the USA, the
importance of "political procedures" (Jensen & Meckling 1979: 481) have been n."Cognised in
58
CORPORATE GOVERNANCE AND RELATED RELEVANT LITERATURES
worker-governed firms by Berstein ( 1980), Turnbull ( 1978a: I 00), and many others, with
stakeholder-controlkd firms analysed by Turnbull ( 1995d).
\Vhile recognising tht: cultural and contextual contingencies of the US system, the current
political model focuses on contemporary issues such as the US proclivity fOr market liquidity
over institutional control (CofTee 1991 ). The political model is also concerned with the
related issue of trading off investor voice to investment exit and institutional agents
monitoring corporate agent as detailed by Monks & Minow (1996) in their book Watching the
Watchers. All these issues arc influenced by govl:mment laws and regulations and so subject
to public policy debate tOr changes and refOrm. Black & CoffCe ( 1993: I) state that:
According to a new 'political' theory of corporate governance, financial
institutions in the U.S. arc not naturally apathetic but rather have been
regulated into submission by legal rules that-sometimes intentionally,
sometimes inadvertently-hobble American institutions and raise the costs
t
. . . . . 10
o parttc1pat1on m corporate governance .
Hawley & Williams (1996: 32) state:
The political model of corporate governance (whether Pound's or Gundfcst's
version) places severe limits on the traditional economic analysis of the
corporate governance problem and locates the pcrforn1ancc-governancc
issue squarely in a broader political context. Political docs not mean
necessarily imply a government role, merely that it is non-market.
In other words, the analysis of economists needs to be truncated and integrated into the
insights of Ben-Porath ( 1978) and Hollingsworth & Lindberg ( 1985) to understand how both
economic transactions and their coordinating institutions are governed. An aspect also
neglected by economists is that national income can be distributed without work or welfare by
59
CIIAP'fR 2
spreading corporate ownership directly to individuals rather than through institutional
intermediaries (Kelso & Adler 1958; Kelso & Hcttcr 1967; I986; Tumbull 1975a; 1988a;
1991b; I994b). However, these considerations were not covered in the Hawley & Williams
survey, who also did not consider the cultural, power or biological perspectives of corporatt.:
control which arc considered in the next Sections.
2.6.5 Culturl.!
Culture provides a way of governing a llnn as it establishes rules of behaviour. The ruh.'S arc
programmable as recognised by the simt)le definition of culture provided by Hofstede ( 1991)
who slates thrlt it is ''the collective programming of the mind. which distinguishes the
members of one group or category from those of another". Another definition is provided
Terpstra & David { 1991} who state, "culture is a learned, shared, compclHng, interrelated set
of symbols whose rneanings providl! a set of orientations for members of society. These
orienlations, taken together, provide solutions to problems that all must if they urc to
n::main viab!c."
Thl.! definition of culture brings with it three important factors: (i) culture is not innate, but
learned through the socialization process; (ii) -culture is shared, and transmitted
by members of a social group; and (iii) defines the boundaries between different group$.
There are various facets of culture, many of which arc interrelated. In the context of firms,
Hollingsworth, Schmitter & Strccck ( !994: 6) provide an example of a cultural perspective:
... transactions are conducted on the basis of mutual trust and confidence
sustained by stable, preferential, particularistic. mutually obligated, and
Jegally non-enfOrceable relationships. They may be kept together either by
va!ue consensus or resource ls, through 'culture' and
'community' or through dominant units imposing dependence on others.
10
Specific d:::1ails of the problem in regulations are di:;cu:>:i<.:d by (1994).
60
CORI'ORJ\ T GOVElt:"'ANCE RELATED RELE\'A.NT LITERATURES
This :statement was made in the context of transactions being governed by networks at the
'mcsoicvcl {eg. the intemu:diate location between the micro-level of the firm and the macro-
level of the whole economy)' rather than of the finn (p,9). However, it is also relevant within
fim1s and in this way it would subsume dements of the stewardship model.
Porta, Lopcz-dc-Silancst Shleifer, & Vishny (1997) found that the type of dominant religion
in a culture can affect trust and hence the ability of strangers in large organisations to co-
operate. In particular, they found that trust in large organisations increases as the proponion
of the population involved in hierarchic;;J! rdigions, like Catholicism, decreases. \Vhi!e Japan
shmved an above average degree of trust was not as high as Nordic countries and China.
Some scholars have that the Japan..!s.e commitment to employee participation and
the fom1ing of strat..::gic ollhmccs between firms arises from their cmbedd<..\.1 belief m the inter-
dependency of thdr many Gods.
\Villiamson (1975: 38) noted tht.: shortcomings of economic <malysis in neglecting "the
t.!xch<mge process itself as an object of value", He idc11tificd the concept of "atmosphcn;" to
.. raise such systems issues: supplying a satisfying exchange relation is made part of the
economic problem, broadly construed". However, this insight is not mentioned or used in
Williamson (1985) or in many of his later writings. However, the need to consider the
cultuml context or "atmosphere'' of transactions within and between t1rms has been analysed
by Maruyama ( 1991 ).
The importance of culture ls evident ffom the vie\v in :v1ondrng6n
12
that social adaptability is
the most critical condition in converting a firm owned by an entrepreneur to a cooperative
e MondragOn illustr:ltcs the imponam:c of cul!ure :v> it provides "an cnvironmcnl where tl1cte is no perceived
threat of opportunism, t-vcn from opportunbt;;!", to us',.; the words ofGhoshal and Mornn {1996: 26) in another
context. MondragOn make:> it clear that mark<:t or planning decisions arc value decision;(' {\eforriwn l 991: '9R}.
Economists, Bradh.:y & Gelb (!933: 30) :sec tl1is as :m odvamage from thJ.: Worltl Bank. Tiley f:<vourably
61
CIIAPTER 2
(Whyte & Whyte 1988: 86). "MondragOn is unlikely to undertake a conversiOn if the
prospects of managers and workers appear poor". In this regard, the Catholic
influence in MondragOn is at odds with the findings of Porta et a!. ( 1997). Morrison ( 1991:
Ill) quotes the founder of Mondragbn, Father Arizmendi as saying, "A company cannot and
must not lose any of its cfliciency just because human values are considered more important
than purely economic or material resources within the company; on the contrary such a
consideration should help efficiency and quality".
Contrary to the concerns of Ghoshal & Moran, Williamson (1979: 104) accepted that trust
could transcend opportunism when he stated:
Additional transactions-specific savings can accrue at the between
supplier and buyer as contracts are successively adapted to unfolding events,
and as periodic agreements arc reached. Familiarity here
pcrn1its communication economics to be realised: specialised language
develops as experience accumulates and nuances arc signalled and received
in a sensitive way. Both institutional and personal trust relations evolve.
The reference to 'communication economics' is taken up below. However, there is obviously
need to integrate culture into the n::search calculus of firm structure and performance.
2.6.6 Power
The explicit usc of 'power' seems to be a neglected topic in theories of the finn. Power in
organisations describes the ability of individuals or groups to take action. Pfeffer ( 1972),
Pfeffer & Leong ( 1977) and Pfeffer & Salancik ( 1978) have developed a related concern of
'resource dependency'. However, even when shareholders, directors, management or any
------ - -----------------------
cornp3re Mondrag6n with the "enriched employment relationship extending far beyond the cash nexus" of
Japanese l1m1s and X-inefficiency (Leibenstcin. 1987) found with 'Western' practices.
62
CORPORATE GOVERNAi"\CE AND RELATED RELEVAi'o'T LITERATURES
other stakeholder have the knowledge and will to act, this is of no avail unless they also
possess the power to act.
A legal scholar, Dallas (1988: 29) developed an explicit power theory of the finn. Her
tabulated summary is reproduced as Table 2.4, 'Efficiencv and power model of the fim1'. The
Table compares the power model with an "efficiency" model of lim1 based on TCE and
agency theory and so closely resembles the finance model. The main difference is that Dallas
Table 2.5, Efficiency and pm\er model of the firm
VARIABLES EFFICIENCY MODEL (a) POWER MODEL (b)
I Finn Nexus of contracts/reactive to Power coalitions/proactive
environment with respect to environment
2 Management Anent
0
Dominant coalition member
3 Fim1 objectives Profit maximisation; cost Multiple inconsistent goals;
minimisation increasing autonomy and
discretion
4 Determinants of Competition in markets Various sources of power
structure and behaviou
5 Contract
hold..::r relationship
6 Board of dir..::ctors ''Monitoring" device "Tool'' of internal coalition
Source: Dallas ( 1988: 29)
Notes:
(a) Dallas ( 1988: 22) describes the "efficiency model" as considering the firm as a "nexus of
contracts" with directors and managers being "agents" of the shareholders and perhaps
other constituencies, to maximise profits or minimise "transaction costs".
(b) The "power model" is describe by Dallas (1988: 39--44) as recognising the legal reality
that directors arc principles with only fiduciary duties to shareholders and that finns "act
to decrease the uncertainty of its environment by increasing its power over, and autonomy
from, its environment" (Dallas 1988: 30). These objectives ar..:: pursued at the expense of
profit, although subject to a profit restraint.
uses the legal perspective of finn adopted by some scholars as "nexus of contracts" (row l)
and so the firm disappears as an actor, making questions as to "corporate responsibility
meaningless" (Dallas 1988; 28). The altcmativc view presented by Dallas is to view the finn
63
CHAPTERZ
as "power coalitions/proactive with respect to environment". This view is consistent with the
findings of Bhagat & Black ( 1997) who found that the number of former regulators appointed
to the boards of firms increa..<.;ed in the more regulated industries.
Dallas points out that describing managers as "agents" is inappropriate as legally directors arc
"principles" who are the "dominant coalition members" as noted in row 2. The efficiency
model of tim1, such as Transaction Cost Economics (TCE), assumes the objcctive
13
of a fim1
is to maximise profits and/or minimise costs as noted in row 3.
Many economists assume that market forces (row 4) detem1ine the structure and behaviour of
firms. The power theory of the firm sees their structure and behaviour detem1ined by
management seeking greater power and security by introducing "poison pill", "shark
n.:pcllent", to repel market competition for their position of power. The po\ver ri10dcl sees
directors being co-opted by managers, because of the superior information, to coop them to
make them a "tool" of an internal power coalition as noted in row 5. The efficiency model of
a finn considers that the boards of directors arc contracted by shareholders to act as monitors
for the shareholders to select, direct and control managers as set out in row 6.
The power of shareholders to act is part of the political model of corporate governance.
Hawley & Williams (1996: 57-60) identify various inhibitions on the power of shareholders
to act arising from security laws, agenda setting by management at general meetings, proxy
procedures, voting arrangements and the corporate by-laws.
13
However. consistent with the characteristics of human nature outlined in Table 3.4 in the nt=xt Chapter, finns
have "multiple and inconsistt=n! goals except in regards to "incrt=asing autonomy and discretion of
management. However, these management objectives depend upon achieving some minimum level of profits as
required by the efficiency model.
64
CORPORATE ANI) RELATED HELEVANT LITERATURES
The power of din,;ctors to control management is dependent upon there bt.!ing a sufficient
number of directors who also have both the knowledge to act and "the will to act" to forn1 a
board majority us noted by Regan ( 1993). Even if non-executive directors have the
knowledge to act, they may not have the will and pO\vcr to act because they are loyal or
obligated to management and/or hold their board position at the grace and favour of
1nanagemcnt Directors arc unlikely to act against management unle.ss they arc supported by
shareholders. However, many institutional shareholders lack the ;.viii to act Tbis was found
to be a major problem for US fim1s in a report into their competitiveness by Regan (1993).
Hawley & \Villi urns ( 1996: 65} noted that martagcmcnt controlled "the infbnnation that does
reach the board. The result can be a board knowing too little, too late and, ewn if it is willing
to act to confront a growing problem or crisis, it is often unable to do so'',
An appropri.:uc separation of powers to creme checks and balances provides a \\'\1)' to incr..:as..:
the of stakeholders according to Persson. Roland & Tahilhni ( 1996). Th-:y make lhc
point that negative welfare may result iftht.: division ofpmvcr is not "2pproprialc". Bernstein
(1980) and Turnbull (l978a: 100; 1993c; have made an analysis of uppropriatc-
division of powers. Dallas (1997: 93) propos!..:d:
That the structure would consist of two boards each ideally composed to
pcrfom1 -certain functions. One board, called the conflicts board, would
perform conflicts monitoring and \vould be composed solely of
directors, who arc outside directors with no business rclutlonships with the
corporation or its management. The other board, callccl the business review
board. would consist of a mlx of different kinds of directors and would
pcrlOm1 other relational roles. A ombudsperson, selected by the
independent directors, would assist the independent directors in pcrfonning
conHicts monitoring on tlu.! conflict board or existing unitary board.
65
CHAPTER2
The Dallas proposal was not based on a study of European practices to be outlined in Chapter
4, but on using the powt.:r model of the firm and a careful analysis of the inherent conflicts of
interest in a unitary board such as those described in Dallas ( 1992). The objectives proposed
by Dallas were achieved without the need for a "full-time ombudsperson", when Turnbull
( J988b; 1992; 1993d; 1994c) introduced the concept of a "corporate senate" into Australia.
This corporate senate carried out the role of a monitoring board and its independence from the
executive board was established by its being elected on the democratic basis of one vote per
investor rather than the plutocratic basis of one vote per share as is commonly used to elect
directors. In this way, minority interests could also be protected from related party
transactions with a dominant shareholder or even a parent company.
Calls by rcfom1crs for greater disclosure and transparency as a way to control fim1s arc made
on the assumption that there arc shareholders who possess both the will and power to act. The
validity of this implicit assumption is largely ignon::d. While disclosure is a necessary
condition for regulation, sclf-n::gulation and self-governance, it is not sutTicicnt unless there
also exists both the power and will to act.
Suggestions for reform of corporate governance processes need to consider the power of
agents to act, or be subject to a veto, when there is a compound board. Pound ( \993a: II)
makes the point, "always have an opposition view" and ( 18) "there must be an opposition
party and the prospect of insurgency". However, Pound docs not consider the principle of a
division of power in his political model of corporate governance, even though he participated
a<> co-chair of the shareholders' committee established at Unites States Steel (USX) for this
purpose (Pound 1992). While the power model of the firm may be but a part of the political
66
CORPORATE AND RELATED RELEVA;o..;T UTERATURES
model, it should never be neglected because, without power to take corrective: action. no
net ion can take place.
For any action to be appropriate, the actors also need infonnation which is accurate, tim.ely,
suft1cicnt anJ y..:t manageable. Whik Pound (1993a) talks about "feedback" it is from
institutional investors who do not, caru1ot and should not have firm specific inside
inforrnatlon. This raises the need for a framework of analysis which can identify the most
appropriate forms of feedback. Also the need to establish the ncccssary and sufficient
conditions
14
fbr feedback information to effectively control, regulate, and govern a fim1. The
infonmnion feedback and control mechanisms that are requir..:d in firms arc also requirements
of all living things, which tead us to consider the biological model of a finn.
2.6. 7, Biological model oft he finn
The biologic<.\1 model of the finn has r!.:h:vancc to TBA in ways hesid..:s their being
based on cybernetic principles. As developed in the next Chapter, humans share nwdes
of communications and behaviour with animals. .Also, some of th<.! principles used in
nature \VOuld seem to have relevance in organisational design,
Hlrshleifi.!r {1977: 320) quotes Rapport &Turner (1977) who noted that "the fundamental
organizing concepts of the domlnant analytical structun:: employed in economics and in socio-
biology arc strikingly parallel", The discovery of evolutionary processes by Darwin and
\Vallacc was influenced by Malthusian ideas and Malthus w.::s in tum influenced by the
biological observations of Benjamin Franklin {Hirschlcifer 1977: 322).
cc--
IJ Titesc nrc ccJt,;idcrcd (c._g. Table 3,7) in den: loping (he TBA framework, which is grounded in the
power model of a firm,
67
CIIAI)TER 2
Hirschleifer ( 1977: 322-6) detailed a number of other mutual influences between economics
and biology and illustrated the parallels between them in tabular JOm1 (Hirschlcifer 1977:
362). These influences arc reproduced in Table 2.6, 'Com12arison ofbioloov with economics'
with columns presented in a different order to highlight the relationship of the fOurth column
added by the author to the other columns. The fourth column extends the biological
comparison from individuals as presented by Hirsh Ieifer to organisations and macro economic
structures. This extends and so compldcs the biological comparison between genes and
organisms with an economic comparison between individuals and organisations.
Table 2.6, Comparison of biology \Vith economics
HIRSHLEIFER TYPOLOGY (1977: 362) ADDED
Source: Table 1. Acting Entities, Units, and Groups By author
System: Biological Econ omic
Agents Genes (B) Organisms (A) Individuals Organisations
"Unselfish" (none) Reproductive Families, "brother Nonprofit
cooperative associations hoods" organisations,
group govcmrnent
"Selfish" Organisms Packs, Finns, parties and Monopolies,
cooperative chromosomes mutualists other political cartels, tariffs,
group and other associations, gangs, bounties
gene linkages exchangc associations
Competitive Set of alleles, Sexes, species, Industries, crafts and National
clusters of genotypes set of niche professions, other alliances,
competitors contending sets (of treaties,
gangs, parties, nations, groupings,
etc.) coalitions, etc.
Universal Gene pool Biota Society (Culture)* Civilisation
group
*Culture rather than society would seem to be more consistent w1th the
arguments put forward by Hirschleifcr in his discussion.
Table 2.6 highlights, that unlike many other economists, Hirsh\iefl:r recognised clans, families
and associations as governing agents in society and the contrary nature of economic actors
who can be either selfish or unscltish (i.e. sclf'..scrving agents or selfless stewards).
Hirsh Iiefer recognises the contrary nature of individuals to be competitive, collaborative or
both consistent with the observations of Wearing (1973) (to be discussed in the next Chapter
68
CORPOHA l'E RELATED n:ELEVAJ'\T LITERATURES
and presented in Table 3.4), The sdfish/unsdfish and compctitivc!collabonnive contrary
behaviour fOund in biology, including humans, represents a yinfyang (Ebrey !933: tiki!
property.
Yin and yang relationships reflect the design principles fOund in all biological physical
structures where it is rdi.:m .. "<i to as '"tensegrity" (Ingber 1998: 30). "The term rcft:rs to a
system that stabilizes itself mechanically because of the \vay in which tensional and
compressive forces arc distributed and balanced within the structure'' {Ingber 1998; 3{}-l),
Buckminster Fuller utilised the same principk:s
15
to design "geodesic" structures \Vhich
economise the usc of material to produce great strength.
Contrary, ytng and yang like propcmcs nrc an intrinsic of holonic structures as
described by Mathews ( 1996a: 4!-.-.-4}. The nature of these properties and their rdcvance to
social structures arc considered in the next Chapter. Holons represent another struc\tlrc tl.1tmd
in nnrure that can also be found in social stnlciurl!s and fim1sH ... TBA identities the b..;-nefits of
holonic architecture in nati.1re, flnns ;md society.
The development of TBA arises from the "cybcmetic" model of corporate governance listed
in Table 2.4. Tbc cybernetic model is one of the gaps in corporate governance scholarship
identified in the next section. Consideration of the cybernetic model becomes pan of
theory development undertaken Chapter 3.
15
The of principles 10 soci:ll struc!ures is considered in developing TBA in Chapter 3 as way to
minimi.;.e the tr.:tnsac1ion ofby1es while maximi:>ing cc!Hrol.
I( Compound boards are inherem femure of firm thai han.: holonic infomJation and conlrol archi:ecmrcs
iilwnra!cd in Chapter 6 und di;;;::us;;t.-d in Chapter 7,
69
CHAPTER2
2.7 Outstanding issues in corporate governance scholarship
Leading theorists have identified a number of the shortcomings in the theory of the finn as
noted in Section 2.5 above. A common concern was that the unit of analysis was not
sufficiently "micro" even within the context of their concerns. However, the scope of
concerns by the theorists was limited mainly to markets and hierarchies which Hollingsworth,
Schmitter & Streeck ( 1994: 5) identified as another shortcoming. As compound boards utilise
other modes of governance such as the personal relationships developed through groups and
associations, there is little in-established theories of the firn1 to provide a basis for analysing
compound boards.
Additional gaps emerge in corporate governance scholarship when a broader perspective is
introduced. One gap arises from the assumption that fim1s arc not created for a specified
limited life. Other gaps arise from employee owned and controlled fim1s, firms controlled by
more than one board, and network finns. The application of information and control thl!ory
und related theories self-regulation and self-governance represent additional gaps. Thesl! gaps
and the presence of ho!onic structures with fim1s arc next considered.
2.7.1 Limited life
A neglected area of investigation is th!.! recommendation of Grossman & Adams ( 1993: 26)
that "corporations should not live forever". The govl!mancc implications of limited life
corporate shares and limited life firms provide a topic for research. The periodic review of
managers by owners is an intrinsic feature of firms that have limited life charters as
commonly exists in joint ventures and in limited liability partnerships. In the USA, limited
liability partnerships arc formed for six years. They arc commonly used for research and
development syndication, property development joint ventures and theatrical and other types
70
CORPORATE RELA TEO RELEVAI"T LITERA Tl!RES
of media financing, Longt:r tcnn limited lifl.! enterprises ore frequently fomH:d with
international joint venture:s. CSj>ecially those in former socialist economies.
need to periodically establish a successor organisation allows a!l contractual
arrangements to be re-negotiated. In thls way management is made accountable in a similar
fashion to those subject 10 a lake-over of a publicly traded enterprise. Dispersed ownership in
!his situation increases rather than dccr;!'ases the bargaining power of owners in the same way
it docs tbr creditors as investigated by Gertner & Scharfstdn (! 99I) and Bolton & Scharfstein
(1996). lfthc owners do not have contidcncc in management they nct.x! not re-invest their
money, This fOrces managers to provide both adequate infomwtion and cash distributions to
retain investor conlidenc(!.
Limited lifl:! equities and lirms were the rule rather than the exception up until the middle of
the last century. except in England where a fl.!w hundred finns obtained charters with ih..:
rights of perpetual succession (Turnbull 1997i; l99Sb). Limited !ile tinns have particular
value when the business is not Jargi! enough to hctvc its shares publicly traded. The need to
rc-rccapitalisc the firm provides liquidity and so an exit opportunity tOr investors,
It also provides. a programm0d exit for fim1s with declining business as sought by Jensen
(1993; 847). There appears to be little published research inlothis topic.
2. 7.2 Worker ownership and control
Researchers from English :speaking (Anglo) cultures have not only neglected the study of
corporate governance found in other cultures, but also the governance; of firms in their own
cultures, which do not have publicly traded securities. TI1cse; include finns,
some of which have been proved to more compdillvc than investor owned firms ns
documented by Thomas & Logan {1982: 126-7) discussed in Section 6.2. While
71
CHAPTER 2
controlled firms may not contribute significant value to modem economies, closed or private
corporations add more value to their host economy than publicly traded fim1s do.
As noted earlier, employees are becoming the largest voting block in many US publicly traded
corporations. The same situation is developing in Australia (Tumbull 1997c). While tinns
which are 100% employee owned and controlled may have small practical significance, the
influence of employe!! ownership is stt.:adily incrt.:asing and it raises two important issues fOr
devdoping a theory offim1s. Firstly, the four temporary and eight pcm1anent assumptions of
agency theory (Jensen & Meckling 1976) lost! rdevance. All 'agents' arc also 'principals', so
there is little or no separation of ownership and control. Secondly, no worker-controlled finn
in an international survey undt.:rtaken by Bt.:mstein ( 1980) had a unitary board, even if this
were the dominant fOrm in its host culture. According to Jensen & Meckling (1979: 503),
"We do not have a tht.:ory that will tell us how supervisory boards will behavt.:". Empirical
research is required to discover if the increased conflicts ofintcn::sts created in a unitary board
with !.!mployl.!e ownership provide the n ~ a s o n why such firms do not survive. Empirical
research is also required to investigate the relevance of the pO\wr, cybemctic or other
perspectives in explaining the operations of finns which arc employee owned or influenced.
2. 7.3 Compound boards
The existence of two or more boards is not only of interest to employee owned firms but in
understanding corporate govemance in continental Europe where two or three boards may be
required by law. Skog (1994: 120) noted that members of the European Union could adopt
similar Jaws, so this topic has current practical interest.
Many publicly traded Asian fim1s arc family controlled (Tricker 1994) and so arc govemcd
by a compound board, as arc firms controlled by venture capital funds and LBO associations.
72
CORPORATE A;.;D RELATED RELEVANT LITERATURES
''that LBOs are enicient organizations" is cited by Shlcifcr & Vishny (1996: 45),
while Jensen (1993: 869) states:
LBO associations and venture capital funds provide a blueprint tOr
managers and boards \vho wish to revamp their top-level control systems to
make them more cf11cicnt. LBOs and venture capital funds arc, of course,
the pre-eminent examples of active investors in recent US history and thcy
serve ns excellent models that can be emulated in part or in total by virtually
any corporation, The two have similar governance structures and have been
successfUl in resolving the governance problems of either slow growth or
declining tinns (LBO associations) and high growth entrepreneurial finns
(venture capital funds).
The theoretical significance of compound boards is currently being overlooked in an
analogous way as multi-divisional fom1 finns \Vcrc overlooked by scholars t(n over
30 y\.!ars until analysed by Chandler {1962: 3-82-3). Compound boards pcrroit decomposition
in information processing and decision making in a similar WilY to firms which change from
unitary fonn stJ'ucturc to
While a number of empirical surveys document the e-xistence and operations of two or more
tiered boards (Analytica 1992; Charkham 1994; Fukao 1995; Francis 1997), liult::
attention lms been given to them except by Bernstein (I 980); Trickt::r ( J 980): Hathcrly ( !994);
Guthrie & Turnbull ( !995), Turnbull ( 1993b;c: !994c:d; 1995o;b;c;d;e;t; 1997b;c;t;h;i;
l998a) and Banca!re (1996). Jensen (1993: 863) states: "The reasons fOr the nti!urc of the
[unitary] board arc not completely und\:rstood".
CHAPTER 2
\Vhile Williamson (1985: 302) and Pejovich (1990: 69-71) note the existence of co-
determination in Germany, only Pejovich provides some cursory analysis. He asserts that co-
dctemlination must increase rather than dccrease the cost of funds because the participation of
labour in the control of corporations "abrogates the property rights of investors". This is the
issue taken up by Sternbcrg ( 1996).
However, the assertion of Pejovich is inconsistent with the analysis by Persson, Roland &
Tabellini (1996) who pioneered the first fonnal theoretical framcwork for analysing the
separation of powers in the context of political institutions. According to Diermeier &
Myerson (1999: 1185), "There arc few theoretical papers that probe the conscqucnces of
dividing lcgislators into separate chambers which represent the same voters". The need for
the separation of powers in corpornte boards has been noted by Dallas ( 1997), Tricker (1980;
1994: 6, 45-6, 75, 78, 156, 247-8;) and Hathcrly ( 1994). Turnbull ( 1992; 1993c;d) reports
11sing a two ticrcd board to reduce the cost of equity in two start up enterprises. In another
venture, a "corporate senate" was established as a shareholdcr watchdog committl:e as
reported by Guthrie & Turnbull (1995), Monks & Minow ( 1995: 317), Renton ( 1994: 36) and
Tricker ( 1996: 75-6). Much more empirical research is required into these issues.
2.7.4 Information theorv
Beer (1959; 1966; 1985; 1987; 1995a;b;c) has been a prolific writer as the founder of
management cybernetics and a proponent of using cybernetics in economic managemcnt.
However, scholars developing a theory of a finn have largely neglected cybernetics
principles
17
. An exception is the citation by Williamson (1985: 282) of Ashby to explain the
infom1ational advantages of M-form firms. The opportunity for the greater utilisation of
cybernetic principles in the theory of the fim1 arises because transaction costs are largely, if
not entirely, made up ofinfonnation.
74
CORPOR\TE GOVERNANCE A:-o:D REL\TEB RELEVANT LITERATURES
Radner (1992: 1392) points out that, "Although managers in a finn have many diff(:rent
fUnctions, one of their most important functions is that of processing infbmltllion" and goes
on to state (1393) that, "lnformution processing would app!.!ar to be a natural object of
economic study''. Daft & Lengel (1984: 192) reported that, " Managers spend the vast
majority of their time exchanging intbnnation".
Firms exist because of the cost of "discovering what the relevant prices are" (Coase 1937: 83).
By economising infOrmation, costs are cconomis(.!d. However, while costs arc a social
construct, infonnation must always be represented in some way that can be physically
detected and measured. As a physical manifestation, all information processing, storage and
transmission is subject to the hl\VS of physics. Transactions costs, and economics in general.
arc not so constrained as they arc based on the social construct of cost which is in tum based
on the social constmcts of money and value \vhich arc not now defined in tenns of physical
units.
The usc of physical units such as bits or bytes in the analysis of organisations provide a v.:ay
for developing a science of organisatlon which is based on the Jaws of nature. Bits or bytes
provide a way ''tOr observing t."ftc phenomena at a higher level of resolution" as sought by
Williamson (1990: xi). \Villinmson (1991 a: i2) later wcm Otl to say:
There is growing agreement, moreover, with the need to engage data of a
much more micro-analytic kind than was hitherto thought to be necessary.
lndeed, there is n:ason to believe that the elusive 'science of organisation' to
which Chester Barnard ( 1938: 290) made reference fifty years ago may take
shape during the 1990s.
11
The nq;lttl ;:\tends to corpomlc Ovcrmmce and the analysi-; of -compound ho3.rd:<. Refer 10 not.: !.
75
CHAPTER 2
As the cost of organising cconom1c transactions is based on the volume of infonnation
required, then transaction costs arc cconomised by economising infonnation. The need to
consider 'infom1ation richness' in organisational design has already been considered by
organisational theorists such as Daft & Lengel (1984). The capacity of communications
channels needs to match the information richness required to govern productive activitics.
Markets are efficient because price is not infonnation rich and very narrow communications
channels can be used. However, markets fail because price signals are not sufficiently
infonnation rich to communicate the qualitative aspects governing a transaction.
From a cybernetic perspective, TCE becomes a special case of infom1ation theory wht:n costs
arc relevant. Transactions costs arc minimised when the infOrn1ation required to activate or
reject a transaction arc minimised. Minimising bits rather than costs allows many of the
findings ofTCE to be extended to transactions and institutional arrangements where cost may
be less important, such as in quality assurance programs, non-profit organisations and social
institutions in general. In this way, the cybernetic approach can be used to integrate the
viewpoints of other disciplines to provide a common framework, which was noted as missing
by Radner (1992), Demb & Neubauer (1992a). It provides a basis in the next Chapter to
develop a theory of compound boards as sought by Jensen & Meckling (1979: 503).
2.7.5. Networks
There is substantial literature on the structure of firms as discussed throughout this Chapter.
A feature of the US based literature is the implicit assumption that firms arc ultimately
centrally controlled. There exists the need to understand dcccntraliscd organisations which
arc accountable to a number of separate constituencies. For example, Galbraith (1973),
Egelhoff, ( 1982), Daft & Lengel, ( 1984) fOcused on the idea that organisational structures
76
CORPORATE AND RELATED RELEVANT LITERATURES
develop to fit infbnnation processing needs. This approach n\:eds to be extended to entertain
dcccntralised organisations and networks of tim1s.
As a network or association of fim1s may itself be considered u fim1 (Mathews l996b: 116),
or "as organisational wholes" (Richt<:r 1994: 24), there is a need to consider the architecmrt:
of networks in the same W<lY theorists have analysed the structure of flnns. When a
compound board is created within a finn it represents a network of infonnation processing
and control centres. Networks can then exist both on an basis and on an inter-firm
basis. Both exist together in MondragOn and both types: of networks need investigating to
understand how they may best be used.
The ownership and control structure of finns hns been extensively analysed by such scholnrs
as Grossman & Hart (1982; 1986), Hart & {1990), Hart {1993: 1995) and \Villiamson
(1975; 1985). But in the traditions of US research, thdr work assumed organis<-ttions were
cemrally controlll:d through a unitary board. Investment risks of rdated parties could he
significantly modified by ownership and control structures which utilised compound boards to
share and manage- risk. There- is a nee-d to re-visit existing work ftom the network perSpective
of Craven, Piercy nnd Shipp (1996).
2.7.6 Hoionic structures
Holons represent an organisational structure identified by Smuts {1926). They have
intriguing characteristics, which suggest that they could make a contribution in understanding
the most etlicicnt way of governing complex productive activities. This suggests they
deserve investigation in regards to firms. networks of firms, communities and the go\'cmance
of sodety at higher levels,
77
CHAPTER2
Simon (1962) describes what Smuts called holons, as (472) Dr "stable
intcm1cdiate forms" (473) to create "nearly decomposable systems, in which th..: interactions
among the ar\! weak. but not negligihic"(474)" Exampks of \'.teak holons arc
divisions in M-fonn finns, 'autonomous manufacturing cells" (Matthews l996a) and firms as
a "hh:rarchy of teams" (Conti & Warner 1996: 103). MondragOn fim1s. groups and system
illustrates a strong holonic structure or .. holnrchy" (Koestler 1967), They are a strong fonn
because the component firms and groups ('sub-assemblies') can exist independently of the
whole ('hol'), !hat is: "able to maintain a separate existence" to represent a "viahic system"
(Beer 1985: I).
\Villiamson ( 1985: 2S 1) uses an "intbnnat(on processing interpretat1on
1
' to explain the
operating advantages of the architecture. The same advantages ansc m ho!ons
because "the reduction In data transmission, and in dma complexity, uchieved by the holonic
architecture, ts prodtgiousu (Malhc\v:s l996a: 30). Both this insight and that of Williamson
(1975: 21) concerning the "neurological limits'' of individuals provide a basis for
understanding how compound boards, networks of t!rms or orgnnismions and alliances .::an
provide operating advantages.
There arc many examples in computer programming where the efficient management of
complexity is achieved through ho!onic architecture as cited by Mathews ( 1996a) and
described as 'ultra-structure' by Long & Denning (1995). Williamson (1985: 383) noted that
"the problem of organisation is precisely one of decomposing the entire enterprise in efficient
intOnnation processing aspects". Holonic architecture provides a way to introduce efficient
decomposition to all0\\1 ordinary people to achieve cxtraordimuy results.
78
CORPORATE GOVERNA!"\CE Al\:D RELATED RELEVANT LITERATURES
Couse (1937: 83) noted that firms exist because markets fail to efliciently communicate
information. Ashby (1960: 34) pointed out that, "prices represent second order information"
dependent on first order qualitative description of what is bc:ing transacted. Prices may also
represent ineflicient communications because they may Jack credibility as analysed by
Akerlof ( 1970). These considerations explain the advantages of using non-market methods
for governing transactions as identified by Hollingsworth & Lindberg (1985). The
introduction of holonic organisations may provide a way to increase the efficiency of
governing productive activities by reducing transaction costs and costs arising from 'bounded
rationality'. Increasing the informational efficiency of organisations would reduce the role
and so need for markets.
2.7.7 Self-regulation and self-governance
The theory and practice of self-regulation and self-governance has been used since governors
were used in the 19th century to control the speed of steam engines. However, littli.! of this
knowledge appears to have bel.!n researched, let alone applied to social institutions or to the
role of government. The Vice President of the USA suggested that the reason for this gap in
the application of knowledge of thl.! 'infom1ation age' is that only nine of the 535 mcmbl.!rs of
Congress have any professional education in technology (Gorl.! 1996). Another reason could
be that social scientists arc not sufficiently familiar with the theory and practice of self-
regulation to understand why it cannot work with the dominant fonn of institutions in
advanced economics. This dominant fonn is based on centralised infonnation and control
without checks and balances.
Ignorance in the theory and practice of self-regulation is so widespread among social
commentators and scientists that they assert that it cannot work for institutions in a market
economy. Ironically, many of the same people support a market system because they believe
79
CHAPTER 2
that it is self-regulating. Design guidelines for establishing a "self-managing, self-correcting
power structure" without markets for Aboriginal finns are suggested by Tumbull (l978a:
100).
The need for government bureaucracies to intercede as corporate regulators arises because
those adversely affected by a firm may not have the infonnation, power and will to correct the
problem. Stakeholder participation in governance provides a way of reducing this deficiency.
lf the interests of the participating stakeholders arc not sufficiently wide to reflect the
concerns of the host society, some government interventions will still be required. However,
stakeholder participation may also be required in govcmmcnt bureaucracies to allow policies
to be mediated to suit local conditions and performance standards established and evaluated
by those affected (Turnbull 1994d; 1995a).
There arc arguments and evidence to suggest that self-regulation and self-govcmance provide
operating advantages !Or social institutions generally and competitive advantages for fim1s
1
s
(Turnbull 1997c;f).
2.8 Conclusions
The literature survey and analysis revealed a number of facts in relation to analysing finns
with two or more boards. The facts established in this Chapter in the various sections noted
were:
Compound boards arc required by statute in Japan and Europe (2.2);
Compound boards arc commonly created when one company controls another (2.2);
Leading scholars have identified shortcomings in the theory of a finn (2.5);
The theories of the finn is based on the existence of a unitary board (2.6 );
10
TBA is used in 7 to consider these issues to demonstrate its to improve the thcol}' and
prncticcs of firms.
so
COHPOR,.\ TE AND RELATED RELEVANT LITERATURES
All non-trivial employee owned fim1s have compound boards (2.7.2);
Firms with compound boards can be internationally c01npctitive (2. 7 .2);
Firms not publicly traded can be internationally (2.7.2).
Some of the gaps identified in this Chapter noted by section included:
There is no generally accepted fn:uncwork to analyse two or more boards'
There has been negligible research into the operations of compound boards' (25);
There is no commonly accepted framc\vork for corporate governance research
There is no generally accepted theoretical iTmnework to compare systems of corporutc
govcrnmu::e across cultures {2.5);
Tbcrc is no theoretical framcwOI'k to compare the relative efficiency of hicrarducal and
non-hierarchical organisations;
scholars acknowledge the need for "a more comprehensive theory" (Coasc
1937: 72) and to "develop a viable theory of organisations" (J..:nscn 1993: 873):
lniOrmation and control theory has nor been us,.:-d in corporat<: govl.!mnncc rcsc.:trch or to
analyse the operations of boards (Footnotes 1 and 17);
.. A thcorctrical framework for analysing bicameral syskms of pmvcr in political
institutions is a neglected topic and no evidence has been found that it has been applied
to firms with two or more boards' (2.7.3).
The facts listed above show that compound hoards within firms arc characteristic of some
countries and that compound boards, between tinns, arc a common phenomena in all
countries. The facts also confirm that there arc shortcomings in accepted theories of the fim1
even for those with a unitary board. The gaps show that there is a need for a more
comprehensive theory of the firm and one which has application to firms with two or more
boards and network firms. The opportunity to fill this gap is identified by the neglect of
81
CHAPTER2
infom1ation and control theory by economists and the neglect by cybemeticians in applying
their science to the governance of finns.
The next Chapter makes a contribution to filling some of the gaps identified above by
developing a framework for analysing fim1s using bytes and people as the units of analysis
and applying cybernetic principles. The following Chapter 4 then traces the development of
the corporate concept and finns contro!!cd by more than one board. The presence of such
finns in Anglo nations is demonstrated in Chapter 5. Complex examples of finns with
compound boards arc considered in Chapter 6 to provide a basis in Chapter 7 to show how
TBA makes a contribution in their analysis and tOr comparing TBA \Vith other theories.
82
CHAPTER3
THEORY DEVELOPMENT BASED ON BYTES AND CYBERNETICS
3.1 Introduction
The purpose of this Chapter is to develop a framework for analysing fim1s controlled by one
or more boards. It introduces intOnnation and control theory used in cybernetics and relates it
to Transaction Cost Economics (TCE) by showing that costs arc a proxy for infom1ation.
Infonnation, which is composed of data and can be measured in bytes, is used to develop a
framework described as Transaction Byte Analysis (TBA).
In Section 3.2, specialist words used in the cybernetic literature arc defined and used to
describe the characteristics of the infonnation and control channels found in individuals,
finns and society.
Section 3.3 identities how all human cooperation is dependent upon the ability of individuals
to broadcast and receive infOm1ation. However, each of the five human senses is subject to
physical limits. An indication of the physical limits, measured in bytcs/sccond, is idcntificd
fOr dilfcrcnt human communication channels based on the five scnscs, semiotics, voice, word
and priccs or cost.
Section 3.4 notcs how infonnational requirements affect the structure affirms. A typology of
fOur ways of human communication and control is identified with an outline of the
advantages and limitations of each method to provide criteria for evaluating and designing
fim1s \Vith one or more boards.
Section 3.5 identifies the psychological, physiological and neurological limitations of humans
to transact bytes and thcir inconsistcncies. Section 3.6 considers the processes of human
thinking and action and the implications these have for evaluating or designing the
infonnation and control architecture of organisations. Section 3.7 establishes the basic
principles rt.!quired for establishing control, sclf-rt.!gulation and self-governance in
83
CHAPTER3
organisations. The inability of a firm with a unitary board to reliably establish these
principles is identified.
Cybernetic principles arc identified in Section 3.8 for ameliorating the limited and
inconsistent ability of humans to transact bytes to enable firms to establish control, self-
regulation and self-governance. These principles arc shown to require the establishment of a
variety in decision-making centres as well as information and control channels.
Section 3.9 considers how cybernetic principles deny the ability of any organisation to
amplifying control cxccpt through thc process of supplementation which also allows thc
transaction of bytcs to bc economised. Thrce strategies are identified for economising the
transaction of bytes consistent with cybernetic principles. These arc the decomposition of
decision making labour through: (i) the Principle of Subsidiary Function; (ii) the formation of
almost self-governing organisational units described as "holons"; and (iii) the usc of a
concept described as "social tenscgrity". Compound boards arc identified as an inherent
requirement of holonic organisational architecture and fOr facilitating thc dcvelopmcnt of
social tenscgrity.
Section 3.10 presents the basic proposition of this thesis, its originality and theoretical utility.
This section outlines the structure of its defence in the following chapters. TBA is presented
as a ffamcwork for identifying cybernetic principles which can be used for ameliorating the
restricted, variable and inconsistent ability of individuals to receive, store, retrieve, process
and transmit information to allow firms to improve their ability to meet their objectives. The
division of control between two or more boards and the resulting increase in the varicty of
information channels is identified as a common requirement for a number of strategies for
ameliorating human limitations in transacting bytes.
3.2 Definitions
The literature on the theory of the finn, economics, organisational behaviour, management,
corporate governance and information theory attributes different meanings and nuances to a
84
THEORY BASED O;>; B\"TES A:'\0 CYBERNETICS
number of words in common usage. Ambiguity exists in the meaning of key words such as
control', 'regulate', 'manage', govern' and 'governance'.
However, some ambiguous: words can be usefuL Aldmm & Dcmsctz (1972: note l) use the
\VOrd "meter" in the sense of botb measuring and cfmtrolling to describe the terunwork
required fOr two men carrying a heavy load. In other words, they are discussing what is
defined befow as 'regulation', Ambiguity in the words 'manage' and 'govern' can likewise be
useful. However, care needs to be taken not to usc ambiguous words unnecessarily. The term
1
govemancc' is often used when the \VOrd 'contror or 'regulate' would be more appropriate or
provide greater clarity of the process involved, The study by Porter (1992) rarely uses the
word 'govcmance.
If the term 'management' is reserved to describe processes !hat involve executive action then
it describes a subset of governance processes. However, the kudos perceived by some writers
in governance matters has resulted in the word governance being over used. Many
board activities arc subject !o management processes such as ..:stahltshing subcommitrees.
GretHer clarity and focus would be achieved by using !crms such as board management',
'board conduct', 'corporate organisation' or 'corporate conduct',
rather than the less more ambiguous and ambitious phrase 'corporate govcmanco:.::'.
Both the ambiguities and circular dictionary definitions need to be resolved to develop a
rigorous theory to analysis the governance of finns and compound boards in particular. To
this end, key words and concepts arc defined below:
Tannenbaum (1962: 5) defined 'control' as "any process in which a person or group of
persons or organisation of persons determines, i.e. intentionally affects, what another person
or group or organisation wm do". This definition provides a wordJconccpt to describe a
situation where no standard of pcrtbnnance is required. The word 'control' is commonly
used in this sense in describing rhc operation of mechanical devices in the engineering and
85
Cl-iAPTRJ
cybernetic likratun;. The Tannenbaum definition provides a basis for grounding TBA m
cybemetics.
Other writers (Etzioni, 1965: 650; Downs. 1967: 144) use the .vord "control' in the sense of
meeting some standard of performance. In these situations, the word regulate will be used
whether or not the 'regulator' is a manager of the organisation concerned or an cxtcmal
bureaucrat. Defining 'control' and 'regulate' in these ways provides a common language with
j'thc science of control and communication" (Ashby 1968: ! ) to facilitate the usc of
cybernetics in corporate govemance analysis. Self-regulation means that those being
regulated establish the standards ofperlbmmnce.
Architecture is usc to describe the pattcm of information and/or control channels in
org::misations" This is the same way the word is used to describe the connections fOund in a
com.puter chip, a network of computers or the pattern of neurons in a brain. Alt control
channols depend upon the transfer of infonnation but intOnnation channels do not depend
upon transmitting control.
The \vord control. as defined above, infers that a person or group possess power w dctt:rminc
what uctions arc taken. Self-control then means that not all the power available is used to
further the sc!f: .. Jntcrcst of the controller{s). Self-control simply becomes the avoidance of
using power in some degree. rmhcr than meeting a given result. This is a requirement of
directors or a board \Vishing to behave as stewards, discussed in Section 2.6,
The word manage will be used to communicate the responsibility tOr executive action, it
could be ambiguous to mean either control or rt.!gulatc. The word govern is likewise
ambiguous. If the term mamlgcmcnt is reserved to describe processes which involve
executive action, then it describes a subset of govemance processes as defined below. As
noted earlier, many board activities am subject to management processes and should be
described as such.
86
THEORY DEVELOP!\JENT BASEl> ON BYTES AND CYBERNETICS
Governance is used to describe a system of control or regulation, which includes the process
of appointing the controllers or regulators by a political process rather than by an authority
relationship. A political process would involve negotiation or some form of ballot. Self-
governance means that the system of control or regulation includes the appointment of the
controllers by the govcmed
19
By this means, self-regulation can be introduced through self-
governance. Self-governance involves a political process within institutions to appoint the
controllers responsible tOr regulation.
The word bit is a contraction of the phrase 'Binary digiiT' (Kur.r.weil 1999: 299). A binary
digit has one of two possible values, usually zero and one. In infOrmation theory, a 'bit' is the
fundamental unit of infom1ation. However, because the word can have other meanings for
social scientists, TBA uses the more distinctive word 'byte'. The word byte is a contraction
fOr 'by eight' (Kur;;weil 1999: 299). "A group of eight bits clustered together to store one
unit of infOrmation on a computer. A byte may correspond, for example, to a Jetter of the
English alphabet". One thousand bytes arc referred to as a Kilo-byte and one million bytes as
a Mega-byte indicated respectively by the Jetter "K" or "M". The amount of infOrmation
that can be transmitted by a communication channel depends upon its 'bandwidth'.
"Bandwidth is essentially about infOnnation tlow - bits (binary digits - ones and zeros) -
mostly in the context of speech, text, pictures, movies, animations and data" (Cochrane 2000).
Information is "A sequence of data that is meaningful in a process" (KurLweil 1999: 304).
Data can be presented in the fonn of signs and symbols that includes words, language,
numbers and prices. All data, information and knowledge can be presented in digital fonn
whose quantity can be measured in bytes. lnfOnnation is contrasted with 'noise' which is a
random sequence of data. In short, information is meaningful data. lnfom1ation theory uses
mathematics to identify the "difti!rcncc between infOrmation and noise and the ability of a
communications channel to carry infomwtion" (Kur.r.weil 1999: 304).
1
9
In a political context this describes democracy. There arc arguments and evidence prescmcd in Chapter 7
!hat this can contribute to advantages in finm and the enrichment of democracy.
87
CHAPTER3
"Structural information is a picture or blueprint: it Is the information obtuincd in sensing,
perceiving and describing an organisation'' (De Vany 1998: 3}. It can be quantified as ''its
probability relative to the number of possible forms; it is also given by the number of simpk:,
binary choices one must 1nakc to describe its form", (De Vany 1998: 6). Smu::tural
infom1ation dctcm1incs the architecture of an organisation and so the existence of two or
more boards as illustrated in by the figures in chapters 5 and 6. Simon 0962: 479) describes
structural intbnnation as a. "state description"). De Vany {1998: 3) described Process
information as '"a recipe, procedure or algorithm fOr creating the object It is the infOm1ation
of action it describes the actions required to create !he organization in question", A
algorithm is described by Kurzwcil ( 1999: 298) as" a sequence of rules and instructions !hat
describes a procedure 10 solve a problem. A computer program expresses one or more
algorithms in a manner understandable by a computer". The constitution of an organisation
which specifics the rules and instructions for governing an organisation is an algorithm,
likewise the DNA code which determines the form of life.
The word 'knmvledge' is used to describe useful inf()rmation. Infommtion becomes useful
when it provides the know-ho\v fOr improving the operations of u business and/or cm1 be sold
to gcncmie revenues. In the context of computers knO\\ ledge engineering is, '"The art of
designing and building expert systems", (Kur;:wcil 199: 304). In the cont..::xt of organisati{Jns
the term will be used to describe the proci!S$ of designing organisations to most
carry out their purpose; that is. to design the structure and construction of organisations. This
will require the dctcmlination rcspe-ctivdy of structural and process infomiation.
The words and definitions introduced in bold above provide a basis for applying cybernetics
to the analysis of finns nnd social organisations in general. The control, regulation and
governance of any organisation rcquin:: the transmission of intOnnation. The various ways in
which people can transmit infbm1ation and so bytes is next considered.
ss
THEORY DEVELOl?ME;:o;T BASEJ> ON BYTES AND CYUER!\:ETICS
3.3 Htlman cooperation dependent upon transacting bytes
Any coiieclive activity bctwct:n two or more people requirt:s the communication of
information. Communication is a necessary condilion ".,which giv<.!s rise to the costs of
mediating exchanges between individuals" (Ouchi 1980: i 29), As Hoshi ( l997) points out
"corporate governance becomes an issue only when firms fllce the problem of information",
Humans have only five senses for receiving information. The distance from which each sense
can receive information is limited, In increasing order of their opcmting range, the live
senses arc taste, touch
1
smell, hearing and sight. In the language of information engineers,
each sense would be to as an information "cbannel".
While humans have tive channels for receiving information, their ability to broadcast
information is limited in practice to only two methods. This is becaust! humans have little
control of !heir flavour and odour. For practical purposes, humans intentionally broadcast
information through only sound and movement All human coordination, including the
governance of organisations is dependent upon the data transac!cd by these t\'m methods.
Body movements can signal infonnatton through touch or by making visible signs. Alchian
& Dcmsctz ( 1972) provide an example of human pmductive effOrt bt.!ing coordinated through
touch. They defined '"team production" as occurring when the output of euch participant in
team cannot be dctem1incd such as when "two men jointly lift a heavy curgo into trucks".
HDwcvcr, this definition is too restrictive for the analysis of human cooperation. So to avoid
this limitationj the tenn "'group" will be used to describe collective productive acti\'ities
vdtethcr or not the "team production" as defined above is involved.
Information that is transmitted in the tOnn of signs may be presented directly as "body
language'' or indirectly, through body painting, dress or moving objects. The movcm.ent of
objects includes those used in writing. The study of communications through signs and
which docs not involve words, is described as "semiotics
1
' (Lohrey 1986: 368).
89
CHAPTER3
Australian Aboriginals relied on semiotics to orgamse complex ceremonies involving
hundreds of individuals speaking mutually unintelligible languages (Turnbull 1978b: 8-11).
Without literacy, numcracy or a common language, it was not possible to usc either
hierarchies or markets to govern their activities. Complex cooperative activities between
strangers was coordinated by signs and symbols related to a shared understanding of the
kinship relationships of totemic fauna and their natural environment.
North (1985: 558) explained how, "Trade evolved in the context of developing tOnns of
communication that were embedded in religions, myths, taboos, kinship tics etc." Ben-Porath
( 1978) discusses the importance of kinship relationships. He described how clan
relationships govern transactions independently of markets or hierarchies. This point was
noted by Williamson (1979; 1985: 394; 1988: 71); Ouchi (1980: 134, 1984); Hollingsworth&
Lindberg, (1985: 249) and Barney & Ouchi (1986: 213, 441). However, while the role of
clans is recognised by some organisational theorists, tOr example, Barney & Ouchi ( 1986), it
has been ignored by most economists, except those like Hirsch lei fer as shown in Table 2.6.
The usc of semiotics in modem organisations 1s subtk, all pervading and influential as
described by Hall (1959, 1963). It can be subtle, because semiotic communications can be
subconscious (Packard 1957). Semiotics can be all pervading and intlu!.!ntial as it is culturally
embedded and it can define the context of other modes of communication as observed by
Ouchi (1980: 139) who wrote: "Exchange relationships arc generally subject to so much
infOrmational ambiguity that they can never be governed completely by markets.
Consequently they have been supplemented through cultural, clan mechanisms". Ben- Porath
( 1978: 7) describes the usc of various culturally specific or identity specific "signals" which
can govern either social or economic transactions whether or not markets or hierarchies arc
involved.
It is useful to identifY five methods by which humans can signal infOnnation to coordinate
collective activities. The most basic method is directly through the five senses. Many
animals share this direct "sensory" method. The semiotic method of communication is .also
90
THEORY DEVELOP:'\IENT BASED ON BYTES AND CYBERNETICS
shared with social animals. Humans and some animals communicate by "voice". Unique to
humans is the ability to transmit information by "word" and by "price/cost".
Table 3.1, 'Methods of communication and their attributes', presents five methods of
communication in order of their evolutionary dcvdopment in nature and humans. Each
method is dependent, to a larger or smaller degree, on different human attributes. These arc
in order of evolutionary development: instincts, culture, language, literacy and numeracy as
listed in column 2 of Table 3.1.
Table 3.1, !\'lethods of communication and their attributes

uommant usage m:
(CoL I) (CoL 2) (CoL 3) (CoL 4)' (CoL 5)' (CoL 6)
mstmcts tJve senses I,UUUM very tamuy, clans, teams,
high groups
. LUitUrC 1 oucn, I,UUUM 111gn AS plUS
Signs/symbols sound, sight assocmttons &
hierarchies
\' OICe Language ouna uu NlCOtUm As aoove
Word Literacy Sight IOU Low As above
Numeracy IU very low ana
hierarchies
Sources: "Bytes/sec, (Cochrane 1997); vRichncss (Daft & Lengel 1984: 194-5)
Each method uses different information channels and the distance each channel can transmit
infonnation, without the assistance of technology, is limited by the senses utilised. Whili.!
humans can usc all five senses/channels to receive information, they can in practice only
transmit infOrmation by sound and movement. Without the aid of technology, such as video
screens and associated image storage devices, the speed of constructing sound and visual
signals is limited by the speed of body movements and speech. As noted in Column 4 this
places physical limits on the rate at which infomwtion can be transmitted to around I 00 bytes
per second for the methods which usc the voice and word However, with
--------------
Cochrane (2000) i!lustrmes his estimates with tht::: following exampk: ""A moving colour TV image requires
about 34 million bit/s, about 500 times that fOr a fixed line telephone call at 64,000 bit/s, and 2,000 times that
for somt= mobile phones. The data !Tom some panorama of IOrt=sts, mountains, rivers and fields can be around
70 billion bit/s, which afwr pre-processing by our sensory systems t=nters our brains at around I billion bitJs.
Hence, we have \o stand and take it all in. The lex\ you arc now reading contains a nominal 600 words, t=ach an
avcmgc of five characters, all defined by eight biK So the total number of bits in the column (and I am taking
somt= libt=rtit=s ht=re so please don't complain)= 600x5x8 = 24.000 bits. If you read the whole text in a lcisurdy
four minutes, the number of bits per second""' 24.000/(4x60)"" 100 hit/s. Typing at 100 words a minute equates
to l00x5x8/60"" 67 bit/s."
91
CHAPTER 3
sufficient time, th!.! sensory and semiotic methods can construct visual images to provide a
very rich transmission of information tOr reception. The limit of transmitting infOrmation by
these methods is limited by the data carrying capacity of sight, which according to Cochrane
( 1997), is around I 000 megabytes per second compared with less than 15 bytes per second for
taste and smell.
Information scientists use the word "band-width" (Cochrane 2000) to indicate the capacity of
a channel to cany data. Organisational scientists, Daft & Lengel (1984: 196), usc a related
concept of "information richness". "Richness is defined as the potential intOnnation-canying
capacity of data" (Daft & Lengel 1984: 196). They presented a hypothesis that,
"Organizational success is based on the organization's ability to process intOnnation of
appropriate richness to reduce uncertainty and clarify ambiguity" (194-5). Egelhoff (1982),
who is discussed later, provided support for this hypothesis.
The most basic sensory method has th!.! broadest bandwidth providing very high richness in
infOrmation with the usc all five senses as noted in column 3 of Table 3.1. The semiotic
method provides a high level of richness through a sma!ler bandwidth using the three senses
of touch, sound and sight. A medium richness is provided by the voice method of
communications.
The level of infomwtion richness (column 5) is not just dependent upon the rate at which
bytes can be transmitted (indicated in column 4) by a channel but also by the rate at which the
information can be interpreted by the human body and mind. Touch has a very low rate of
transmitting infOrmation of around 5 bytes per second (Cochrane 1997) but contact with
boiling water can product.! a quicker tactical bodily response than that provided by sight which
transmit bytes at l 000 million per second. The rate at which humans can interpret language,
writing and numbers reduces the richness of the voice, words, and price/cost methods to
respectively 'medium", "low" and "very low" as set out in column 5 of Table 3.1.
92
THEORY DEVELOPMENT BASEl) ON BYTES AND CYBf.Rl'\ETJCS
As each method of communkntion becomes more specialised, requmng more advanced
human attributes, the natuml operating range of the relevant senses increases. However, the
"richness" of information decn:ascs from being very high for the most basic sensory method,
to becoming very low forthc most specialised method of price/cost channeL
Speech and writing can signal much more informarion than taste
1
smell and touch. Sight can
in turn transmit so much more information than voiccJwords that it can cx.cl!cd the ability of
the human brain to process it. As noted by Williamson ( 1975: 21 ), social institutions need to
be designed to recogn.ise such ''neurophysiological limits". TBA provides a vvay to recognise
not just the neurophysiological limits of processing infonnation but also the limits introduced
by bodily movements and speech, which provide the only practical ways for humans to signal
infonnntion,
This is a contribution ofTBA to theories of thi..! firm and aliows the analysis of firms
to become grounded in physiology and cybernetics. ln this way, TBA grounds theories of the
fim1 in applied and pure science to provide a basis fOr devdoping what Williamson (l99l:
12) describes as "tht: elusive science of organizution".
Difi{;;rcnt types of organisations and institutional tOm1s favour the use of some methods of
communication mor..-:- than other methods. Traditional Australiun Aboriginals used neither
markets nor hierarchies to organise their collective activities. Without literacy or numeracy
they relied only on sensory and semiotics methods. They used these methods to organise the
activities involving their families, clans and tribes which represent the ''community" method
of governance described by Strccck & Schmincr{ 1985} as was shown in Table 2.3.
If the voice and word methods of communication arc merged together to crente only four
methods of communication used by CJch the tOur governing mechanisms described by
Stret..-ck & Schmltter become somewhat aligned as indicated jn column 6 of Table 3.1.
93
CIIAPTER3
The efficient operation of both markets and hierarchies can be dependent upon semiotics as
noted above by Ouchi ( 1980: 139). Prices used in markets, and costs, used in hierarchies, are
just numbers. Because numbers have very low infom1ation richness shown in Table 3.1, they
can be transmitted with little etlOrt to many people over large distances (noted in Table 3.2 in
the next Section). However, the effectiveness of price/cost in communication is dependent
upon much more infOrmation being available to those who usc the infOrmation. Price/costs
represent "second order" infom1ation (Ashby 1968) which has no meaning without "first
order" qualitative infOrmation to define the nature and quality of the items being priced or
casted. Also required is information about the integrity of the exchange mechanisms,
including the trustworthiness of the parties involved in any potential exchange as analysed by
Akcrlof (1970).
To quote Ben-Porath (1978: 2): "Market transactions arc a subset of all transactions no
matter how one defines the whole set or what language is used to describe non-market
transactions". The numbers used to signal prices require numeracy and so represent a sub-set
of language. Words arc in turn a subset of infonnation transmitted by voice. Words and
numbers arc subsets of signs and symbols, (i.e. semiotics).
The complex cooperative activities of ants, bees and other social animals arc governed by
semiotics. Even lower life fonns such as slime moulds demonstrate "impressive capabilities
of organisation" according to Zeleny (199la: 80). The usc of voice has been detected as a
means tOr whales and primates to coordinate their activities.
An infOrmational perspective provides a way to relate communications methods used by
animals to govern their activities to those found in society. It also provides a way to compare
the organisational arrangements of primitive societies with modern societies (as is set in
Table 7.4 and illustrated in Figure 7.4), as well as communication and control systems within
and between finns as considered in the next Section.
94
THEORY DEVELOPMENT BASED ON BYTES Al\'D CYBERNETICS
3.4 Methods of human communication and control
Scholars such as Galbraith (1973), Williamson (1975), Bernstein (1980), Egelhoff(1982) and
Daft & Lengel (1984) have identified evidence of organisational adaptation based on
infonnational needs. Galbraith showed that the amount of infom1ation proct.:ssed within an
organisation explains why certain organisational fom1s arc effective. Williamson used an
infonnational perspective to explain the advantages of M-fonn firms over U-fom1 fim1s.
Bernstein (1980: 116) showed how "sharing management-level infom1ation with employees"
with an "independent appeals system" is required to sustain the operations of employee
owned finns.
Egelhoff showed how information-processing requirements detennined the strategy and
structure of multinational corporations. His study found that diversity in structure matched
the diversity in products and markets. The cybernetic "law of requisite variety" (Ashby 1968:
206) predicts this observation as discussed in Section 3.8.
Daft & Lengel (1984) analysed how managers select a medium of communication so that it
can carry the richness of infonnation net.:ded to understand the complexity of the problems
being confronted. They point out that Hlct.:-to-fact.: communications provide the richest
medium with audio-visual cues and body language to provide immediate feedback. The usc
of the telephone, written personal notes, written public notices and numeric infom1ation
representing a declining order of richness and speed of feedback within the management
context discussed by Daft & Lengel.
Table 3.2, 'Characteristics of communication and control methods', outlines the benefits and
limits of using each method of communication described in Table 3.1 on the basis that
the" voice" and "word" methods arc merged together. The result is an analysis of four
methods: (i) sensory; (ii) semiotic; (iii) voice/word; and (iv) price/cost. In modem societies,
most people who arc literate are also numerate to allow these two methods to merged. In
practice, the two channels have become closely interchangeable. To reduce the various
features for consideration in the voice/word method, only those that apply to hierarchies are
95
CIIAPTER3
considered as these currently represent the dominant fonn of organisation found in either the
public or private sector of modem societies.
Table 3.2, Characteristics of communication and control methods
(\Vith limits and benefits in shaded portion)
Attntmtes i\Iethods ot commumcatwn and control
VOICC/\''t'Ord
l Ucpcndcnt lnstmcts Logmtive processmg Language &
upon: of signs & symbols lltt!racy
l IndiVIdual Culturally ror ot
perception determined rules of hierarchy*: needs and
Basis of of people's behaviour of people requests & responses m
operation needs and and social institutions orders monetary values
responses through a
chain of
command
3
usc, r:.xcnanges
child, kin, design of property & bureaucracies between
Examples tribes, artefacts. Dress, and military individuals,
of method partner- behaviour, tenure groups and other
ships, work attributes in social organisations in a
groups, institutions - church, market economy
cabals, etc. government, firms.
4
Type of
mtUJtive ana 1 ana mana noaucuon ana.
spontaneous change m tenure and obedience exchange of goods
operations relationships of and services and
people to property or negotiable assets
social institutions.
,
;HotJ\'atmg Jnstmcts :::iOCJa! COJldltlOilll1g J<cspccUusc Matena!Jsm
forces ofpowcr
0 iYieans ot ::;ensory ::;1gns, I<equests ana valUatiOns, oners
commun- aggregate behaviour, orders and bids
icating eg. usage, migration,
needs votes, etc.
7 Limlls 01 rcw people 1 lV1ay mcK opcrationm Amount"', l':on-monctary
commun- and short response or be non- accuracy of characteristics
ication distances directive inforn1ation
0 LimitS ?J KCSOUrces or lime or 1 rust m peop1e;
cooperatiOn available mmonty response quality of goods

1 vtncr umJts :crsona! Ill LUCK or 1 msensltivc to non-
relationships servtcmg needs chmce, economic values
flexibility & and needs
sensitivity
I !U
l>cncuts ot 'peed ot Managmg tile quality PrCCISIOll Ot 'peed, large
method reaction of social and physical execution on a numbers,
environments large scale precision, &
sensitivity to
preferences
*For expositional convenience othcr fom1s of organisations have been omitted.
96
THEORY DEVELOP:\1ENT BASED ON BYTES AND CYBERNETICS
The sensory, semiotic, and price/cost methods of communication and control arc
dependent upon human attributes. These arc listed in the first row of Table 3.2 and arc
respectively: Instincts: Cognitive processing of signs & symbols; Language & literacy; and
Numeracy. Characteristics of each of the four methods of communication and control
considered in the follmving paragraphs 3.4. I 3.4.4. These arc considered in order of their
development.
3.4.1 Scnso[)'
The operation of the sensory method depends upDn the perception of other people's needs and
responses such as found with mother and child or in clans, tribes, partnerships, teams and
work groups, The communication and reactions arc spontaneous and intuitive, motived by
instincts and so limited to close physical proximity, The need tOr bodily responses limits the
range of operations and so the number of people and resources that can be mobilised quickly
for achieving collective action, The effectiveness of integrating collective action by this
means is dependent upon the social retationship of the people involved, Hov.:cver, the
advantage of this method is speed of reaction.
Semiotic
Semi-otic coordination is depended upon individuals being progrmnmcd with shared cultural
knmvlcdgc, This requires an investment in human C(mditioning (}r "pmgrarmning
11
{()
interpret the information carried by re:lativdy simple signs and symbols, which De Yancy
(1998: 16) describes as a '"'set up" cost, Semiotic communication can operate over longer
distances than by tbc senses, and given timt:, !hey -can be used to coordinate large numbers of
people. Body painting, style of decoration and dress provide examples of the semiotic
method of communication. The usc oftimt: such as being late or early for a meeting and the
use and style of property provide other examples documented by Hull (1959, 1963). So
changes in the ownership, control and use of property and artefacts can represent components
of this method of communication and controL However, changes in rdalionsbips to property
and other artefacts may be slow nnd!or be non-directive in servicing people's needs. On tbe
97
CHAPTERJ
other hand, such changes can provide effective signals for managing the quality of the socioll
and physical environments as set out in row ten of Table 3.2.
The cullural knowledge on which semiotics is dependent would be described as "structural"
infommHon a distinct from "process intbnnation" used to carry out specific tasks. StnJctural
information determines what DeVany (1998: 9) describes as the set up cost of economic
ins!itutions, which can provide economics of scale. He Stutes that, "The size of the set up
cosis depends on the economic institutions; 1f the instilulions supply a template for
organizations, then the set up cost per organizntion is n.:duccd" (DeVany i993: 16). DNA is
an example of a "template" created by nature to efficiently distribute the knowledge of
f!.!productng the complexity of life. Shared cultural understandings of signs and symbols
provided an eilicicnt basis tl)r Australian Aboriginals without a common language to
communicate very etllcicntly. The contract of association between the MondragOn bank and
the new finns it creates provides an example of a "structural template" used to reproduce new
organisational components. The contract represents ''process information" discussed in
Section 3.2. H illustrates the institutional efficiency in r..::ducing set up costs described by De
Vany and the pwccss of self-renewal described as "autopoicsis" (iv1athcv>/s 1996a: 44).
3.43. Voice/word in hierarchies
Modem technology allov.'s communication through vmcc and words to be transmitted
instantly to om unlimited number of people. However, in a chain of command, the rate at
\\hich requests can be passed up through each level of the hierarchy and orders sent down
through each l,;vd can be subject to delays. Another inherent problem is that infonnation
sent up the chain must be simplified to avoid information overload at higher levels. Likewise,
orders sent down the line must be interpreted, as it is not practical for those in authority to
provide operational details appropriate for each situation.
Any communications passing up and down any organisational hierarchy can suffer quite
serious misunderstandings, mistakes and omissions when relayed through just three or four
people, even when all individuals possess the VCI)' best of intentions. When these peopJe are
98
THEORY BASED 01" BYTES At'\0 CYBERNETICS
ln a management hierarchy, it is rarely in their self-interest to report to a superior, infonnation
that may rctlect adversely on th,.;:ir own pcrfonmmcc. This provides ,an incentive fbr biases,
distortions and omissions in communications, The need to interpret infonnation sent down a
chain of command and condense information reported back up increases the problems of
control and monitoring. These problems arc common to organisations in either the private
and public sectors. They have been analysed by Downs: (1967: ll6-ll8} nnd illustrated
along the lines shown bclovv in Table 3.3, 'Loss and distortion of intOmHltion in a hicrarchv'.
Down:<. assumed that the biases of officials resulted in I 0% of the true meaning of the
information being lost each time it was relayed through each leveL He also assumed that 5%
of the true meaning is los! tfom errorS in transmission. The loss of meaning and errors
reduced the correct information by per level. Correct infonnation would only represent
85% of that \Vhich was condensed by 50% at each level. The cumulative compounding result
in a hierarchy of five levels each \vith a five p0rson span of control is shown in the "correct"
and "missing" columns of Table 3.3. The table highlights the possibility that even the Chief
Executive Officer (CEO) may not have the tnfomtation rcquired to regulate tht:: organisation
and illustrates the point rnude by Jensen (1993: 864} that. "Scrious infOnna!ion probkms limit
the effectiveness of board members in the typical large corporation.
Table 3.3, Loss and distortion of informatio-n in a hierarchy
' lY
IN I

AI lVI'
,;;
r ICr.o:>
(public or private sector) Volume correct M1ssmg (say a span 01 J J
Legislature (50/o losV (85'% ot or wrong per ccummulatc
d
i\'limster/sharcnomcr(s level) Iowa level) meantng level total
o! directors
1.4% Y:::.OYo
-cmcr Executive utticcr ()_..) ;{}
.>.J'lo
""''"
I I
:-,cnmr management _.:;, 0
'
Yo
"-'"''
,
;;
,vtlUUIC management _J.u% Oi.Y%
... :s- .. -
... ,
JO.l'Yo
J cant l<:a ers >U.U% 4.:...3 1o ) /.::do J.) l)b
worKers I UU.U'to ' IUU.UU'' ll.'!% ().)
"'
'
It was to avoid infomiation errors and overload that large US firms in the beginning of this
century changed tfom U-fonn to M-fOrm as discussed by \Vj]{iamson (1985: 279-283).
\Villiarnson ( i 985: 282) recognised the cybernetic signitkancc of technical and temporal
99
CHAFTEn3
spccinlisution or organisational infonnation by quoting the work of Ashby ( 1960) and Simon
(1962). The line of argument is used in Chapter 7 to compare unitary boards with
compound boards.
The ability of a hierarchy to operate depends not just on its members sharing a common
hmguagc and literacy but also on respect of authority and \villingncss to accept orders. The
great advantage of org.:mi.sing collective action by voice/word is in the precision of execution
on large scale. However, this means that within a hierarchy there is lack of choice and
operating tlcxibiHty for the people involved as shov.:n in row nine of the voice/word column
in Table 3.2.
Another serious problem is thm each time a request or order is passed through a level in the
chain of command of an organisational hierarchy, the infOrmation can be subject to biases.
errors and omissions as dc.scribed by Downs (1967: 116-118). Jnherent ln organisational
hierarchies is the problem of condensing infonnation sent up the hierarchy. Collective ac!1on
organised through a hierarchy is dependent upon people accepting orders and so requires both
tht: respect of power and the usc of power hy those in authMity, Notwithstanding these
limitations, word!voict.:: communication can provide precision in the coordination of a farge
number of people. However. the in obtaining precision is a lack of quick accurate
information, lack of flexibility in responses and luck of choice in collective
activities. These drawbacks become less critkal in armies and govenunent departments than
in fim1s operating in a dynamic complex market place.
3.4.4
Coordinating activities through price/cost signals is dependent upon those opcrming in the
market having access to qualitative infom1ation as to the nature and specifications of the ircm
subject to exchange and the trustworthiness of those lnvolvl!d in any prospective trnnsaction.
The price/cost method of organising collective action can be used between individuals.
groups, corporations and most other types of organisations. It depends upon agents
establishing a value of an item or service and making offers or accepting bids. However, the
100
THEORY DEVELOPMENT BASED ON H\'Tt:S A:'iO
price/cost method is dependent upon a materialistic value system for allocating resources. It
cannot operate when agents ;m: not materialistic and/or when values and needs
arc involved, However, prices can provide great speed in dealing with unlimited number of
people at great distonces with the ability to identify their preferences.
From the nbove discussion it is evident that each of the four methods for governing collective
activities haw: diftbrcnt strengths and weaknesses as outlined in rows 7. 8. 9, and lO of Table
3.:2. Traditional societies like the Australian Aboriginals utilised mainly the sensory and
semiotic methods. As humans developed literacy. thennumcracy, additional choices emerged
in the way societies could be governed. In particular modem societies some methods arc
mnrc suitable than others are. The result is that modem societies utilise all four methods in
varying degrees. Howevcr
1
their mix may change to specific requirement fOr governing
ditl'erent activities. As noted by Turnbull (l978b: 52. 1994d: 328) the mlx of methods used
in governing society can vary by culture and this is discusst.>d further in Chapter 7.
TBA also provides an additional dimension for analysing evolutionary and biologicalthcori:.:s
of the tirn1 dcvdopi.!d by Alchian ( 1950) & H irshlcill!r ( 1977) and soclal stn:ciures in general
(Zeleny 199ib). Hirschlcifcr, (as discussed in Section 2.6.7}, idcmlfied smne similarities
bt.:tween economic structuri!s and biological struciures. l-lowev<::r. he did not the
concl!pt of either holons or tensegrity in nature or in firms. Whi!e the au!hor extended the
comparison made by HirschlcifCr in Tnhle 2.3, TBA reveals hov. the comparison can be
further extended by considering the cybt.:metic characteristics of social organisations.
However, to allow TBA to be grounded in the behavioural and inf(>nmltion processing
characteristics of people, thcst.: need to also be considered as undertaken in the next Section.
3.5 Human behaviour and the transaction of bytes
There are psychological, as wei! as physiological and neurological limitations on the ability of
humans to reliably transact bytes, which need to be considered in analysing the operations of
organisations and their boards or control centres. Wearing {1973} pointed out tlwt the
pcriOnnance of humans in processing infommtion could be dependent upon the infonnation
!01
CUAPTER3
being processed as well as upon the psychological disposition of the individuaL An
understanding of the variations in the ways people transact byt-.::s is a fundumcntul
requirement fOr the nna!ysis of finns.
Another lUndamental requirement is the need to understand how humans behave, make
decisions and initiate <1Ction. The assumptions used by many economists muy not be
consistent with the understanding of psychologists. The differences were tabulated by
\Vcaring ( 1973); a Professor of Psychology as reproduced as Table 3.4, '.QjfTerenccs between
Economic" and ''Real'' pooplc'. Ten assumptions commonly utilised by economists are
listed under the column headed "Economic people''. The understanding of psychologists on
how people behave nrc listed in rhc column heade-d "Rcnl people". The processing of
infomHltion is explicitly involved in rO\vs 2, 6, 7 and S and implicitly involved in rows, I, 3
and 4 as discussed below.
Human physiology
1
as wdl as psychological nc..::ds arc "dctcnnincd and limited by the
necessity of maintaining the organism in a state of dynamic ..:quilibrium" as nokd by Wearing
in row l ofTabic 3A. Any fOrm of animal or plant lite C<1nnot exist unh.:ss n has
to make autornatic adjustments to match changes in its cnvironmt::nt The tem1 "cybt::mctics''
includes the scientific study of such feedback and comrol infonnation so this charactt::ristic of
real people is dt!pendcnt upon the transaction of bytes. Feedback is also a feature of
organisations as observed by Williamson (1985: 282) who noted that tinns created
bimodal fi:::cdback in a similar way to "evolutionary systems that arc subject to bimodal
disturbances". Wearing points out in row 2 of Table 3.4 that 'Real peopl' arc n<Jt completely
infOrmed but they reduce, condense, summarise and thus necessarily lose information. In
addition, "an irnpcrfcct communicmions network in their environment also restricts and
attenuates the How of ln the micro-economic literature, tht:se probJems .are
associat<."d with "bounded rationality" (Williamson 1975: 4--7).
102
THEORY DEVELOPME"'T BASED ON BYTES AND CYBERNETICS
Table 3.4, Differences between economic" and "real" people
ECONOMIC PEOPLE REAL PEOPLE
I'
untm11tect appetite 1 Appetite ctetermmect anct limJtect by the necessity
of maintaining the organism in a state of dynamic
equilibrium.
2 '-'ompletely mtom1cd 1 Keduccs, condenses, summanses
thus
necessarily loses) information. In addition, an
'imperfect' communications network in the
environment also restricts and attenuates the tlow
of infonnation.
j consistently orcters hiS/her 1 not consJstcntly orctcr llJS!Jlcr preterenccs (1e,
preferences between outcomes over changes his/her mind over time, may prefer A to B,
time. B to C but C to A).
4 MaxJmJses somethmg (usually one 1 Attempts to opt1m1se with respect to a large
thing). number of criteria (needs).
)
1 competltJvc 1 :sometimes competitive, sometimes cottaboratJve,
usually both.
D 1 Kequ1res a va.tuc system onty m a system m orctcr to provwe a
order to provide a criterion against framework fOr the ordering of needs, the selection
which to maxnmsc (e.g. profit, of intOnnation and the weighing of multiple
utility, prestige and power). decision criteria.
I 1 Not cxplrcrtly related to the world 1 m an cybern:uc relatlonsmp t.o
as an clement m mteract1vc system Jus/her commumty and environment and 1s
and remains unchanged as a result changed as a result of any interaction.
of any interaction.
0 sJ.gnn.Jcant amercnces oetween 1 oetwecn maJVJaums arc s1gnmcant ana
mdJvJduals. Important.
,
i'liO on . mronnatJO.n L:umtca mrormatJOn processmg capacny so
processmg capac1ty, so 1s slow rates of change, (ic. nearly stable systems).
unaffected by differences in rates of
change.
IU Nee s arc s1mp c ana cw. Nceas arc s1mp e ana many.
Source: Wearing (1973)
Bounded rationality refers to human behaviour that is "i11tendedly rational but only limited(\'
so"- emphasis in the original- (Simon, 1961: xxiv). The tem1 arises from Hayek (1945:
527) who noted that "the problem of a rational economic order is trivial in the absence of
bounded rationality limits on human decision makers". Williamson (1975: 21) explains that:
The physical limits take the form of rate and storage limits on the powers of
individuals to receive, store, retrieve and process information without error.
Simon observes in this connection that "it is only because individual human
beings arc limited in knowledge, foresight, skill and time that organizations
are useful instruments for the achievement of human purpose", quoting
Simon ( 1957: 199).
103
CIIAPTER3
According to Williamson ( 1975: 21 }: "Bounded rationality involves neurophysiologicallimii.s
on the one hand and language limits on the other"11. \\'eating also recognised the limitation
introduced by imperk>ct communication in the cnviror1ment as considered by Downs ( 196 7}
and Hlustratcd by Table 3.4.
In explaining language limits, \Vi!liamson (!975: 22) says that it:
refers to the inability of individuals to articulate their knowledge or feelings
by the usc of words. numbers and graphics in ways, which permit them Hl be
understood by others, Despite their best efforts, parties may find that
language f,;1ils them (possibly because they do not possess the requisite
vocabulary or lhc necessary vocabulary has not been devised) and they
resort to other means of communication instead. Demonstration,
and the like may be the only means of achieving understanding
when such language difticultics develop.
Leuming by doing involves sensory communication methods, which can transmit bytes ten
millions times faster than voicc/\vord methods .as in Table 3.! _ Without !he to.!chnology
of electronic audio/video communication channeis, the need to communicaw 1hro\1gh
demonstration rather than instruction through voicc!\vord introduces spatial limits on
organisations, Williamson (1975: notes that ''a change in organizational structure may
be indicated" when individuals arc exposed to ''infomuHion-processing limits". By lhcse
words. Williamson is explicitly acknmvlcdging that organisations need to be designed
according to the ability of people to transact bytes. He is also providing an example of using
an informational pcrspectiv..: to analyse organisations.
The variability of people, noted in rows 3 and 5 of Table 3.4. increases the contradictory
nature of human behaviour. People can change their minds, as noted in row 3, and/or change
their nature, from ctnn!iCtitivc to collaborative, as noted in row 5. This variability helps
explain the conflicting research findings concerning agency theory and stewardship theory
reported by Donaldson & Davis (1994), Agency theory assumes that managers will
l! The cybernetic in;,igi!ls to be di:wu:-;scrl in Scctio:n 3,8 ideniify how bounded rationality can b.:- mitigated
104
THEORY OEVELOPMEl\'T BASED 13YTES ,\.,-..;D CVBER!'IETICS
appropriate shareholder value to further their own pecuniary and non-pecuniary self-interests
(Jensen & Meckling 1976), Stewardship theory assumes that managers act selflessly in the
best interest of investors. Rows l, 3, 4, and 5 of Table 3.4 shows that n::al people' could net
either as a self-interested agents or self-less stewards.
A basic assumption of economists is that people seck to maximise some particular
However, a.'i noted in row 4 of Table 3.4 people attempt "to optimise with respect to a larg<:
number of criteria" consistent with "maintaining the organism in a state of dynamic
equilibrium" of row l. Like the characteristic of people in row I, row 4 is ul.so implicitly
dependent upon the transaction of bytes. The attempts of people to optimise and the
changeability that this introduces. reinforces the ncl!d to treat the operating characteristics of
people as a variable as explicitly noted in rows 7 and 8. This is a distinctive tt::ature ofTBA.
Wearing 0973) poims out in row 6 of Tab]\! 3.4 that people need to select infonnmion to
dcdsions. Economists ignore this because they assume that individuals arc "completely
infom1cd'' as stated in row 2 and that ;h.:rt: is no lintit on their "information processing
capacity'' (rder to row 9).
The generally w;ccpted economic modd for people is that the behaviour of pcoplc is not
related to their etwironmcnt or their intentc(ions with it as noted in row 7. However, Wearing
states that individuals
1
'stand in an interactive cybernetic relationship to his/her community
and environment and is changed a.'> a result of any interaction". In other words, besides being
an independent variable, people can also be a dependent variable, according to the
infonnation that they receive, In this way, the transaction of byres can become a key
determinant of how people and so organisations behave,
\Vhilc row 7 of Table 3.4 indicates that human behaviour is contingent upon their social
environment, row 8 indicates that with the same environment, different people could act in
different ways. The power ofTBA is in its ability to recognise this variability in people and
through an information architecture, which provide:; varicly in compuwtion, communicalion ami control,
10<
CHAPTERJ
identify how organisntions can achieve re:liable outcomes from variable components by
utilising cybernetic principles discussed in later ~ t i o n s of this chapter.
An import;mt simplification made by economists noted in row 9 ofTnh!c 3.4 is that there arc
1
'no limits on infbmwtkm processing cnpadty" so people arc "unaffected by diil'crenccs in
rates of change". W!.!aring states that people have ''limited information processing capacity"
so they prefer slow mtcs of chnngc. Williamson { 1975: 45) uses this point ro demonstrate that
consensus "All-channel network" decision making fuvourcd by rhc "New Left" literature is
not tCasibie. His arguments arc also based on the need to limit the number of communication
channcis to any one indivtdual, as the quantity of infOnnation increases to the power of the
number of channels. The need [0 limit the number of intOm1ation channels to any one
individual explains the need limit the number of subordinates \Vho report to each supervisor.
This is referred to in the management literature as the need to limit the- span of controL
The information processing and communication limitation of humans is similar to those of
computers. The similarity is not ju:;t a metaphor becaw:;c infi)mmtion is embedded in data and
.all data must have some physical tbm1. This mc;ms :hat all informmion, wbkh is by
definition is meaningfUl data, must also have a physical form" Likewise, knowledge is useful
inf(Jml<l.tion. The processes lOr communicating infomi<Uion in biological material are now
being revealed by natura! scientists such as Scott & Pawson (2000),
The ability of humans to obtain infonnation from data is dept.:ndent not just on their
neurological capabilities but many other factors such as their embedded knmvlcdgc, ski\I,
training and motivations, The human body obtains and reacts to much information
unconsciously such as changes in temperature, prcssun:, smell, taste, touch and internal
feedback from its own physical activities, Not all these unconscious ti.:cdback signals need go
through the brain. Bytes that arc transacted by the- brain can be processed in two different
ways. These ways and how people act in a social context arc next considered.
106
THEORY DEVELOP'\lENT BASED ON JJYTES CYBER:'\ETlCS
3.6 The processes of human thinking and action
There are two ways in which bytes: of data received by the brain are processed to provide
intOnnation. One is through the recognition of patterns, which requires massively para lid
computations and the other is through sequential analysis. It i-s pattern recognition which is
most prevalent in all living things. The ability to undertake sequential analysis is. most highly
developed in humans and this only occurred n::cently in our cvolutionary dLWCfOt)ment.
Kur;.:wcil (1999: I 03) notes:
The human brain has about 100 billion neurons. \Vith an estimated average
of one thousand connections between each neuron and it neighbours, we
have about 100 trillion connections, each capable of a simultaneous
calculation. That's rather massive parallel processing, and one key to the
strength of human thinking. A profound weakness, is the ex-cruciatingly
slow of neural circuitry, only 200 calculations pt::r second. For
problems that benefit from massiv.: paralk:tism, such as neural-net-based
pattern recognition, the human brain do!.!s a great job. For problems that
require extensive sequential thinking, the human brain is only mediocre.
This compares with the hundreds of millions of sequl.!ntial cnlculations per sccotid
(1Vlegahcrt:z) of desktop computers in the year 2000. In ;tnothcr couple of decades, according
to Kurtz,veil, computers will catch up with humans in being abh:: to carry out massively
parallel calculations required for complex pattern recognition. It is through recognising
patterns rather than making calculations that humans succeed in undcrtnking complex tasks.
Kut'.twcll ( 1999: 79) also points out that, "One key to intelligence is knowing what not to
compute. A successful person isn't necessarily bcltcr than her less successi\Jl peers at solving
problems; her pattcmMrccognition facilities have just learned what problems are worth
solving," lt is by pattem recognition tbat humans solve most problems.
Kut'Lweil gives the example of a ten-year-old child who catches a ball. Knowing the speed
and direction the bail is thrown, and many other i3ctors, it Js possible lo calculate where the
!07
CHAPTER 3
ball will nt any cimc in much the same way an anti-missile rocket calculates where its
target will be when they meet the child has no computer, pen, paper and
knowledge of calculus '-lr simultaneous equations to make lhc calculations within a .second or
two to catch the bait Success depends upon training ''her neural pattern-recognition
ability" (Kumvcil 1999: 79).
The connections between neurons are called synapses and these develop in
strength according to their use. lnfonnation is stored through the pattern of both their
strength and connections, To solve problems efficiently without the need for calculations.
humans have to train their synapses to 11rc and so develop appropriate patterns, This creates a
pattern of response for iUturc usc. The build up and reinforcement of the ability of synapse to
fire allow a person to make physical responses based on pattern n.:;;;ognition rnthcr than by
logical reasoning. Tbc process of conditioned reflex action is applicable to executives as well
as childnm.
The neurological processes can be considered the "set up cost" of achieving
proficient responses to ..:nvironmcnlal siwa!ions. This is h(l\V people lcam to drive cars and
why an investrnem of time in sa thy drills arc required to alknv people to react automatically
or "instincrivcly without thinking" as may be required. It also provides a rationale fur
teaching business by the case method to lay down panems of situations and r<!sponscs in the
neural nets of students. Chi.;f executives and company directors arc no exception,
One way of reducing "bounded rationality'
1
is by incurring the "set up cost" of neurological
conditioning so responses can become aulomatic, like driving a car; rather thnn needing to
work out every response to changing situations. However, limits of information processing
may occur in the organs, which detect inforrnation signals or in the nervous: system nnd th!!
brain that respond to the data. The cybernetic principles used by the brain to minimise these
problems can also be used by organisations and wi!J be discussed later in this Chapter and
illustrated by the case studies in Chapters 5 and 6,
lOS
THEORY HEVELOPMEi'T BASEl) OK BYTES A!'\D CYBR1'\ETICS
Information and so knowledge: can be stored in mnny forms. In the brain it is the strength of
the connections between the synapses. The infom1alion required to create living things,
including humans and their brains is stored in the pattern of molecules found in DNA. This
type of infOrmation is described as "process infbm11.1tion" (refer to section 3.2). "Structural
infOrmation" explains how a structun: operates (refer to section 3.2) and is illustrated by the
Figures showing the infonnation and control channels of the case studies in Chapters 5 and 6.
But what ever its fom1, information can be decomposed into bits and bytes to provide a
universal numeric for measuring the quanta of intl>m1ation. The use of bits and provide
a way to indicate "infomuHion richness as shown in Table 3.2,
Knowledge is retained in the brain by the state of synapses connecting the neurons. Kurtwei!
( 1999: 119} estimated that ''tibout a million connections per chunk'' of knowledge is required.
\Vith 100 trillion in the brain, it has the capacity for 100 million chunks of
knowledge. Each chunk may be recognition of objects, a fhce, smell, meme, word, phrases
and so on. Kurzwcil (1999: 119) rcpons that "the number of conce1Hs- 'chunks' of
knowledge- that a human expert in a particular fidd has mastered is remarkably consistent:
about 50,000 to 100,000". This is only a smal! frac:ion the gcn.,:ml knowledge of a typical
human. But it indtcatcs how and why the knowledge and reasoning of humans is subject to
iimits which need to be rccognisl!d in analysing the operations of firms.
Like humans, computer chips limited information processing capacity and memory. So
just as computers need to be designed within the operating capabilities of their components,
so do social organisations need to b..: designed to recognise the operating linoitations of
people. In section 3.3, it was noted the lnfomwtion processing needs of an organisation
determined its foml, In the next section, some basic principles an:: developed to relate human
behaviour to the control and n::guiation of organisations.
The efficiency and effcciivcncss of computers and their chips is dependent upon thi.!
architecture of their internal circuits as \veil as the architecture of how both the chips and their
computers arc connected. Their ability to pcrfonn different tasks can be improved by
IM
CHAPTR3
ad-opting a specialised architecture tOr pnrticular applications or situations. This also applies
to the information and control architecture of organisotions as investigated by Simon ( 196:2),
Galbraith (1973), Williamson (1975), Bcrstcin (!980), Egc!ho!T (1982), Daft & Lengel
{ 1984). An outstanding example of corporate architecture being designed to establish
strategic and operating advantages is provided by MondragOn tirms as described in Chapter 6
(Turnbull l995d).
A fundamental concern of TBA is to cons1der the limits of human information processing
abHity. TBA provides a way to identify how finns and compound hoards provide a way to
decompose decision making labour in organisations so individuals can operate within their
infonnatlon processing ability. This is illustrated by the case studies and analysed in detail
for a Mondragon cooperative in Chapter 7.
Evolutionary biologist, Robin Dunbar, has identified limitations of the human brain.
Dunbar ( 1993: 685} reports that the capacity of the human neocortex limits the ma.ximum
an individual establish social bonds and trust with to around !50. He
also reported \\-hich that 500 a "critical thr;:,;shold beyond
\vhich social cohesion can be maintained only if is an appropriate number of
authoritarian officials" (Dunbar, I993: 687). These findings provide another reason why
firms hav;; diminishing return to scale in addition to the three by Coase (1937)
discussed in Section 7.4.2.
The analysis of Couse was made in the context ofU-fonn fim1s, as M-fonn fim1s had not then
evolved. The evolution of M-form, H-form, net\'>'ork and holonic tOrm firms provide a basis
for reducing the number of people involved in the need to e:;tablish trust and social cohesion
in a fim1. The findings of Dunbar become more important in the architecture of a t1nn as the
need for trust and social cohesion increases in the \Vork place to provide sustainable ami/or
competitive advantages.
Ito
TIIEORY DEVELOP:\lENT BASED ON BYTES A!\D CYBERI'\ETICS
The need to recognise the limited infonnation processing abilities of individuals means that
part of TBA is based on economising of bytes whereas TCE is based on economising costs.
When costs arc a proxy for information, TBA becomes a microdcment of TCE. Bytes
provide a way for "observing the phenomena at a higher level of resolution" as sought by
\Vi!liamson (1990: xi) and the other eoncems by scholars on theoretical shortcomings noted
in Section 2.5.
A summary of human constraints in transacting bytes is set out in Table 3.5 'Human
constraints in transacting bvtes'. The middle section of the Table lists the various limits of
the human brain to transact bytes as discussed in this section and relates them to the
limitations of human input and output channels shown at the top and bottom of the table as
discussed in Section 3.2.
Table 3.5, Human constraints in transacting bytes
(K= Kilobytes, M=Megabytes)

1 aste 1 oucn >Ignl
IN
L!lanncJ
I
TRANSACT
capactty m <10 <15 <15 lOOK I,OOOM
BYTES CREATED
' bytes/sec"
!
BY:
I RECEPTION through organs Physiology
2 STORAGE through nervous system Physiology
I'ERCEI'TION/UNDERSTANDING Neuro10oy
3 through the activation and strengthening of
. ;:. .' .
expenence, tra1nmg,
neural networks which correlate current motivation and
NATURE
patterns with previous ones psychological status
OF
INSIGHTS/KNOWLEDGE through As above plus size
TRANS-
4 sequential processing in neo-cortex limited and architecture of
ACTING
to around 200 calculations per second nco-cortex and
BYTES
(Kumveil 1999: I 03) psychological status
IN
Proxtmtty/distance,
HUMANS
5 EXTERNAL RESPONSES transmitted by environmental
movement and vocal chords conditions, culture,
literacy & numeracy

IOUCil "gns 0011110 ::::.peecn lntom1at1on _?c
mg received 10,000
Channel
faster than the rate at
capacity in <15 <15 <15 <lOOK <lOOK
which it can be
bytes/sec transmitted
Source of channel capacity: Cochrane ( 1997; 2000)
t I t
CHAPTJm3
Infonnation is n::quircd to measure both changes within an organisation and in its
environment so <is to determine !he need for making corrective action. Organisations also
require infonnation channels to provide instructions on how to make any conx:ctlon that may
be required. In other words, intbrmation is required to provide both f!.!edback and control
defined as regulation in Section 2.2 (Turnbull 1997f).
All con!rol channels carry infonnation. In organisations. control is dependent upon humans
using intOm1ation to take action. Th!!rc arc thre..:: basic requirements: for one of more
individuals to exercise control or regulate a firm or any other type of social institution.
Firstly, they need sufficient infom1ation to obtain understanding to take action. Secondly,
they need the will to act. Thirdly, they need to have the opportunity or capability to
implement action.
H is no usc an individual having the infonnation to control or regulate if they are not
motivated to take action. Motivation requires that they haw the ne-cessary incentive and that
there arc no over-riding disincentives. A director may lose the motivation to .act if her or his
position on the board might be lost from proposing initiatives that arc against the interest -of
those who have the power to tcnninatc her or his tenure. The ahility or capability of a
director to act depends upon tbcir social context. A director wbo is a member of minority
group on a board can be inhibited in hcrjhis p-ower to act t-o control or regulate a firm.
However, even a minority of one may have the capability to act if there is some system to
promote and protect whistle-blowers. The case studies in Chapters 5 and 6 identify processes
for problems which can be triggered by an individuaL
The three basic requin::mcnts discussed abDvc become a fundamental part of TBA. When
analysing how any individual, board or control centre in an organisation may act, \VC need to
ask the qul.!stions if he, she or they have the: (i) infom1ation to act; (ii) will to act; and (iii)
power or capability to oct. These three conditions arc utilised in the next section, which
considers finns organised in the form of a centrally controlled hierarchy as considered in the
ll2
TliEORY DEVELOP:'\IE;.>T BASED ON BYTES C'lllERNETJCS
third column of Table 3.2. Comhlions necessary for achieving control, regulation and self-
governance arc then considered.
Hierarchies: their regulation and self-governance
Control in organisations depends upon power, as considered by Dallas (1988: 29), (as was
discussed in Section 2.6.6). In corpormions, the formal allocation of control powers between
shareholders and their directors is set out in the corporate constitution attd!or by"laws. The
allocation of corporate powers and the processes of information and comml become another
fUndamental concern of TBA. 1l1ls sub-section considers some of the ways power can be
exerted, used and abused in the dominant tixm of a flm1 controlled by a unitary board.
Shareholders posses the power 10 change corporate constitutions \Vithin the discretions of
corporate law which are quite extensive" Case studies of compound boards to be outlined in
Chapt<:r 4. confirm thar corporate law in Anglo nations docs not prohibit the establishment of
compound boards within a company. Shareholders in publicly tradlxi corporations in Anglo
cultures VL'St nearly all control powl.!rS in a sing h.: board of directors and maintain only Hmitcd
rights such as the appointment of din:ctOr:i, din!dors' n:muncration, the appointment of
auditors and approving any chungcs irl shi.ltC structur<:: or the constitution of the fim1. \Vhen
tbcr.;;: is no dominant shareholder and so no significant shar..:holdcr represented on the board.
the self-interest of directors can be at variance with the o\vners. This is referred to as the
'"agency'' problem m the literature as discussed in Chapter 2. When there is a dominant
shareholder, such a shnrcholdcr can cxcrt suil1cicnt control for the company to enter into
transactions with the shareholder, which arc not in the best interest of other shareholders.
This is referred to as the suppression of minority interests or fraud on the minority. Most
countries have laws against such action. But this does not stop such activities laking place as
they can be difticuh to detect, and if detected, diflicult to prove in many cases and so
expensive and problematic to rcc!ify.
113
CHAPTER 3
Then.! are a number of other ways in which the directors of a unitary board can usc their
power to control, regulate and govern a company to further their self-interest and to maintain
their position on the board. While in theory, it is the shareholders that approve the
remuneration and other benefits which directors may receive, it is the directors themselves
who dctem1ine this when there is not a dominant active shareholder.
\Vhile directors may be required by Jaw, stock-exchange rules or the constitution of the fim1
to disclose pecuniary and even non-pecuniary benefits, they have the power not to reveal this
information. Directors also have the power to disguise rc\ated party transactions through
complex chains of corporate, nominee and trust structures. Unitary boards have absolute
power in both theory and practice to decide how to manage any conflicts of interest of any or
all their members. Unitary boards can direct business to interest associated with their
members and may be required to do so by a dominant shareholder on favourable tem1s. They
can issue shares or options at discounted values to t!H.:msclvcs or associates or acquire assets
ffom associates at inflated value. Directors can trade on favoun::d tenns with parties who
providl! private benefits to directors, or use firm resources fOr their private benefits in other
ways as listed in Table 3.6, 'Corrupting powers of a unitarv board'. Table 3.6 was developed
by Turnbull ( 1992; 2000c) to identify the powers of a unitary board which can be exploited
by opportunists and rogue directors of publicly traded companies with or without a
controlling shareholder. It indicates how directors can maintain their board positions and
private benefits from their ability of "marking their own exam papers" (Tricker 1994: 246).
In other words they define their own performance objective and can detem1ine how they
report their pertOm1ance to investors. There arc many ways in which a board can manipulate
the presentation of financial reports such as controlling the appointment and pay of the
auditors and providing return favours of additional non-audit work.
Directors also control the appointment, remuneration and terrns of reference fOr other
advisers, which the law or stock exchange listing mles may require to be "independent".
Even within accepted accounting standards, directors have considerable discretion on how
they value stock, debtors, fixtures, fitting, plant and machinery, realty and intangible assets.
114
TIIEOHY DEVELOP!\'IENT BASEO BYTES ANO CYBER;-..<ETICS
Many of these discretions require specialist knowledge of management, which may not be
available to directors (NEDs). So even when an audit committee of the board
is established with NEDs, the basis on \vhich profits arc dctennincd can be controlled by the
executive directors. Tltis is why Tricker (l994: 263) can report "that audit committees really
don't work" and Donaldson & Davis (l994: 157) to state: ''the non-cxt:'cutivc board of
dircc!ors is, by its design. an ineffective control device". Donaldson & Davis (1994: 155) cttc
evidence to support the view that "the whole mtiomt!c tbr having a board becomes suspect".
Table 3.6, Corrupting powers of a unitary hoard
Directors have pon'er to:
1. Obtain private benefits for themselves fand!or control who anpni_nLlhcm} bv:
{a) Detc:m1ining their own remuneration and payments to associates;
(b) Directing business to intere-sts associated with tbcmsclvc:s;
(c) Issuing: shares or options ar a discounted value to themselves and/or associates;
(d) Selling assets of the firm to one or more directors or their associates at a discount;
(e) Acquiring assets from one or more directors or their <lssociatcs at inflated values;
(f) Trading on fayoured tem1s with parties who providt:: directors: with private benefits;
(g} Using finn resources and/or their status in other ways.
2. Maintain their board positions and privak benefits hv:
(a) Rcportin,g on their own pcrfom1m1cc and intlucncing "independent"' advisers by:
(i) Selecting auditors and other independent"
(ii) Dctt:rmining their fees;
(iii} Controlling the by which auditors arc appointed by shareholders;
(iv) T l.!m1inating the appointment of auditors and other" indep!.'!ndcnt" advisers:
(v) Paying fees for work which is not required to be "independent";
(vi) Determining the tcm1s of rcfCrcnce on which" indcpcndt:nC' advice is provided.
(b)Dctcmlining the level of profit reported to shmchofders by:
(i) Selecting the basis for valuing or writing ofT trading and fixed assets;
(ii) Determining the lifC of assets and so the cost of
(iii) Sdecting basis for recognising revenues and costs in long tenn contracts;
(iv) Selecting accounting policies wiihin accepted accounting ,
(v) Sekcting, controlling and paying "independent" va!ucrs and de-termining the basis!
f(lr them to provide valuations. i
(c) Not disclosing full pecuniary or benefits even if required to do so; '
(d)Dctennining how any conflicts ofinterl.!st are managed;
(c) Filling casual board vacancies with people who support their own position;
(f) Nominating new directors who support th!.'!m at shnrdm!dcr meetings;
(g)Controlling thc nomination and election procedures and processes;
(h)Controlling the conduct of shareholder meetings;
(i) Appointing pension fund rmmagers for the finn who also provide them proxies;
(j) Voting uncommitted proxies to support their own election;
(k)Not allmving the firm to compete with related parties who can vote tOr them.
115
CHAPTER 3
Audit committees were first created not to detcm1inc protits but to dctcm1inc if management
were keeping the negative pledges imposed by bankers. NEDs became personally liable if the
pledges were not honoured and the business as explained by Guthrie & Turnbull
( 1995). Their current use developed from recognition of the fundamental conflicts of interest
in having managers "marking their own examination papers".
To avoid similar fundamental conflicts of interest, the practice of establishing remuneration
and nomination committees was established. This practice provides a veneer of respectability
in managing these contlicts but it cannot be cfiCctive as "an infomwl separation of function
docs not provide the same guarantees as a formal separation" (Tricker 1994: 247). Tricker
then goes on to quote John Stuart Mill who said, "The same reason which induced the
Romans to have two consuls makes it desirable for there to be two chambers of parliament;
that neither of them may be exposed to the corrupting influence of undivided power" (247).
As management can control many of the expenses and privileges of a director and tht.:
allocation of additional pecuniary and benefits, NEDs become obligated to the
executive. So even if NEDs make up a nomination or remuneration committee, there can be
persuasive incentives for them to make decisions desired by the executive. It is more than a
matter of collegiate loyalty among directors. The interdependence of the executive and NEDs
creates a mutual reinforcing symbiotic supportive relationship.
A common criterion for appointing new directors is their reliability in providing board
solidarity and teamwork. The objective is not to select director candidates who may be
conformists or whistlcblowcrs in regards to exccssivt.: benefits provided by the company to
c:xecutivcs or dominant shareholders. Directors have a duty to the company as a whole.
\Vhcn there is a dominant shareholder, it can become a matter of opinion and judgement if
transactions with a dominant shareholder arc in the best interest of the company as a whole.
It can depend upon the technicalities of the transaction, which require detailed management
knowledge and experience to determine. NEDs who hold their position at the grace and
favour of the dominant shareholder or management arc placed in the position of giving the
116
THEORY DEVELOPMENT UASED ON BYTES AND C\'Bl<NT!CS
benefit of any doubt to the vested interests. For similar reasons, auditors have the incentive to
give the executive the bene fir of any doubts in the way profits arc dctcnnincd. In both cases
this creates a situation to remove the will to act even when they have Information to act.
A unitary board has absolute discretion in nominating candidates to filt casual vacancies and
first mover advantage in nominating new directors for shareholders. to be elected to the board.
Incumbent directors also have the advantages of controlling the conduct of shareholders
meetings and the process of electing direcwrs.
A powerful but h i ~ n way in which directors can maintain their position is by awarding
additional business to influential pension funds who hold stock in their company by
appointing them to manage some or all of the pension funds associated with their O\VIl
company. In this way directors can obtain tbe voting support ns noted in item 2U) of Table
3.6 to maintain and protect their tenure and benefits.
The result is sharcholdt::rs who arc widc!y dispersed may possess little opponunity or power
to dismiss or nominate directors or block shan.':bolda resolutions which t3vour management.
Even if shareholders have thiJ infonn:.nion and will to a;;:t to control management, they may
lack the power to act. However, the financial infOrmation presented to sharclH)ldcrs is
controlled by management, so in any event they may not obtain accurate or timely
infbm\atfon to act. ln the leading Anglo tndustrialisc::d countries, ins!itutional investors lack
"the wJI! ro act'' as noted by Regan ( 1993). This lack of will arises because Institutional
investors arc fCc earning agents and there arc costs in researching and initiating actions. Any
costs they incur provide a ''free ride" for other shareholders. It Is simpler to the do the "\Vall
Street \Valk" and dispose of their holdings if they lack confidence in management or the
future prospects of the business. Not voting shares or selling them quietly also avoids
alienating influential management who could become their clients. by engaging them to
undertake pension fund management and other financial scr\'iccs.
\Vhcn a dominant shareholder is not .n financial institution but an operating business, the
reason for controlling a publicly tradL"rl company is to obtain strategic and tactical benefits for
CHAPTER 3
its dominant shareholder. These may not necessarily be aligned with the minority
shareholders as discussed earlier for reasons outlined in items Ia to lg in Table 3.6. The
Anglo system of corporate governance, with or without, institutional investors being
dominant, lack the basic requirements for corporations to become accountable and maintain
competitiveness as analysed by Porter (1992). Jensen (1993) who documented the failure of
corporate control systems in Anglo publicly traded companies supports this work.
Communication problems in controlling hierarchies were considered in Section 3.4.3 and
illustrated in Table 3.3.
Additional problems in controlling hierarchies arc identified in Table 3.7, 'Evaluation of
hierarchies to control, regulate or self-govern'. This table identifies the condition precedent
for the establishment of control, regulation and self-governance in finns. Unless a firm has a
workable control system it cannot be regulated. Likewise, if a tinn cannot be regulated it
cannot be governed, let alone achieve sclt:governancc.
Table 3.7, Evaluation of hierarchies to control, regulate or self-govern
OBJECTIVE CONTROL REGULATE SELF-GOVERNANCE
(Command only) As for control plus: As for regulate plus:
UDeaJCllCe to Aaequate mtorn1at1on TOr
I commands monltonng of governed to evaluate controllers
outcomes or new nominees for election
Accurate rcportmg processes tor tl1e
2 communications of outcomes up governed (stakeholders) to
REQUIRE- down hierarchy hierarchy reward or penalise controllers
MENTS Meanmgtul Meanmgtul I Independent processes tor tile
3 operational condensation of governed to appoint and retire
implementation reports controllers
lnnely Appropnalc and cvaluallons tor
4 implementation timely responses to rewards/penalties and review of
variations appointment of controllers
I U!SObCd!CIICC lncompl.elc Incomplete mtormauon or
momtormg subject to bias from controllers
2
I:S!USCS,
in relaying
!'-Cportlng slow,
biased, missing or
or
detern1ining their own standards
commands incomplete of performance and their own
PROBLEMS rewards and penalties
3
ltncrrectum
operatmnal

inadequate analysis
or
determmmg their own
implementation of variations appointment and retirement
_llmClllleSS O_t Inappropnate controllers mtlucncmg or
4 implementation responses to correct determining the time of their
variations own evaluation or retirement
118
THEORY DEVELOP:\lf:Nl' UASl.:U ON BYTES A:-:D CYRER:"<<ETfCS
There arc four basic requirements fOr a workable system of control as listed in Table 3.7.
These are: (i} Obedience to commands; (ii) Accumte communications down the hierarchy;
(iii) Meaningful operational implcmcnHHion. with (lv) Timely application. The four basic
requirements lo oblain a workable system of regulation then become respectively: (i)
MeaninglUI monitoring of outcomes, (ii) Accurate reporting of outcomes up !h..: hierarchy;
(iii) Meaningful condensation of reports to superiors, with (iv) Appropriate and timely
responses to variations. The lOur basic requirements to obtain a worknblc system of ::;df-
govcrnance then become respectively: (i) Adequate infOrmation fOr the governed
(stakeholders) to evaluate the controllers or new nominees for election as controllers; (ii}
Independent processes for the governed to reward or penal is.:: the controllers; (iii) Independent
processes to appoint and retire controllers, with (iv) Timely evaluations for rewards/penalties
and rcYiew of appointment of the controllers.
The tour basic requirements tOr a workable system of control, regulation and self-governance
of hierarchies arc summarised in the top section of Table 3.7. Problems that can arisl.! in each
of the il1ur basic requirements are listed in the bottom section ofT<1blc 3.7. Each problem
represents a contrary condition to the requirements discussed in the previous paragraph. Each
problem is likdy to be present in fim1s organised as ct.::ntrally controlled hierarchies as
discussed in Section 3A.3. Table 3.3 indicates thc problt.::ms of a board or CEO in obtaining
accurate and timely infom1ation which is jcopardised by loss of accuracy and biases in ihe
communications up t h ~ : hierarchy. Likewise the meaningful implementation of inslructions
down the hierarchy is jcopori;.:ed. These problems in the control and regulation of centrally
controlled hierarchical firms arc set out in the bottom section ofT able 3.7.
Front Table 3.7 it is evident that a unitary board, with its concentration of power, docs not
provide ;J basis tbr establishing independent processes by the governed to reward or penalise
corporate controllers and regulators. Nor does it provide a basis for the governed to
participate in the appointment or retirement of the controllers and regulators as noted in lines
two and three of Table 3.7.
ll9
CHAPTER 3
Beside the corrupting influence of absolute power in managing their own conflicts of self-
interest, unitary boards introduce two other basic problems, They are: (i) Establishing a
centralised m<magcrnent hkmrchy, which creates communication proble1ns, as identified by
Downs (1967); and {ii} Forcing ccntrnliscd decision making and control which creates
information overload.
3 . .7..,JJnfommtfon overload
The problem of intOnnation overload within the hierarchy of a finn \Vas overcome by the
establishment of M-forrn firms because they allow organisations to be decomposed "into
relatively independent sub-systems, each one of which can be designed wilh only minimal
concern for its interaction wilh the others" (Simon I962: 474). Williamson (1985: 283)
observed that "the problem of organization is pr<.."Cisdy one of decomposing the enterprise in
efficient infomtation processing respects" and cites Marchak & Rudner (1972) and
Gcanakpolos & Milgram {1934). From a cybernetic viewpoint, decomposition allows tbe
establishment of network infonnation and control architecture. In particular, it permits the
establishment of the most l..!volutionary robust method tOr managing complexity, which is
described in !he next section'""' a "holon".
\Villiamson {1975: 140) noted that, "'Imitation of the M-fonn innovation was at lirst rath!.!r
slow" and that ''prior to 1968, most European companies administered their domestic
operations through or holding company internal structures". However, there was less
need tbr large European finns to adopt M-forrn architecture because decomposition in their
decil>ion making was an inherent feature of their multiple bourds, which arc described in
Chapter 4 and lllustratcd in 4.3.
The powers, which allow directors to appropriate value from shareholders through their
conflicts of sclf-interest
1
need not be those required by dir.::ctors to add value fOr shareholders.
It is thus possible to separate those powers by which directors ctm appropriate value to
themselves from the powers used to add value for shareholders as is achieved in many types
of compound boards found in Europe and in Anglo countries. The division of powers in this
110
THEORY DEVELOP:\1ENT BASED ON BYTES AND C\'BERNETICS
way can protect both investors and simplify the role of directors to reduce their exposure to
personal liability (Turnbull 1993b;c;d; 1994c; 1995a;b;c; 1997b;d;f; 1998a).
The ethnocentric influence of US scholarship in the theory of the firm (discussed in Chapter
2) has resulted in the assumption by many scholars that all powers not held by shareholders
arc vested in a single board. However, in some countries, the law mandates two or three
tiered boards and multiple boards commonly exist in the US for employee owned firms, firms
with Employee Share Ownership Plans (ESOPs), MBO associations and for most venture
capital firms. Compound boards arc also found in the USA and elsewhere when fim1s with a
single board obtain a dominant shareholder that is not a sole owner or the tirm enters into a
shareholder agreement such as with venture capitalists or MBO association. A unitary board
firm can also become part of a compound board through arrangements arising out of joint
ventures, alliance, franchise or a productive network.
It has been widely observed that power corrupts and absolute power corrupts absolutely.
Persson, Roland, & Tabellini ( 1996) provided the first fonnal proof of this observation and
analysis of its solution from the division of power to create checks and balances. The
Persson, Roland, & Tabellini analysis was based on political structures where the controllers
may b ~ : seeking advantages of power, status and influence rather than just economic bene tits.
They showed that by introducing an appropriate division of powers, the welfare of
stakeholders can be increased compared with that available from unitary control. In their
equations they allowed "agency costs" described by Jensen & Meckling (1976) to become
positive to include the possibility that those seeking elected ofticc might contribute value to
gain power and status.
Insights into the internal organisation of bicameral and higher order divisions of power
among political control centn!s arc provided by the analysis of Dicrn1cier & Myerson ( 1999).
Their game-theoretic model concludes that committees within a unitary legislature are weak
in initiating policy because the real power of infonnation is within is the bureaucracy of the
ministry (Dicrmcicr & Myerson 1999: 1183). The importance of parliamentary committees is
121
CHAPTER3
in owrsc(.!ing government bureaucrats. This situation resonates well with the operation of
large company boards. In a unicameral legislature, Dienneier & Myerson ( 1999: 1190) show
that each member can maximise his/her long-term pcrsonal p y ~ o f f s by adht':ring to the wishes
of the leader. This may explain why boards value teamwork.
However, the pay-offs are not related to tht: wclfurc of the stakeholders affected by the
legislation as considered by Persson, Roland. & Tabcllini. This suggests that the interest of
unitary board members may not be aligned with shareholders or other swkcholdcrs.
Hmvevcr, in a bicameral legislature, there is less incentive for members to adhere to fractional
discipline in the model used by Dicrmeier & Myerson (1999: 1191). The arises because the
personal pay-off:S from vested interests arc more widely distributed with two control centres
to reduce the incentives which can be provided by any fraction. Dienneier & Myerson ( 1999:
1195) concluded that:
The greatest incentive 10 delegate legislative powers !o a coherent leadership
was fOund in a simple unicameral legislature. The addition of a President
with veto pmvcrs, who in effect constitutes a onc-pcP.Oon second chamber,
can provide incentives fOr the first chamber to dismantle a system that
ddegates il:gis!ativc power to a single !eadcL
The cxistcncl! of veto povvcrs by another authority aiso providl.!s !ncl.!ntivcs for members of
the chamber to consider arguments that they may not otherwise would if they were subject to
cabinet andlor party discipline. In a board situation, this would avoid the "group think"
approach, which can blind boards from insights into corporate strengths, \Veaknesses,
opportunities and threats.
Many scholars have analysed the failure of tlllitary boards to control or even sustain the
economic viability of businesses as identified in Section 2.4. However, few have fOcussed on
the conf1lcts of self-interest and power relationships in unitary boards compared \
1
.:ith those in
a compound boards. An exception is Dallas {1997) who based her argumems fOr "a duai
board
11
on au interdisciplinary approach using accepted theories of the firm. empirical studies,
law and psychology. One reason why scholars do not focus on contlicts of interest between
122
THEORY BASED ON BYTES AND CYBERNETICS
directors or shareholders and the company according to Dallas (l988: 28) is that a company is
treated as a "nexus of contracts". This eliminates the existence of a fim1 as an actor which
can be party to conflicts of interest. Another problem is that Anglo scholars consider unitary
control as the natural order of things and so do not consider alternatives as noted by the quote
from Gilson ( 1994: I 32) in Section 2.5.
As a result of this view, or because of it, no accepted framework has been developed for
analysing compound boards. Part of the problem is the "cultural specificities in theories and
practice" of corporate governance identified by Tumbull (l997a: 185) as discussed in Section
2.6.5. TBA offers a way to overcome these problems and to fill the research gap without
relying on culturally specific social constructs. Examples of this approach arc provided in
Tumbull (l978b: 6; 1994d: 328; 1997a,b,c,d) with the last cited paper suggesting design
criteria for building effective social institutions based on cybcmctic principles to be identified
in the next few sections.
3.8 The necessity for requisite variety in infomtation and control
The power of TBA to provide 'insights'22 into the operations of tinns with one of more
boards and all other social structures arises from the application of cybernetic principles. The
purpose of this current section is to describe the three basic cybemetic principles on which
these insights arc based. These arc the necessity of requisite variety in decision making,
communication channels and control responses. To utilise these three principles
organisations need to adopt an architecture, which introduces multiple boards. A compound
board in tum provides the means of introducing a variety of infonnation and control channels.
A compound board can also provide: (i) A condition precedent for self-governance (Section
3.7); (ii) A basis for managing infOnnation overload (Section 3.7.1) and; (iii) A basis to
introduce holonic architecture to be described in Section 3.9.3.
22
These 'insights' arc developed and discussed in Chapter 7.
123
CHAPTER3
3.8.1 Varietv in decision making
Neumann ( 1947), a mathematician, identified the advantages of introducing variety in
centres. He was one of the founding fathers of the science of cybernetics
and explained how the brain could obtain reliable results from unreliable elements. Beer
(1995b: 448) described this as the Neumann theorem, which states: "outputs of arbitrarily
high reliability can be obtained from computing clements of arbitrarily low reliability if the
redundancy factor is large enough". This observation is quite general and applies to social
organisations. In organisations this means that errors in decision making can be diluted to
irrelevance if there arc sufficient number of decision-makers who obtain correct answers.
3.8.2 Varictv in infommtion channels
Shannon, another pioneer of cybernetics, was concerned with the design of World War II
secrecy systems and made a somewhat similar observation. Shannon (1949) established
mathematically that accurate infonnation could be obtained when noise, distortion and bias
exist in a communication channel by establishing variety of information channels. Beer
( 1995b: 282) states:
For example, if management were compel!ed to rely on the information it
n.::quin.:d through "orthodox" channels ofconununications, it would certainly
never have anything like requisite variety for controlling the for
the simple reason that the orthodox channels could not transmit it.
To correct for nOise, errors, distortions and biases, a variety of independent channels of
information arc required. By having a variety of independent sources of infonnation, the
integrity of infonnation can be established to overcome the problems of lost or distorted
information as was illustrated in Table 3.3. The need for collaborating evidence is a common
feature in many types of investigations and many CEOs establish infonnal information
networks to supplement fonnal channels of reporting. However, idiosyncratic infom1al
124
THEORY DEVLOP:\IE:-<T BASED BYTES AND CYBER'I.OETICS
channels do not represent a systemic::!:;. process for assuring the integrity of management
infonnation.
3.8.3 Varictv of control channels
Another fundamental law of cybernetics is the related 'Law of Requisite Variety' 'which states
11
thc variety of a regulator must that of the disturbances whose effect it is to
(Ashby 1968: 202). Another formulation by Beer ( l995a: 41) is "that control can be obtained
only if the variety of thl.: controller (and in this case all parts of the controller) is at least as
great as the variety oft he situation to be controlled."
Beer describes this as Ashby's Law, which be observed is poorly understood. To overcome
this problem, Be<:r (1995c: 84-96) provides scwral examples to communicate its meaning.
Beer (1995b: 279) uses the fOotball team metaphor to illustratt: the law. To have the chance
to control the players of an opposing team, the same number of players arc required. A team
without sufficient players, (i.e. n:quisik variety) then become uncompetitivc. and likewise.
tinns.
Consider the case of a firm which is affected by a number of performance variables. Panda
number of conformance variable, C. Ashby's Law means that when P types of variables in its
environment af!Cct the compctitivc standing of a fim1 then corporate controllers need at least
P types of responses to competitive. If the confonnancc requirements of the board
require that C types of activities to be regulated then directors need at least C types of control
mechanisms. For directors to effectively carry out either their pertOmmnce or confonnanec
roles they need requisite variety in their control system to manage all P and C variables.
However, many parts of a control system rl!quircd to manage P variables will also manage
many C variables and Hence, the control systems needed to improve
competitiveness and self:.regulation can support each other.
::!J A process can be achieved by npproprimdy compound boards as found in a Japanese
keiretsu or a MondragOn eooper.nive discussed in Chapter {1 and analysed in 7. The competitive
adv:mmge$ of these a.rrang:cmenL-. nrc described by Turnbull (1994b; l997a;b;f; 2000b) and ns cons.idcrcd in
Chapwr 7.
125
CHAPTER3
In the words of Ashby (!968: 207), "Only variety can destroy [ie control] varil.!ty", Another
fOmmlation of the law of requisite variety is thut complexity is n:quircd to mmwge
complexity. NotHrivial tinns with a unitary board do not ml.!ct the test of possessing
rl.!quisitc variety in tht!ir infomHltion and control channds and so their competitive
capabilities cannot match those with an appropriatdy designed compound board.
3.9 Cybernetic strategies for economising information
Tht.!rc arc limits to how much variety humans can cope with as shown in row 9 of Table 3.4
and there arc also limits to the rate humans can absorb and process information. Electronic
infOnnation systems have similar limits and the cybemetie strategu!"S used by system
engineers to ove-rcome and! or work around these !imits also apply to finns.
3.9.1 Amnlifving control throue.h
The procc;;.s of "supplementation" (Ashby 1968: 265) can overcome these lirnits in
infOmlation communication and processing. Ashby ( 1968: 245) not!.!S that:
Similarly, befOre Shannon's work. it was thought that any channel with a
little more skill could bl.! modified to carry a liHh.: morc information. HI.!
showt:d that the engineer's duty is to get reasonably ncar the maximum, for
beyond it no one can go. The law of Requisite Variety enfOrces a similar
strategy on the would-be r..::gulator anti controller. He should try to gl.!t ncar
the maxim urn -beyond that he cannot go.
In discussing the capacity of any comrolkr 10 variables, Ashby ( 1968: 268)
states, "The law of requisite varkty, like the law of conservation of energy, absolutely
prohibits any direct und simple amplitication but it does not prohibit supplementation". One
man would not be able to directly load hundreds of heavy containers on to a ship but the Law
of Conservation of Energy does not prohibit him tfom supplementing his energy by using a
crane.
TIIEORY DEVELOI':\IENT BASED Oi'\ BYTES Ai'\D CYBERNETICS
Likewise, supplementation of regulation depends upon one regulator being used to regulate
many others. One man could not regulate the temperatures in a I 00-room hotel as the
weather changed during each day if he had to adjust the heaters/coolers in each room directly.
However, if each room had a them10stat, which sensed changes in the air temperature of each
room and made adjustments accordingly to its air conditioning system then one man could
control the temperature of all rooms.
The ability of one person to manage directly many variables is limited. One person may !cam
to juggle five balls in the air but would need another skilled juggler to share the load if there
were more than tive balls. The number of subordinates reporting to a supervisor is likewise
limited for a similar reason. If the span of control were limited to five, the supervision of 781
workers would require four levels of hierarchy as shown in Table 3.3. However, each
additional level in a hierarchy increases the errors in reporting and communicating control
infonnation and extends the time to take corrective action to manage disturbances. In
addition, infom1ation overload on senior management concemed with short-tcnn operating
decisions as well as longer term strategic decisions increases as noted by Chandler (I 962) and
\Villiamson (1975). This problem can be reduced by decomposing decision making to
separate operational decisions from strategic decision as is achieved in M-fonn firms as
discussed by Willi11mson (1985: 292).
3.9.2 Economising bvtes through the "Principle ofSubsidiarv Function"
The success of M-fom1 firms in reducing infOrmation overload and decreasing the time to
take corrective action arises because each division obtains some degree of autonomy 111
decision making. The degree of autonomy may vary with different fim1s. Divisions m
multinational corporations could have more autonomy when organised as separate fim1, under
a holding company to create an H-fonn tim1 (Williamson 1985: 280).
There arc vanous ways m which the decomposition of decision making labour can be
achieved. Limiting the span of control of a manager is the most common approach. The
objective is to reduce infom1ation overload for individuals. One basic strategy is to usc the
127
CHAPTER3
'Principle of Subsidimy Functton (PSF). One fonn of this principle was enunciated by
Schumacher ( 1975: 203) who stated, "that no higher order association should undertake any
function, which can be undcnnkcn m a lower level", The principle \Vas also advocated in the
Encyclical Letter of Pope Pius XI (1931 :40) which probabiy int1ucnccd the thmking of the
Jc.:;ult Priest who designed the architecture of the MondragOn Corporacion COOjiemtiva
(!'v1CC) which wiH be presented as a case study in Chapter 6.
The decomposition of decision making Into operational and strategic concerns through an M-
form firm illustrates the application of PSF. firms can also demonstrate PSF and
may provide ndditlonal decision making discretions frnm the holding company having a
sevarate board from the operating company. In this way compound boards provide a way of
implementing PSF to decompose decision making labour as is illustrated in th{! CUS(! studies
presented in Chaptt:rs 5 and 6.
As the complexity of business increases, so does the need f.or M-fnnh, and matrix
management systems, These arc described in the next Chapter and illustrated in Figure 4. I.
Network (N-fom1) firms provide the grcat<:st variety of inf(mnation <l!)d control c:hnmhlls and
it is this fOnn thut is flwoun.::d by infom1ation technology (IT) fim1s.
A network of tinns may itself be considered a tirm (Mathews 1996b: I !6) OJ' "as
organizational wholes
11
(Richter 1994; 24). There is now a growing lite-raturl.! of this of
finn (Alstyne 1997; Craven, Piercy, & Shipp 1996; Jackson 1996; & Eccles 1992;
Podolny & Page 1997). Any network of fim1s with unitary boards, \Vhich creates an N-fonn
finn, \\'Ould lbrm a compound board. ln other \vords, all N-fonn fim1s haYc compound
boards. Some fim1s like the MCC arc thl.':mselvcs made up of firms, which
in tum are composed of finns with compound boards as will be analysed in Chapter 6 and
illustrated in Figure 6.2. The of such rccursivt:.ncstcd structures arc
explained by considering the concept ofholons considered next.
THEORY DEVELOP>1ENT BASEO BYTC.S AND CYilR:\F.T1CS
3.9.3 Economising bvtes. through a hierarchies ofholons
Some finns can fonn relationships that possess the properties of a "holon" described
below. According to McHugh, Mcrli & Wheeler (1995: the advantages of a holonic
architecture arc leverage, speed. flexibility, shan.'-d risk, independence, fOster growth and
increased profits, sustainable customers, less capital rt.'<{uirernent, quick failure recognition,
aJld increased ability to deal with inevitable change. Mathews {l996a) describes additional
benefits ofholonic architecture as discussed in Chapter 7 which considers the utility ofTBA
in understanding complex organisational architecture. In a similar way the identification of
holonic architecture in nature helps provide a basis: fOr understanding its complexity. TBA.
can be used to explain the infonnational efficiency of ho!onic architecture and holonic
architecture becomes part ofTBA.
Smuts (1926) identified the complexity of the universe being made up of simpler components
along the lines illustrated in Table 3.8, 'Holarchv: Hierarchv of holons'. While this Table
includes some of the original clements identified by Smuts it has been developed and
extended by the author to include some modern examples and case studies used in this thesis,
While Smuts used th!! term "holism'', it \vas Koestler (1967) who coined the word "holon" to
describe the components who togciher as a whol..: (hol) produced characteristics diflercnt
from their cm1stituent parts a.:; illustrated in the table.
Koestler { 1967) also coined the word "holarchy" to describe a hierarchy of ho!ons as
illustrated in the rows of Table 3.8. The rows have been divided in three arbitrary levels" of
"first''. second" and "third", which have no intrinsic signHicunce but al!ov; each row to be
described as a "discipline" or "subject" such as "physics" or "chemistry" iOr the first and
second rows ofTable 3.8.
It will be noted that the holonic component listed as the .. third level" becomes the holonic
component of the next "first level''. Rows one to seven arc linked in this sequential manner to
describe the structures of nature. The remaining eight rows describe structures created by
humans and do not maintain linked hierarchies between rows except for rows 10 and II
129
CHAPTER3
\Vhlch d-escribe the MCC. The shaded rows eight to thirteen describe social structures and the
last t\\'0 unshadcd rows tOurtecn and tiftccn describe engineering structures.
Table 3.8, Holarchy: Hierarchy of holons
In nature (rmvs 1 .. 7), socicry (rows and engineering {rows 14 and IS)
Discipline/Subject First Jevel Second level Third level
I'
tnystcs UrtiCICS
I
/\toms ! MOICCU CS
11 1 Chcmtstry Molecules
comp6unos-T-
oases
0 ll.lCnCtiCS Bases
I
ul'i'\ Genes
14 1 tlJology Ucncs 1 Chromosomes ' \...CIIS
I
> 1 l\natomy '-- e s
I
rgans
'
lnOIVIUUaJS (tlJOta)
0 ll::nv1ronment .otota
I
t:.COJOgiC<H unam (cartn)
systems
i I
Astronomy J:arth I :::C.olar system
I
.

OCIOtOgy
._!f]()JVIOUaJS
ramwes Lommunmcs
9 1 vrgamsatrons Autonomous

rmns llgr .,,
cells/divisions
.
.
i IU worK groups : ::socm council ucnerai assemOiytco-op
l l 1 Mondragon system : coopernuve M?:1Uragon,
(MCC) 1 groups Cooperaliva (MCC)
''"
v J'A care
ueogr3j)fiiC--untt ----IMcinlier:oanK v !:SA ntmattanal
. ,,
i uovemment i t-ommumttesitowns ;)tates t'latlons

14 ngmecnng components ;,:u -asserntmcs 1 M3C1tliC
: J>
! Mltware des>gn Sub-routmes Koutmes

programs

Th;; fOundations tOr establishing a basis tOr TBA to explain tht! informational efl1ciency of
holonic organisational architecture wen; established by Simon ( 1962). Simon used
probability analysis, and without drawing on the work of Smuts described id.::ntical structures
\Vhich he described as "sub-assembles" {refer to line 14 of Table 3.8}, "stable intem1ediatc
fonns'' or "able to maintain a separate existence". He also described them as "nearly
decomposable systems", in which the interaction among the sub-systems are weak, but not
negligible". In social organisations and fim1s, this thesis will refer to them as "almost sdf ..
governing components".
It Js because the organisational components arc almost self-governing that the .. interactions
among the arc weak". Weak interactions among sub-systems in an
orgaHisational context means that the transaction of bytes is weak to reduce intOmmtion
overload when organisations arc made of almost sclfwgovcming components or holmlS. This
130
TIIEORY DEVELOP:\IENT BASED ON BYTES AI"'D CYBERNETICS
is why holons become an clement of TBA and how TBA explains the cflicacy of holonic
architecture.
In Table 3.8 each level in each row represents a "sub-assemble", or "stable intcnnedintc !Onn"
"able to maintain a separate existence" or what Beer ( 1985: I) would describe as a "viable
system". Each component can exist alone as a stable entity and meets the test of being a
halon. For example, sub-atomic particles arc holons because they represent "sub-assembli!..!s"
which make up atoms. Atoms arc in tum arc sub-assemblies of molecules. However, when
the holonic components combine together they create a more complex structure with
characteristics quite different from the components and with the ability to exist on their O\VIl.
In this way a hierarchy ofholons is created.
Simon illustrated his analysis by considering two watchmakers. (Refer to row fourteen
describing "Engineering" in Table 3.8.) With random interruptions to the production process,
output was maximisl..!d by the watchmaker who used sub-assemblies (i.e. holons). Simon
used this example to provide an explanation of how nature could construct the complexity of
life from random associations of its constituent materials.
Mathews (1996a: 30) reports that Japanese robot manufacturers designed "holonic
manipulators". In this case, the holonic architecture did not provide mechanical advantages
but informational advantages because, "The reduction in data transmission, and in data
complexity, achieved by the holonic architecture, is prodigious." This was the reason why
Fujitsu Laboratories adopted a 'holonic' solution for switching communication networks
Mathews ( 1996a: 32). Also, why software designers usc object-orientated programming
(OOP) based on a holonic architecture of objects composed of routines and sub-routines in a
design process described by Long & Denning ( 1995) - refer to the last row of Table 3.8.
Holonic architecture provides a way for a complex system not to become dependent upon the
internal details of another part of the system.
JJI
CHAPTER 3
I-1-fonn firms have some characteristics of holonic architecture, MMfom1 fim1s, "autonomous
manufacturing cells" (Mathews l996a), and firms as a "hierarchy of teams" (Conti & Warner
1996) would represent a weak form of holonic architecture, For organisations, Mathews
(1996a; 34) adopts a stronger definition for a halon than used by Simon or Koestler. He
states that "it is essential that each 'halon' be endowed with its own processing ability, its own
autonomy, its own 'mind' or intdligcnce", He goes on to identify "holonic autonomy, system
dependence and rccursivity as the defining features of holonic organisational architectures",
Mathews (1996a: 40), Each of these three features is illustrated in Chapter 7, which uses
TBA to investigate the complex infonnation and control system of the MCC presented as a
case study in Chapter 6,
For an organisation to have its "its own 'mind' or intelligence", it requires a board or control
centre. So any organisation, which is made up of holonic components, will possess multiple
boards. To provide a basis to compare holonic fim1s with other types its is useful to note the
characteristics on holonic organisations. Mathews ( !996a: 41-44) describes holonic
organisations as possessing the following characteristics: Centralisation/decentralisation;
BottonHlp/top-down; Autonomous/integrated; Order/ambiguity. In comparing them with
hierarchies, holonic organisations provide centralisation and decentralisation of control;
systcmic reliability and flexibility; systemic responsiveness; systemic learning and
mganisational innovations: autopoiesis. Mathews (1996a: 41) claims that "holonic systems
exhibit superior performance on all these points than conventionally structured hierarchical
organisations". But it is their prodigious "reduction in data transmission and in data
complexity", noted by Mathews (1996a: 30) which is of special interest as this as this
provides a basis for TBA to explain their "superior pcr!Omw.ncc".
A prodigious reduction in data provides a basis for achieving a corresponding prodigious
reduction in 'bounded rationality'. In finns, this provides competitive advantagcs in both
controlling internal operations more effectively and adjusting to complex operating variables
in their market place.
132
TIIEORY BASED 0]'1; BYTES AND CYBERl\'ETICS
In supporting the case for holistic systems, Beer observed that, "Centralized systems don't
work and decentralized systems don't work". One of the reasons for "the failure of internal
control systems" that was noted by Jensen ( 1993: 831) was excessive regulation as described
by Bhide (1994). To counter these problems Bhide (1994: 137) reports that, "the SEC has
sought to strengthen broad based participation in corporate governance". This is consistent
with the recommendations of Porter ( 1992: 16-17), Fukao ( 1995: 74,77 ,78), Turnbull ( 1995b)
and Blair (1995: 322) who sec the need to involve customers, employees and suppliers in the
governance of large US corporations.
A well-known organisation that has holonic architecture is VISA Card. However, its founder
and CEO Emeritus, Dec W. Hock, apparently was not aware of the concept and combined the
words "chaos" and "order" to create the tenn "chaord" to describe the ownership and control
architecture of the organisation. Hock ( 1994: l) stated:
By Chaord, I mean any self-organizing, adaptive, nonlinear, complex
community or system, whether physical, biological or social, the behaviour
of which exhibits characteristics of both order and chaos. Or, more simply
state a Chaord is any chaotically ordered complex.
The bonks who crcoted the VISA organisation came to the conclusion that they had to
"reconceive" organisational structure and finally agreed that: (i) "It was equitably owned by
all participants"; (ii) "Power and function must be distributed to the maximum degree"; (iii)
11
Govcrnance must be distributive"; (iv) "It must be infinitely malleable yet r.!xtremely
durable"; (v) "It must embrace diversity and change". The result was an organisation which
"has multiple boards of directors within a single legal entity, none of which can be considered
superior or inferior, as each has irrevocable authority and autonomy over geographic or
functional area" (Hock 1994: 7).
Both Mondrag6n and Visa illustrate Hock's "second law of the universe: Nothing can be
made simpler without becoming more complex". Hock concludes that society has "an
institutional problem" from relying on simple hierarchies that should not, and cannot, be
133
CHAPTERJ
trusted whether they arc in the private or public sector. This view is consistent with by the
findings of Dunbar (1993) on the limited capacity of individuals to establish close trusting
relationships with more than 150 people. The Dunbar findings suggest that the number of
individuals in a holonic unit should recognise this limit when trust is a crucial characteristic
for operational advantage.
3.9.4 Economising bvtes through tcnseerity
Section 2.6.7 identified the yin and yang like principles oftensegrity found throughout nature
including in humans. The nature of humans is changeable as set out in Table 3.4. Row five
shows that people can be "competitive, sometimes collaborative, usually both". People can
also be scltish or seltless as identified in Table 2.5.
In the context of biological structures, Ingber ( 1988: 32) explains the role of tensegrity. He
states that: "Organic structures - from simple carbon compounds to complex cells and
tissues" utilise this principle as it offers "a maximum amount strength for a given amount of
building material" (Ingber 1998: 32). This is demonstrated by considering the construction of
the human body.
Neither the human skc\eton, which is designed to withstand compn::ssion fOrces, nor muscles
which operate as a tension component, can create a stable, strong or adaptable structure on
their own. But in combination they create not only a stable structure, but also one that can
maintain stability in very many configurations. This suggests that a combination of both self-
serving agents and selfless stewards and/or co-operative and competitive relationships in
social structures can provide the most infOm1ation-efficicnt architecture to control social
structures. A contribution of this thesis is to introduce the concept of what will be described
as "social tensegrity".
An hypothesis can then be formed from paraphrasing the words of Ingber quoted above, to
state that: Social tensegrity provides "a maximum amount of control (strength) fOr a given
amount of bytes (building material)".
134
TIIEORY DEVELQlll\fEi'T BASED ON BYTES AND C'i:'BERNETICS
Like Simon and Hock, Ingber did not usc the word "halon" to describe what he described as a
"component" when explaining the role of tensegrity in biological structures. Ingber ( 1998:
30) stated:
This phenomenon, in which components join together to form larger, stable
structures having new properties that could not have been predicted form the
characteristics of their individual parts, is known as self-assembly. It is
observed at many scales in nature. In the human body for example, large
molecules self-assemble into cellular components known as organelles,
which selt:assemble into cells, which self-assemble into tissues, which self-
assemble into organs. The result is a body organized hierarchically as tiers
of systems within systems.
While Ingber was describing the role of tensegrity in creating self-assembled !'itructures, it is
clear than he is also describing holons although he did not name them as such. In other
words, holonic architecture is required in physical structures to achieve maximum strength for
a given amount of material.
Likewsie, an inherent feature of social holonic architecture is its ability to accommodate
contrary properties as referred to above by Mathews (1996a: 41-44) and Hock (Hock 1994:
7). In other words, holonic architecture is required to introduce social tensegrity. Social
tenscgrity could therefore be additional basis for holonic organisational architecture providing
a prodigious reduction in data transmission and in data complexity as described by Mathews
( !996a: 30).
Just as the physical stability of simple carbon compounds, complex cells, tissues and the
human body is established by combining both compression and tension components one can
hypothesise that sustainable stability of social organisation depends upon providing
opportunities for competition and cooperation or selfishness and selflessness together. Like
yin and yang, too much of either characteristic can be dysfunctional; a balance of both is
required. The phrase" sustainable stability" is used to differentiate tfom organisations, which
135
CHAPTER3
m;:tintain their stability or viability, fi'um special attributes of key personalities who happen to
be influential in their op-..!r<Hions at a particular time, The distribution of power in a
MondragOn cooperative described in Chapter 6 create a situation in which competitive and
cooperative forces are distributed and balanced within the stmcturc'' as described by Ingber
(1998: 31).
Pound (l993b) has suggested thnt competition fOr power, status and influence within a finn
provides a much more efficient inct:ntivc to make firms competitive than rely on the more
costly and uncertain market for corporate controL Evidence is provided in Chapter 6 that
both and Visa arc intemationally competitive. Neither is publicly traded and both
h<tvc holonic architecture. This supports the vk'!\V that firms need not be publicly traded to be
comp..:titivr.:.
Il also supports a corollary to Coase 's insight of why tirms exist. Coase ( 1937) proposed that
finns exist b!.!causc markets to eflicicnt!y communicate intOm1ation to govern productive
transactions, One can then f<xm a corollary !hat markets exist when social organisations arc
not as in pmviding infOrmation lOr governing pmductlon. This. raises. the question if
the usc of the dcsign principles identified by TBA pnwldes a basis for making. grm:rnrncnt
owned firms controlled by stakeholders more dlicicnt than publicly traded finns, .and
Stakeholder owned Jlrms more cti\cicnt than government owned tinns controlled by
stakeholders.
These and other issues .arising from applying information and control thi.!Or)' to tirn1s to creilte
TBA are considered in Chapter 7. The next Chapter investigates the evolution of tinns and
the contingencies that producl!d a compound board within a fim1.
3.10 The thesis and the structure of its defen-ce
This chapter bas developed a basis to ;;malysc finns governed by mom than one board based
on bytes. The volume of bytes transactl!d has been u:scd to analyses the information and
!36
THEORY l)EVELOP:\IENT BASEO ON BYTES ~ D Clt"BElt:'\ETJCS
control relationships within and between people, boards, fim1s and their operating
environment This creates the basic proposition of this thesis, which is:
The limited abilir,1 of iltdividuals to transact bytes can be ameliorated by jirms bei11g
governed by more than OJIC board which applr !he pri11ciples of i11/0rmation and control
science.
3.1 0.1 Original ltv
The basic proposition of this thesis has thrt!e clements of originality:
( i) The use of bytes as a basis to analyse the governance of firms;
(2) The analysis of finns governed by more than one board;
(3) Th!! application of information and control science to the governance of fim1s;
The usc of bytes was not found in either the govenmnce literature or in 'thl!orics of the finn'.
The ann!ysis of finns controlled by more than one board has been a n'.!gltct..:d topic as
discussed in Section 2.5. While the principles of infomu1tion and control have been wdl
established in the management litcratun.:, it has not ken used 1o <Ina lyse corporate govcrnnncc
except in contributions by the author written during rsearch for this thesis.
3.10.2 Theoretical utilitv
The usefulness bytes as a unit of analysis is that it identities the limited ability of the human
brain and body to consistently transact bytes to provide criteria for analysing and designing
the governance of fim1s with one or more boards.
There are limits to the number of bytes which can be transacted per second; (a) Within the
human brain; (b) Within the human body and (c) Between one person and another. The limit
for each type of transaction can be different This point is lost with theories based on
information rather than bytes. fn this way, bytes provide a way of analysing components of
"bounded rationality" and grounding them in the physical means by which bytes arc
transacted. As the concept of "bounded ration;)Jlty" is a fundamental element of various
CIIAPTERJ
'theories of the firm', TBA becomes a microclcmcnt of these theories and provides a basis for
grounding them in the natural sciences,
Bytes provide a way to quantitY the limits to concepts like "communication overload"
(Williamson 1985: 281), as indicated in Table 3.5. Bytes also provide a way to quantity
.opportunities tOr ''decomposing the cntCllJrisc in efficient infomwtion processing respects"
(Williamson 1985: 283).
The limited ability of humans to consistently transact andior process bytes, in tum places
constraints on the ability of a board to receive and process infOrmation for directing and
controlling a firm. Case studies in the later chapters show how compound boards can
decompose decision-making labour to ameliorate human limitations in transacting bytes. The
use of bytes as a unit analysis allows the govemancc of finns to be nnatyscd ffom the
perspective of decomposing; (a) decision making, (b) infonnatio:1, and (c) control as
illustrated !n the case studies.
The 'theory o-f!hc finn' developed by Coase, and extended by Williamson, is based on a finn
having a singk entrepreneur and/or board. This !s also an implicit assumption of Agency
Theory {Jensen & Meckling 1976) and other 'theories of the flrm'. 1t IS tbr this reason that
fim1s, owned andfor controlled by employees, are excluded from their analysis
as noted by Archibald (1987: 357). TBA makes a contribution by providing a common basis
to evaluate fim1s with one or more boards and so meet the objectlv;; of this thesis.
As Sl.!t out in Table 3.4. TBA rt."Cogniscs not only the limited ability of humans to transact
bytes hut that such transactions can be variable, unreliable, inconsistent and even contrary,
This allows TBA to explain ditfcrenccs in empirical investigations as to whether directors act
as altruists or self:. interested agents. In this way, TBA is difi"Crem from current theories based
on agency costs or TCE, which do not accommodate individuals with .contrary characteristics.
Likewise, TBA accepts that people can be both cooperative and/or compci!tivc. TBA al!O\vs
the contrary characteristics of peopJe to be reJated to the contrary characteristics fOund in the
l38
ruEORY RASED ON B\'TF:.S ANI) CYllf.:R:\ETJCS
physical structures of nature described in 3,9.4 as "tenscgrity". These features
represent an additional contribution ofTBA.
Tllc ability to analyse and compare fim1s with any type of architecture creates another
contribution of TBA. The usc of bytes in communications between people, within and
between firms and tbeir boards is a universal ft:ature not dependent upon finn archiK>;;tur..:.
So TBA can be used fOr any type of firm, board or social institution. It provides a way to
analyse ''hierarchical and non-llicrarchical organizations within a common model'' as sought
by Radncr ( 1992: 1384).
Another contribution of using bytes is that the strengths and weaknesses in the way the
human brain opcmtcs can be related to tbc information and control architecture of finns and
thdr strat'l.':gies fOr acquiring knowkdge. As noted by Kurzwcil ( !999; 79), the architecture of
the neural nets in human brains makes !hem much better at solving problems by pattern
recognition rath<:r than by calculation. This explains the advantages of "learning by doing"
and study methods over logic and text book analysis. These insights into the way !hat
humans bytes provides a b:1sis for analysing or designing \vays organisations create
or acquire information, knowledge and wisdom.
The application of cybernetic principles to the field of corpmate govcm::m.cc Js another
contrlbutilm of this thesis. Cybernetic prfncipks and ho!onic architecture could be applied tu
corpomtc governance analysis without needing to utilise bytes. But the need for finns to
adopt cybernetic and holonle principles arises because humans transact bytes in an
lnconsistent, variable, contrary and limited manner. Bytes provides criteria, v:hich in theory,
could be quantified tOr determining improvements in the design of a finn's infonnarion and
control architecture so as to cope with human limitations and variability in tnmsacting bytes.
1.1 0.3 Evid!!ncc of .. !Jt!litv of the TBA frarncwDrk
Evidence of the existence and variations in the types of compound boards are presented in the
fbUowing chapters, The case studies are used to develop and illustrate tbe various inter-
139
CIIAPTER3
related clements that make up the TBA framework. The TBA framework contains a number
of dements, which can assist in overcoming human limitation and consistency in transacting
bytes" The dements are: (i} Division of power into two or more boards; (ii) Distributed
decision making; (iii) Distributed infomtation and control channels; (iv) Principal of
Subsidiary Function; (v) Holonic architecture; (vi) The use of cybernetic principals to
ameliorate human variability and establish self regulation and; (vii) The concept of social
tcnscgrity to facilitate
Chapter 4 traces the historical development of the corporate concept This shows that finns
with t\VO or more boards arose in countries where corporate concepts evolved under common
law rather than civil law. Chapter 5 demonstrates that firms with two of more boards also
exist in countries where corporate concepts developed through civil law as in Anglo nations.
However. these arc almost exclusively fOund in employee owned firms where all "agents" are
also '"principals" and so cybcmetic principals of sclf-rcgula!ion are required to sustain th!!
operations of the firm. The informntion and control architecture of firms are illustrated in the
case studies of Chap!crs 5 and 6 to illustrate how the TBA framework can provide new
insights into the information and control architecture of fim)S with one or more boords.
A number of as listed in the Summary, arc developed in Chapter 7 to provide
additional tests to defend the ofTBA for understanding and designing the infonnation and
control of flnns governed by one or more boards.
!40
CHAPTER4
THE EVOLUTION OF CORPORATIONS AND COMPOUND BOARDS
The purpose of this Chapter is to investigate how the corporate concept and the internal
development of compound boards evolved. A ownership and controlta\:onomy is created to
compare the development of coqmratc concepts in different nations and identify why and how
firms with two or more boards evolved in some countries. The nature of the ownership.
control and information architecture of finns in leading industrial countries are identified for
those controlled with two or more internal and! or external boards.
4.1 Evolution of firm control structure
The separation of ownership and control of finns began thousands of years ago when
merchants associated together to finance trading vessels under the control of a hired captain.
Phoenician merchants would share the cost of financing trading ships and share the profits of
the venture with the captain (Hobdcn 1925: 8}. Profit sharing would include any losses or
gains on selling the vessel to a subsequent trading syndicate. In this wny the captain (like
Sin bad) obtained an incentive to maintain and repair the ship during the voyage.
The separation of ownership :.md control also took place in banking syndicates 2j000 years
ago in Persia and Rome. Depositors would provide their 1Unds to moneylenders who would
loan the money to third parties. Until after the middle of the 17th century all c-ollective
investments throughout the world were carried out as unincorporated time limited ventures,
However, this did not necessarily limit the duration of operations, which might continue
through successor ventures.
The longest operating commercial enterprise in the world existed through a succession of
unincorporated ventures (Stora 1999). The Stora Kopparbcrg mine in Sweden began
producing copper around 850 AD. It was operated by a series of contemporaneous time-
sharing, time limited syndicates organised by master miners for over I .000 years. Time-
141
CHAPTER 4
sharing arose from the master miners taking turns in digging for copper from the same
location. One group of master miners would leave the mine to smelt their ore and others
would take their place at mining. The mortality of Master Miners made their ventures time
limited. In 1347 the Swedish king, with traditional sovereign rights of perpetual succession,
imposed a "royalty" of I 0% on all copper production. In return tOr this fcc, the King
provided infrastructure services such as pumps, smelters and timber. The interests of the
master miners were merged in 1868 and became incorporated in 1888.
The industrial revolution was financed without facility of either limited liability or the rights
of perpetual succession. Until the mid 19th century, all European firn1s were unincorporated
except for fewer than 100 ventures established in England by a Royal Charter or Special Act
of Parliament (Unwin 1904). All other commercial ventures in the world were financed by
investors associated as unincorporated enterprises such as a partnership, joint venture,
cooperative, common law or civil law company without limited liability (Begbie 1848).
Common law companies did not have the power to create an entity with perpetual succession.
All common law companies were formed for a specified period of time stated in their
investment agreement. The deed, or articles of association between investors, usually made
provision for the venture to terminate at an earlier time if a detlned signitlcant proportion of
the funds invested was lost. This protected investors and managers from being associated
with an insolvent business for which they might become personally liable.
Nor was it in the interest of investors to have their funds committed for an indefinite period.
The need to rc-capitalisc a business at set intervals provided an opportunity for investors to
liquidate their interest It also facilitated ownership changes. Most importantly, it made
managers accountable to their owners, as they would not be re-hired by the re-capitalised
successor business if their perfOrmances had not been satisfactory. Limited life ventures
enforced periodic management accountability.
142
THE EVOLUTION OF CORPORATIOSS AND COMPOUND BOARDS
At the beginning of the 19th century, about 200 for-profit companies had obtained charters
from State governments in the USA (Grossman & Adams 1993: 7). Companies were
chartered for a specified period but these could be cancelled earlier for "fraud, negligence,
misconduct". "abuse or misuse of its povcr, privileges or franchises", or "acts contrary to
public policy". Investors in companies chartered by states at this time were specitically liable
for the debts oft he enterprise. Incorporation did not provide limited liability.
Tllc need tOr a charter to form a company was not to obtain limited liability bul to obtain a
licence 10 operate a business. The operating licence was neither unconditional nor for an
unHmited length of time. However, the existence of these conditions created incentives for
management to share fhvours with legislators to extend their operating privileges, This
included the rights of obtaining limited liability and perpetual suceession,
Investors in unincorporated ventures cou!d obtain limited liability through one or more
stratagems. One approach was tOr the imcstor to become a silent partner and so unknown to
creditors. The anonymity of this approach suited many people who advanced funds to
moneylenders. Also, by not participating in the management of trnding ventures the silent
partner could not become involved in incurring liabilities of the business. The separntion of
financing the business with ownership like participation from contmi also made good
busi11Css sense from the view of the managing pm1ncr(s) and creditors. Jt clarified and
sat'eguar<k"<i the control role of the managing partncr(s). It provided u strong disincentive for
silent partners not to meddle in the business to avojd becoming personally liable. For the
creditors, it clarified \vho was accountable fOr paying their debts. The principle of investors
not sharing in the liabilities of a venture vhen they are not hwolvcd in its management is
maintained in current limited liability partnership law in Australia and the USA (Etfringbam
1848: !88-98).
Limited liability partnerships provide a common law method for investors to participate in
ventures. Their exposure to loss was limited to the fUnds that they Invested provided that they
did not participate in the management of the business. The managing p r t n e r ~ or partners, had
143
CHAPTER4
joint and several liabilities for an the debts of the enterprise. Like ordinary partnerships, a
new entity was created whenever the-re was a change in the membership of the unlimited
liability partners. However, this did not mean that the limited liability partners obtained the
option of exiting the venture and \\'ithdrawing their invcstmcnt with any share of the
accumulated proflts.
To overcome this problem, limited partnerships would be tOrmcd with limited life. Civil law
t'acHitarcd this type of business through the Queensland Mercantile Act of 1867 with the
requirement that the partnership be every seven years to provide an exit
opportunity tbr investors. It was not untii 1904 that civil law recognition was introduced for
limited liability partnerships in England. Civil law recognition of limited liability
partnerships was introduced in Tasmania 1908 and Western Australia 1909, but in both cases
without limited Htb (Huberich 1912).
An additional way in which investors in unincorporated finns could limited their liability to
the value of their investment was by being both a silent partner rmd anonymous. One way to
this \Vas tOr the Articles of Association of common law compnnies spo.!:cif}' that bearer
shares be issued. The issue of bearer certificates v.:as a common practice in banking.
Customers \Vho deposited gold in banks would be issued a receipt in the tbnn of a certificate,
which any bearer could redeem back into the specified amount of gold. Such certificates,
10
payable to bearer", became currency notes. Bearer shares, likewise, provided their holder
with entitlements to specifk."\1 ownership rights in a firn1. Thcr.: was no need or mechanism
for finns to a keep a register of investors. Owners could remain anonymous from both
creditorS and management!
Unincorporated companies fonned in France with 'anonymous' investors at the beginning of
the industrial revolution. They became known as a Soci6tJ AnonymJ (SA). French corporate
concepts evolved from the Socifitl? en commandiui par actions formed by the 1807
Napoleonic Code and 1863 legislation which introduced the Societe a respansibilltit. While
all common law companies were created for a limited time period, civil law companies of
144
OF AND COMPOUND BOARDS
continental Europe acquired the rights of perpetual suct:ession like those created in England
under Royal Charter or by Act of Parliament This \vas made practical by the development of
stock exchanges to allow shareholders to exit their investments independently of the need to
rccapitalisc the business.
The practice of issuing bearer shares has been maintained in both France and Germany. In
Gcm1any, private companies with limited liability arc known as Gcscllschaft mit bcschranker
Haftung (GmbH) and public companies as Aktiengesellscbat\ (A.G.)
The use of bearer shares led to distinctive ownership, control and governance practices. The
lnitial investors in a new venture, which issued bearer shares, would want to have confidence
that management would be accountable to investors, Lead investors would establish a
shareholder committee to appoint, direct, control and/or dismiss the managers. To avoid
personal liability, these lead shar<!holdcrs of unincorporated companies would not become
involved in management. The shareholders' committee became a supervisory board with a
committee of managers forming the executive board,
Two tiered boards were created fi'om pragmatic investment and personal liability
-considerations. Before the industrial revolution began in the late 18th century, the need for
-collective investment for private enterprise was mainly limited to trading ships, banking und
mining. The industrial revolution created tbc need to fUnd public infrastructure such as roads,
canals, water supply systems, gasworks und railways, In both England and North America,
custom designed laws were created to licence the operation and management of public
infrastructure by private investors. However, limited liability was not provided except in
England up until the mid 19th century. The facility to incorporate companies with limited
liability with or without rhc rights of perpetual succession spread through rhc industrialjscd
countries at the end of the 19th century.
145
CHAPTER4
4.1.1 Ownership and control taxonomv
To describe and identify the change in ownership and control of firms, a taxonomy has been
developed by the author as set out in Table 4.1, 'Ownership and control taxonomv of
comorations'. The table identifies in four columns, two types of ownership and two types of
control. Each of these four types shown in columns is sub-divided into four categories shown
in rows. Its dispersion (A) and the nature of the owner (B) describe ownership. Control is
described ownership by its architecture (C) and the nature of the controllers' (D).
Each type of owner (B) can be somewhat similar to the nature of the controllers' (D). \Vith
each type of owner or controller there arc categories, numbered one to four, to provide a basis
for specifYing the nature of ownership and control in a given example by using a column
Jetter and a row number. For example, Berlc & Means ( 1932) concerned themselves with
widely distributed (4A) ownership. (This type of ownership is implicitly assumed by much of
the scholarly literature as noted in Section 2.2).
Table 4.1, Ownership and control taxonomy of corporations
TYPE OF OWNERSHIP
(a) Limited (5-10%)
minority
(b) Diverse mi
i (not
related such as
institutions and
146
or
appointed by
supervisory board.
or
Watch,dog Council.
(b) Works Council,
Social Council,
ESOP trustees.
(c) Customer/client/
supplier councils.
TH EVOLUTION OF CORPORATIONS 1\ND BOARDS
The literature commonly assumes that finus possess 3B owners with a C I or C2 architecture
and various mixes of2D and 3D directorslcotHrollcrs. In other \vords. the literature is focused
on only six of the possible i6 categoril.!s: Identified in the table and only considers these with a
limited number of combinations. This illustrates the limited boundaries and Anglo
ethnocentricity of the literature discussed in Sections 2.2, 2.5 and 2.6. However. the
assumptions made in the lltcnJture may represent only a caricature rather lhan a reality,
Firms in Anglo cultures are commonly controlled by family interests or multinationals which
introduce lA, 2A, and 3A ownership with 48 owners and 4D directors. Except for lA
ownership, all other categories can be found in Anglo cultures when only publicly
traded finns are considered.
The nature of l B owners is the same as I D controllers but 2B owners arc ditJerent from 20
controllers. This is because the 2B O\vncrs do not have a trading interest with the firm. as do
2D controllers .vith associated interests.
The nature of 38 owners could be identical with 3D controllers except when an otlicer of an
institutional investor also becomes a director. While this is not usual with Anglophile
institutions and boards, it is common in Japan and continental Europe as indicated in Table
4.4. The 4B mvncrs may be identical with 4D controllers in all nations.
Shareholders who take on active supervtsory function will be described as "relationship
shareholders", lA. 2A and 3A ownership could allow relationship shareholders to have the
power to appoint members of the operating hoard. RehHionship shareholders can be present
with 3C and 4C firms. as well as l C and 2C fim1s to create higher order compound boards,
Higher level compound boards can also be created when there is more that one additional
centre of control with 3C and 4C finns.
Compound boards arc not considered in economic theories of the tinn and were not evaluated
in the analysis undertaken by Porter (1992). He recommended changes in control variables B
147
CHAPTER 4
and D ro improve the competitiveness of US fim1s while not explicitly recognising control
variable C which was implicitly assumed to be category lor 2.
4,1 .2 Management structures
M-fbrm managem<!nt structure evolved ffom U-tOnn structure to reduce infonnation
overload and allow frequent short tcnn tactical decision making to be separated from longer
tcnn less fn:qucnt strategic considerations as considered in Sections 2.7.4 and 2.7.l. With
M-fonn finns operating internationally with geographic considerations to be taken tnlo
account a Matrix structure evolved from the to provide both functional and
geographical lines of reporting. The network tOm1 of fim1s typically arises from those with
close subcontracting relationships and alliances, Network firms cJ.n act independently or
provldtt a cooperative or integrated approach in providing goods and scrvic.:s. As goods and
services become more complex, more network relationships arc emerging between firms to
provide greater flexibility and quicker decision making to adjust the nature of their oulpuL In
the more dynamic knowledge based the fOrmation of inter-firm networks has
emerged and has become- quite widespread (Lam 2000).
Just as incr.casing complexity has introduced more complex management structures. it has
introduced more complex control and governance structures. As the complexity of board
infom1ation increased, unitary boards es!ablishcd specialist sub-committees to nw.nagc
specific tasks. Typical of such decomposition in decision making labour would be the
establishment of rmdit, remuneration and board nomination committees to produce 2Ca.
architecture. Geographic spread of operations gave to some companies establishing
advisory boards so as to form links with local influence leaders and strategic stakeholders to
produce 2Cb architecture. Board and other sources of advice established by a
board do not represent an independent centre of control as ddincd in Section 2.2 and so
cannot be described as a compound board.
The following Figure 4. i. !}f.anagement :-tructures and control architecture of finns prepared
148
TilE EVOLUTIO:-.; OF CORPORA AND COMPOUND BOARDS
Figure 4. 1, Management structures and control architecture of firms
Lowest integration
Lowest diversity
(Centmlisation)
Diversity
increases
Higher diversity
Least responsive
Lowest diversity
(Centralisation)
Diversity
increases
Higher diversity
structures
Integration increases

(Unitary) (Matrix)

(Divisional) (Network)
'
Control architecture
Responsiveness increases
SIMPLE ADVISORY
UNITARY BOARDS*
BOARD (I C) (2Cb)
(Note I)
UNITARY (2Ca) COMPOUND
BOARD WITH BOARDS
COMMITTEES (3C, 4C)
Higher integration
Highest integration
Highest diversity
(Decentralisation)
More responsive
Most responsive
Highest diversity
(Decentralisation)
*Advisory boards are established by the grace and favour of management, unlike a compound
board established by tbc corporate: charter and/or stockholders to obtain ffom
management or cvl.!n the executive board, e.g. supervisory and
1
'watchdog" boards established
in Europe or a keiretsu council in Japan. Refer also to Guthrie & Turnbull (1995).
by the author compares four types of management structures with the analogous four types of
comroi architecture. Tbc purpose of the Hgure is to illustrate how the degree of diversity and
lntcgmtion in the four management structures, mirror the degree of diversity and integration
149
CHAPTER 4
with the ditTerent types of control architecture. An N-Fom1 management structure can
become compound board (3C or 4C) to allow a merging of management structure and control
architecture to create the highest degree of diversity and integration.
4.2 Development of corporate concepts
4.?.1 English origins2.;
The concept of creating an artificial entity with its own name, signature and the rights of
perpetual succession evolved in England. Corporate concepts evolved not from commerce
but for political purposes and administrative convenience.
The concept had its origin in the 12th century when the English sovereign issued 'Letters
Patent' to delegate some of his suprt!me temporal and spiritual powers to Monasteries as a
basis to legitimate their right to exist and obtain some operating discretions. Letters Patent
were also used by the sovereign to bestow monopoly-trading privileges on favoured subjects
who supported the sovereign in some way. The origin of modern patent laws can be traced
back to this practice.
Corporate concepts evolved from 'Letter Patents' becoming a Royal Charter to recognise and
limit the rights of self-management of social institutions such as towns, guilds, universities,
boroughs and local government bodies in general. The charters were issued to the boc(v
politic. which becomes a boc(r cmporate distinguishable from its component members. The
Sovereign in etTect licensed the right of social institutions to exist and operate in his or her
realm for the purpose set out in the charter on specified conditions.
The charters perpetuated a 'world view', that authority flowed from above to lower levels
consistent with the Christian Church and a sovereign with absolute temporal and spiritual
power. Citizens had no rights to change either their god or their monarch. When
corporations developed to create shares and shareholders, their rights to change their
:?A This section is based on Burton (1933), Rccs (1934) and Unwin (1904).
150
THE F:VOLUTI()N OF Al'\D COMPOUND BOARDS
'governors' was likewise not entertained. The constitutions of prtvate companies in the 20th
century would often make provision for a 'governing director' with life tenure.
In 1504, the English sovereign established his authority to supcrv1se the operation of all
guilds and trade wjthin England. This was nine years after the Pope had decreed that all
international trade be divided soley between Portugal and Spain. At this time the Pope mised
money by granting monopoly"ttading rights within and between countries. The head of the
Church of England follO\\'Cd lhis practice when it was formed in 1536.
The Engiish sovereign granted to groups of merchants and investors monopoly rights to trad..:
with specified territories, In this way, the sovereign avoided English merchants competing
among thl!msclvcs instead of competing with Portugal or Spain who the Pope had given
trading monopolies. The Portuguese and Spanish sovereigns directly fimmced their trading
\'Cnturcs and so did not need to provide authority to their citizens to undertake trade under a
charter and occupy forcigH lands in the name of the sovereign.
The English sovereigns granted charters in return lOr a shan: of trading profits coll..:ct<:d in the
form of customs duty. The incentive to gmnt a charter wtts to finance both the sovereign and
the building of the British Empire. In other words, the English privatiscd the cost of building
an empire \Vhilc Portugal and Spain built their empires on a 'socialis.cd
1
model with direct
control and funding. The first English charters were granted at the end of the 16th century for
trade with Russia (1553), Africa ( 1553), Turkey ( 1578), Sc;mdinavia ( 1579), Guinea ( 1588)
and the British East India Company (1600). These charters granted rights
between England and the specified territory to a body of people who did not obtain any
property rights in any company hut only in the trading ship and its cargo which they financed.
The East India Company charter was granted, for example to 218 persons who became
associated with The Governor and Company q{lvferchants of London Trading into the Easr
Indies. It was not initially a corporate entity separate fiorn its members. A 'Court of
Governors' controlled the company \Vho maintaint-d monopoly rights for indivldual members
151
CHAPTR4
to trade with India until 1813, However, there was no fixed investment in the company.
Money was raised ifom members for each trading voyage ns an unincorporated joint venture
with the profits fully distributed after each venture,
The Court of Governors hod the power to call up additional investment funds even if a voyage
Htik"<.l. The need for investors to obtain limited liability was to protect them from such calls
from management, not to protect investors ifom creditors, Limited liability for investors who
were described as 'venturers' was obtained by Royai Decree in 1662,
The introduction of limited liability assisted in making the interest of venturers negotiable.
This facilitated the negotiability of interests nt the coffeehouses where debts of the sovereign
were brought and sold. The ability to exit an investment in a company \Vith perpetual rights
assisted in raising non-refundable contributions. However, it was the Dutch East India
Company who first issued shares in 1609.
From the late 16
1
!! to the tirst half of the 17
1
" century, before shares had been introduced !o
Englund, there were no owners. The Corporate Charter was obtained as a licence to manage
andior establish activities, which had political significance, be they for religious, educational,
trade or local government purposes. Corporations whlch created profit making opportunities
for investors would promote the formation of time limited syndicates which operated in the
name of the company. Venturers who might <let as lead investors for silent partners described
as "under-venturers" financed the syndicates.
\Vhen shares were established later in the 17th century, lead investors would become directors
to establish "shareholder control" (refer to Figure 4. f). The board of director.:; was d!!scribcd
as a "Coun of Governors" consistent with the political objectives of granting a Royal Charter.
Companies fonned to trade with foreign lands obtained the authority of the sovereign to
govern the relevant portions of those lands. For example, The East India and Hudson Bay
companies were formed in the 17th century and the Van-Dicmans Land Company in the 19th
century. Consistent with the imperial ambitions of the sovereign. the charters did not permit
152
TilE EVOI.UTIO:"f OF CORPORATIONS A:"D C0:'\1POUND BOARDS
companies the right to mortgage their land so as to avoid any newly established colony
being acquired by a foreign money lender as a ''mortgagee in possession''.
The motivation for the sovereign to charter a company arose from the: (i) Opportunity to raise
funds for the government (e.g. import royalties or through note issue by the Bank of
England); (H) Need to control significant community services such \Vater supply, insurance,
roads and later canals; and (iii} Opportunity to expand the realm. ln 1627, Parliament took
over the power of the Sovereign to grant monopoly rights, except for patents.
The right to fOrm a company was a licence to carry out specified activities on specified
conditions, which furthered the interest of the sovereign or Parliament. This situation also
applied in the USA. However. after the War of lndependence, there was no sovert.::ign with
rights of perpetual succession and there was an additional concern that any licence to operate
could allow fOreign interests to transgress their m!\vly won political independence.
Local control could be assured by chartering companies for a limited time. Renewal of the
licence to exist and operate was subject to (he periodic revie\v by the local polity. In
many cases the licence to operate was not renewed. In this way. 1nffnstructure financed by a
company could became a public good in the same way as an invention became public
property \Vhen a patent tenninatcd after 20 years. Toll roads and canals became pubiic
property in this way.
By the beginning of the 18th century there were around 150 joint stock companies operating
in Engl<md with investment fUnds of around stg5 million, They included
firms established for domestic ventures such as insuranct:
1
the supply of water to London and
stgl,250,000 invested in 1699 to establish the Bank of England. The Bank of England was
granted a charter to provide funds for the sovereign to fight the French. The incentive tOr the
Sovereign to grant a charter was a source of funds and/or extending the domain of the empirc.
However, charters were also granted to fund what would now be described as 'infrastructure'.
153
CHAPTER4
The South Sea Company was formed without a charter in 17 I 9 and failed the following year
after spectacular trading in its shares. As a result, in 1720 the "Bubble Act" was introduced to
effectively inhibit the formation of unincorporated companies. Without the ability to form
common law companies, there was neither the need nor opportunity fOr two tiered boards to
develop in England as the industrial revolution got under way.
At this time, England was relying on custom created civil law companies. The first Joint
Stock Companies Act to allow the fonnation of civil law companies without an Act of
Parliament was introduced in 1846. Even though all investors had unlimited liability under
this Act, over two thousand companies where incorporated during the following years until
limited liability was introduced in 1855. These enterprises were mainly involved in public
utilities, shipping and insurance with ownership separated from control.
As the sovereign had the rights of perpetual succession, the sovereign had both the incentive
and the power to create charters with the rights of perpetual succession. Sovereign control of
all social institutions was envisaged to extend in perpetuity. Likewise permanent existence
was envisaged for the social institutions created by the charters. As a result, many corporate
charters, which brought finns into existence, did not possess any time limit. However, all
charters providing exclusive rights to inventions were time limited as were all copyright to
music and the written word.
As there was no political incentive to limit the existence of towns, guilds and universities and
local government bodies, they obtained charters with rights to match the perpetual ambitions
of their sovereign. As corporations obtained charters to extend the British Empire, or provide
domestic public infrastructure in the fom1 of water supply to London, banking, and insurance,
there was likewise no incentive to place a time limit on their licence to operate. When the
formation of social institutions was taken over in the 19th century by an elected legislature,
the practice of providing civil Jaw corporations with rights of perpetual succession was
continued.
!54
TilE EVOLUTION OF CORPORATION'S Ai'<D COMPOUND BOARDS
The nature of ownership and control changed during the dcvelopmc:nt of the corporate
concept This is indicated in Figure 4,2, 'Evolution of "Anglo" corporate architecture'
prepared by the author. In the l6
1
h and centuries, the captain of the ship or fleet, managed
the venture. This separated ownership from cotltrol from all the investors. Later, when
domestic ventures became publicly tUnded, lead investors would constitute a "coun of
governors" tO hire, direct and monitor management as shO\vn m the top mi-ddle panel of
Figure 4.2, In Europe, the development of the corporate concept under common law rather
than civil Jaw as discussed above resulted in lead investors forming a supervisory board as
shown in Figure 4.3 in the next section.
Figure 4.2, Evolution of ''Anglo" corporate control architecture
Chartered or Special Act Company Act
16th, 17th, 18th & early 19th Century
late 19th Cen1u;y
Shareholder Lead shatehO!der Entrep:encuria!
con:rct (A3-4} COnirOI (A3-4) control (A1-2-3}
1 Shareholders
Shareholders' : Sharehc!ders
I
t
'
:'oaru o
BOatd 01
Board
Govenors
Govenors
Enlrepreneur
Shafeholdets
Shareholders
:P:us profess:ona:
(No outslders
'
(No outsiders
advisers
or employees}
' or employees}
'
' :ChaimJaniCh:ef-
'
'
.:>nare..-; Executive:
:::;mps
older/Direclar i
Entrepreneur
Captain
!
j.
Other
Employees I
I Other
Employees
Employees
'
- - - - - - - - - - - -
- - -
Late 19th Century 20th Century
Relationship (or family) Mixed Management
control (A2-3) control (A3} control (A4}
1
I
Shareholders
l
1 Shareholders 1
t
j. j.

Board
Board
Relationship
Sharehold-ers
Chief Executive
investors o: family
plus pro!esskmal
& executives with
plus proFessional
advisers v.ithuut
few o: no shares .
.advisers 'J.i1hout
t;:hares {no
Professional
shares
employees)
Advisers with

I
Managing Director
some
indepcodems
(without shares)
with no shares
t
j.

v"'"'
I
I emp1oyees,
Employees Employees some with shares
15:5
CIIAPTER4
In England, individuals with investable funds were the elite, landed gentry and those with
inherited wealth. Corporations provided a way for the emerging merchant class to be funded
by the upper classes. The maintenance of class distinctions was an important influence in the
evolution of English and Australian patterns of corporate ownership and control. This is
evident by the absence of any employees on the boards of English or Australian companies
until the middle of the 20th century. Employees were by definition, \vorking class, or at best,
middle class. Board positions were the domain of those 'born to rule' from the upper classes,
including retired generals.
The need for a Royal Charter or an Act of Parliament to form corporations in England up
until 1846 limited their operations to mainly public services such as water supply, canals,
roads, banking and insurance with ownership separated from control (A3-A4). After 1846
individuals could list their family companies to create (Al-2-3) control as shown in the top
right panel of Figure 4.2. This also allowed the family members to employ a chief executive
as shown in the bottom letl panel. This lead to mixed (A3) control and management (A4)
control commonly found in the 20'
11
century as shown in the last t\vo panels of Figure 4.2.
As the power to make civil laws moved from the English sovereign to Parliament during the
18th and 19th centuries, the granting of charters became more dependent upon obtaining
political support. This limited the activities for which charters could be obtained. It was not
until incorporation became possible without a Charter in the late 19th century that family
dominated public enterprises developed as shown in the first bottom panel of Figure 4.2.
Only family members of lead shareholders would become executive directors. Non-family
chief executives would only become general managers. The various patterns of ownership
and control arc labelled with letters and numbers according to the typology developed in
Section 4.1.1.
The corporate concepts developed in England were exported through colonisation first to
North America and then to a number of other non-Anglo cultures. Table 4.2, 'Number of
156
THE EVOLUTIO;>; OF CORPORATIONS AND COMPOUND BOARDS
listed "Anglo'' companies' includes over 50,000 publicly companies of which two thirds can
be identified as being Anglo" cultures or fonner colonies (FfVB 1999). This helps explain
why the study of finns with two or more boards is a neglected topic -of research. Firstly,
because most scholars interested in the theory of the tinn arc based in Anglo cultures, and
secondly, because the existence ofnvo or more boards within investor owned .firms is limited
to n o n ~ Anglo cultures. Anglo cultures do have companies controlled by two or more intemal
boards, a.<> shown in the next Chapter, but these were employee owned and not publicly
traded. As noted earlier, this contributes to such !inns being neglected by scholarly research.
Table 4.2, Number of listed "Anglo" companlcs
IVIUJOr '"AnglO
countries and
former colonies
India
USA
Canada
United Kingdom
Australia
Egypt
Malaysia
South Africa
Hong Kong
Pakistan
Singapore
New Zealand
---rot at
:Others/non-Anglo
4.2.2 Austmlian dcvclonmcntsJ5
!
I No. or nstco
, domestic
! companies
I
15,239
8535
2,768
1,957
1,162
869
728
642
665
389
312
122
33.388
16,992
Source: FIVB 1999
Australia and North America provide examples of countries that developed their corporate
concepts from those established in England. In Australia, \Vestpac Limited bcgrut trading ln
1817 as an unincorporated association of "proprietors" known as the Bank of Nc\V South
\Vales. A special act of the New South \Va[cs Parliament in 1850 incorporated the bank and
so provided the Proprietors with limited liability. The NS\V Parliament passed a ''Company
Acr' in 1 8 4 ~ but it did not provide for Iimited liability. Limited liability and the facility to
fonn Co-operative Societies were provided in } 873. These initiatives followed the fonn of
their English precedents, which vested most powers with a single board of directors. Sliding
25 This section is based on Huberich {1912), Mason (!974: 1-1 l) and Shano (1930).
157
CIIAPTER4
scale voting was used to limit the ability of any one shareholder to challenge or change the
directors of public and/or listed companit.!s. A common provision was to limit the voting
power of any one shareholder to 25% of all the votes cast. This provision remained with
many publicly traded companies until the latter half oft he 20
111
century.
As in England, the corporate concept was also used in Australia as a means for providing seJf.
govemment for towns. Special acts of the NS. W Parliament were used to create The
Adelaide Municipal Corporation in 1858 and to incorporate bodies for goveming the towns of
Melboume and Geclong in 1858. Like business enterprises it is now possible to incorporate
local govemment bodies in Australia under various local govenunent acts in each state
without the need for a special act of Parliament.
Some of the better known enterprises incorporated by special acts of Australian colonial
parliaments were: The Hobart Gas Company (1854), Australian Mutual Life Society (1857),
Launceston Gas Company (1858), The Gcclong Gas Company (1858), AGL (Established by
Act of Council 8 William IV in 1837 and incorporated in N.S.W. in 1858), The Bank of
Adelaide (1865), Tht.! Newcastle Gas and Coke Company (1866) and the Australian
Agricultural Company ( 1866 but originally chartered in England in 1 824). Both the banks
and gas companies were tOm1ed to service their local communities and all except the
Australian Mutual Life Society had their shares listed on regional stock exchanges. None of
these ventures represented the development of an existing family business tOr flotation on the
Stock Exchange. They were all newly created tOr and by investors with ownership separated
from control.
The class distinction between the landed gentry in Australia followed English traditions.
Graziers dominated the board of many public corporations except those involved in mining
where the nouveaux rich entrepreneurs were also represented. The chief executives of all
Australian banks were general managers. It was only during the 1960s, that some banks and
insurance companies began to invite their general managers to join their board as managing
directors.
158
THE EVOLUTION OF CORPORA TIOi'\S AND CO:\IPOUND BOARDS
4.2.3 US devclopments26
For one hundred years after the American Revolution, citizens and legislators fashioned the
US economy by directing the chartering process. Having expericnced how the English
sovereigns had chartered the East India Company, the Hudson Bay Company and many
American colonies in order to control property and commerce, the revolutionaries did not
give governors, judges or generals the authority to charter corporations. Citizens made
certain that legislators issued charters, one at a time and each for a limited number of years.
Legislators kept a tight hold on corporations by spelling out rules each business had to follow,
by holding business owners liable for ham1s or injuries and by revoking charters.
After the American War of Independence, business ventures needed a licence to operate from
their local town authority or state government. Having fought the English to establish their
independence, the Americans colonies did not want to loose it again from allowing ownership
of their commercial enterprises to revert back to English investors. For this reason and to
keep the authority of a business to operate under constant review, only limited life charters
were provided up until the middle of the 19th century.
Citizens governed corporations by detailing the rules and operating conditions not just in the
charters but also in state constitutions and in state laws. Incorporated businesses were
prohibited from taking any action which legislators did not specifically allow. This is the
doctrine of Ultra Vires found in English and Australian corporations up until the middle of
the 20
1
h century. All states limited corporate charters to a set numbcr of years. Maryland
legislators restricted manufacturing charters to fOrty years, mining charters to fifty and most
others to thirty years. Citizens kept banks on charters with a particularly short period of from
three to ten years. The power of large shareholders was limited by scaled voting as practised
in Australia until the 1970s.
2
6
This section is based on Grossman & :\dams (1993).
!59
CIIAPTER 4
Early corporate did not give !imitt!d liability, only a licence to carry the specified
business for the specified duration. However, judge made law by an elected judiciary
gradually gr..mted more powers to corporations. As noted in Section 2.6.4, corporations
and sold governments" and the history of constitutional law is '"the history of the
impact of the modern corporation upon the American scene", By 1886, the US Supreme
Court recognised corporntions as having the same rights as natural persons and sheltered by
the Bill of Rights and the 14th Amendment. Soon, state legislators were competing \Vith each
other to provide limited liability and unlimited life, \Videspread concern over these new
privilegl.!s for corporations at the beginning of the :20 century a number of States
introducing cumulative voting to elect directors as noted in Section 2.6.4. However, "charter
bargaining" has resulted in n1ost States repealing such requirements (Gordon 1993).
\Vhilc there were significant differences in the development of the corporate concept within
Anglo cultures, there were even greater differences between Anglo and non-Anglo countries
as considered in the following section.
4.3 National difference in control architecture
Significant differences in the ownership and control structure of fim1s exist within Anglo
cultures as well as in non-Anglo cultun!s. In both cultures, fim1s with more than one board
can be fOund. This provides evidence that unitary boards ore not the only way companies can
be governed and companies with more than one board can provide a viable altemative
architecture. Some examples arc described in the following sections to show the need tbr a
framew-ork to analyse and compare tirms with one or more boards.
4.3.1 Anglo
While Anglophile countries generally adopt a centralised 'unitary
1
control sttucture fOr their
corporations, there arc exceptions with customer or employee owned corporations. Even. in. a
culture where unitary boards are the dominant fonns, Anglo tinns, which
are not professional partnerships, invariably possess an internal compound board. Even
160
THE EVOLUTION OF CORPORATIONS AND COMPOUND BOARDS
when a unitary board is involved, there can be many variants in the way it operates. Some
may establish board and advisory boards as indicated in Figure 4.1.
A unitary board may establish one or more and/or advisory boards as
identified in cell C2 of Table 4.1. The board may be composed of individuals from any of the
categories listed in column D and be appointed by any type of ownership structure - refer to
columns A and B of Table 4.1.
Shareholder control represented an incorporated fonn of an investment partnership. Lead
shareholder control represented an incorporated form of a limited partnership with a
managing partner. In both cases ownership was integrated with control. As entrepreneurs
passed on their control to their relatives, family control evolved. While the board may also
have extemal directors (3D) any strategic decisions would depend upon
agreement or direction from outside the boardroom. This situation also exists with
"relationship" investors as described in Chapter 2.
When there is a relationship shareholder, be it a family or professional investor \Vith ;;1
controlling interest, then a facto dual board architcctun; is created. The management of the
relationship investor has the power to appoint directors like a supervisory board fOund in
Europe.
Historically, mixed and management control followed as the founding entrepreneurs or
families sold out and/or had their interests diluted with new share issues. Management
control became common early the 20th century and gave rise to the study by Berle and Means
( 1932). However, the separation of ownership and control, described as 3A or 4A in Table
4.1, has existed since investors financed merchant adventurers thousands of years ago. As
noted earlier, this was the typical fOrm for the early civil corporations, which developed in the
17th century as shown in Figure 4.2.
161
CI1APTER 4
However, the development of invcstm.cnt institutions in the latter half of the 20
1
" century has
introduced an additional level of separation between ownership and control in the leading
Anglo countries such as the USA, Canada, and Australia. Since Drucker ( 1976) wrote about
"Pension fund socialism'' the extent of institutional investment in the lJSA has more than
doubled to around 60% in value of all publicly traded shares.
ln Australia, the Investment & Financial Services Association (IFSA} gave evidence to the
Australian Parliamentary Joint Statutory Committee on Corporations and Securities that their
60 members held bct\\'Cen 40 and 50% in value of all publicly tradt.."\1 shares on the Australian
Stock Exchange (JSCCS 1999), If fOreign institutions were included then the value would be
in excess of 60% (JSCCS 1999). According to Stapicdon (l999), foreign and domestic
institutional investors hold around in value of all publidy traded companies in the UK.
Utilising the infOrmation provided in Analytica ( 1992}1
7
the author has prepared Figure 4.3,
'lntemational cornnarison of control architccturc' to illustrates ditTcrenccs in the control
architecture of fim1:s \Vi thin and between some coumrtes. Figure 4.3 shows the vurious fonns
of supervisory boards fbund in Europe discussed earlier and included in tho..: 'Ownership and
control taxonomy' of Table 4.1. The non*Anglo architectures .shown in Tabk: 4.1 ure
discussed in Iuter sections.
\Vhilc Japanese countries have a unitory board like Anglo countries their control architecture
becomes quite different when the fim1 is pan of a keiretsu, us indicated later in this Chapter in
fjgurc Publicly traded examples of all the different architectures illustrated in Figure
4.3 exist except tOr the one described as "Anglo \Vith Senate".
There is no legal impediment in Anglo countri!.!s for corporations to adopt alternative Jbnns of
infOrmation and control systems such as illustrated in Figure 4.3. (Employee owned fim1s
have adopted compound boards in Anglo countries as detailed in Chapter 5.} Advisory
27
1he passage of time since this survey was undcnakcn is not com:cquential to the discussion.
28
The architecture ofkeire1su illuslrated ln figure 4.4 is compared with tbc MondrngOn. control .system itl
Crwpler 6.
Hi!
TIIE EVOLUTION OF CORPORA TIO:":S A!\:D BOARDS
boards are common with banks, especially those operating internationally. BefOre it
mutualised, the AMP Society in Australia had advisory boards in each state. The NS\V
Teachers Credit Union has an Audit Review Board independently appointed by its members.
The author established a compound board in the tbnn of a 'corporate senate' for an Australian
start up company in 1988, lt allowed less costly equity funds to be obtained from US
investors (Turnbull 2000b). Its establishment did nnt require any change in company law-
only shareholder approval to change its Articles of Association.
Figure 4.3t International comparison of control architecture
Angto Anglo with
Senate
Dutch/indonesian
II
SharehOlders
I
SharehO!detS
I I
Shareholders
I

: , l I
(No employees: :
' Board
I
or assoda:es;;
'
t
'
'
I
Board
I
: boaro I
: of executives
I -l
f j
'
' Emp:oyees Employees I
'
'
'
Japanese companies have similar architecture bvl w:Jil c;.vi!e a d:fferenl
ownership structure and relationships, \Vith !he result that !heir governance
information and control systems converge wilh thal found in
German French
French#
Traditional Optional sincc-1966
I
101uers I
(bearer shares)
1

{bearer shares}


1
(bearer shares)

+

t
"
I
'
""
Comptes
I oe, I
'
l:'onseu _ue
Compte
1 (outsiders &
'
(State Survei!iance
'
d'Administ-
(Stare
' employees) ' owned)
' '
' '
ration owned)
r::::L"":.l
#Censeur

(Fillar,c;m
'
PDG I
insfitu/lon)! !
'
_ ... 1 exectJt1ves
'
'
--
I .,o,.s,j
I I
council
+
t
"'-
I
t::mptoyees 1-- 1 t:m;Myees 1 l t::mp oyees 1
#A ''watchdog
8
, audit comm!tlee or Kcorporale described as
des Comptes" in State controlled companies and KCenseursN
in financial institutions, creates a three tiered board system.
PDG = Prcsident-Din:-ctor-G-enera1 (Chairman & CEO)
)63
CIIAPTER4
The objective of establishing the 'senate' as a 4C type of compound board was to provide
superior investor protection for a new share issue. A majority of the directors had related
party interests (4D) when a substantial ownership spread (3A) existed. Superior investor
protection was providt.::d by the senate having veto power over any action of the directors
involving a conflict of interest and by the three Senators being appointed on the basis of one
vote per investor instead of one vote per share. One vote per investor meant that senators
could protect the interest of minority investors against any related party transactions with a
majority investor. Only individuals, who had no related party interest with the corporation
(3D), were eligible for appointment as senators.
The senate had no other powers except the ability to report to shareholders, independently of
the board. However, its veto and reporting powers allowed it, in effect, to carry out the roles
of audit, remuneration and nominating committee as all these functions involve the directors
with conflicts of self interest and loyalty with their colkagues. To assist the senate in being
properly infom1cd about any actual or potential conflicts of interest, directors were appointed
by a fOrm of proportional representation described as "cumulative voting" (Bhagat & Brickley
1984; Gordon 1993). This system of voting avoids an "elective dictatorship" Hailsham
( 1978: 125) and so protected directors from being dismissed by one or more influential
shareholders \vho may object to a director blowing the whistle to the senate on any related
party transactions and! or those actions not in the best interests of company as a whole and all
its shareholders.
4.3.2 Dutch and Indonesia
The citizens of Amsterdam who had established the first public bank in 1609 established the
Dutch East India Company in 1621. While the bank did not initially issue paper money, the
Dutch East India Company pioneered the issue of shares. As a common law organisation, it
provided limited liability to investors by separating ownership from control with a two tiered
structure as indicated in Figure 4.2.
164
THE OF CORPORATIONS AND COMPOUND BOARDS
Such two tiered boards are still found in Dutch companies and in its fonncr colonies like
Indonesia, In cell 3C of Table 4. 1, these are described as a dual or binary boards. When then!
is this type of a dual or binary board, the supervisory board appoints the management board
and members of the supervisory board cannot be a member of the management board.
As at 1991, there were !87 companies listed on the Amsterdam Exchange (\Vymccrsch
1994:87). Royal DutchmShcll accounted for 34% of total market capitalisation with four other
companies contributing another 20% of the total market capitalisation. The remaining 46% of
capitalisation was shared among the other 182 listed companies. By 1998, there were 212
companies listed on the Amsterdam Exchange (FIBV 1999}.
4.3.3 German
Larger Gennan public companies have two tiered hoards, which evolved from their common
law progenitors. Comrnon law companies were created by investors contracting together to
establish enterprises. \Vhen legislation for stock corporations in Prussia was introduced in
1843 there was a legal vic\v that companies represente-d a contract urnong shareholders who
would be viewed as the true owners of the company's assets (Baum, 1994: 39). This !ega!
doctrine was abandoned after the First \Vorld War. However, theorists
commonly conceive of a firm as a "nexus of contracts"' as discussed in Chapter 2.
Gem1a11 law considers other stakeholders, especially employees, to be members of the firm.
This view had its origins from academic proposals in 1835 to create
1
'workcrs councils''. ln
1835 when the first elected Gennan Parliament met in Frankfurt, it rejected a law 10 provide
for worker representation (Rcichsgcwerbcordnung) in finns. However, a number of
companies considered it in their own sctf.interest to appoint representatives of their
employees andior their unions to their supervisory boards (Pcjovich 1990:67). Increasingly,
companies and their shareholders behcvc that it is in the best interest of investors to share
ownership as well as control with employees. This is evident through the spr!.':ad of Employee
Share Ownership Plans (ESOPs) and employees being appointed as trustees lo share plans
and superannuation funds (Blair & Kruse 1999).
165
CHAPTER4
The first \vorks council Law was enacted in Germany in 1920. Co-determination was
introduced with a 1922 law requiring one or two employees be appointed to supcrviso1y
boards (Aufsichtsrat}. AHer the Second World \Var, the allied military government further
strcngth-=ned the l;:;ws on works councils and co-determination.
The Works Constitution Act of 1952 provided for workers to obtain rights at the individual,
plant and supervisory leveL At the individual level, workers obtained rights to information
and terms: of employment. At the plant level, employees obtained the right to elect a works
councH to represent their social interests. At the decision-making level, firms that employed
more that 500 people have one-third of their supervisory boards elected by employees by
secret ballot. Unions do not have a statutory right to appoint representatives but individual
companies may provide this.
The Act of 1976 all firn1s employing more than 2.000 employees
to have a supervisory board of 12 members \vith six elected by employees. Other members
and the chairmanj \Vho has a casting vok, an! dected by shareholders. There are only about
500 finns which employee more than 500 people.
No individu<Jl can be on both the management board (Vorstand) and supervisory hoard.
Members of a supervisory board can be appointed for up to four years and members of the
Vorstand cannot be appointed fOr longer than five years. Shareholders determined the
remuneration of supervisory board members and the supervisory board dctcnnincs the
remuneration of members on the Vorstand. The supervisory board can dismiss members of
the Vorstand. Members of the supervisory board can be removed by a 75% vote at a
of shareholders (Hauptversamrnlung).
The auditors report to the supervisory board, which has veto powers over the Vorstand.
Major strategic decisions requtre the approval of the supervisory board. The Vorstand
166
THE EVOLUTION OF CORPORA AND COMPOUND DOAROS
operutcs more as u team of cqun1s rather than as a management hierarchy. There are few if
any comminces fonned by either board,
ln many companies. non-voting, restricted voting and multiple voting share structures restrict
voting nghts, so that the company is controlted by a small blocks of shares (Analytica 1992:
80), Only a smaH number of listed companies have divers:itled ownership (Becht & ROll
1999}. Corporate are common and cross share holdings between rdatcd
enterprises is commonplace (Baum 1994: 52, Analytica 1992: 83). Banks exert great
influence through voting the bearer shan.$ deposited with them by their clients and to a lesser
extent from their mvn holdings of corporate equity, Banks represented more than four-fifths
of oil votes present in meetings with voting rights highly concentrated in the three largest
ba11ks (Baum 1994: 45} as indicated in Table 4.3. "Nature ofGcnnan and UK ownership' as
prepared by the author tfom data in Analytica ( 1992:80). The Table shows the dominance of
pension fund investors in the UK who generally act as passive investors with only a minority
exercising their vote, This compares with the active block holders who can act !ike a
watchdog board in Gcnnany, France and other countries in continental Europe
Table 4.3, Nature of German and UK ownership
1 :,.narc 10Jocrs :'taturc : ucnnany Ul<.
ll'OfCigncrs tL ' 2U':'/o ll%
'
nvatc mvcstors lL
'
!U% .:!1'/o
'
'
1 tsanKs
,,.
' Yo -
'
1 Lorporate

'
>"''
-
tunds iJo
'
Jc/o bl%
'
nsurancc cos, tlj
I
J%
-
! ;,tate & 10ca gov. ' I/o -
'
'
lUiAL lUV% lUU"
4.3.4 French
French corporations have two basic types of control architecture as outlined in Figure 4.2.
Only a small minority of the 914 listed domestic companies has adopted the optionul
arrangements introduced in 1966. However, three tiered control structures exist in the state
owned sector and with financial institutions in the private sector.
167
CHAPTER4
To quote from Analytica (1992: 96):
France's mode of corporate governance mirrors its political institutions m
two important ways:
- In keeping with France's 'Caesarist' tradition, nmmng from Louis XIV
through Napoleon to De Gaulle and the constitutions of the Fifth Republic,
the President-Director-General (PDG) has absolute power over the board of
directors (usually known as the Consei! d'Administration) and over the
shareholders assembly. The PDG of one of France's leading industrial
groups argues that France is the only western country where one man
determines the strategy of the company, executes it and controls it, without
the counter-power of the board of directors.
- Centralised power combines with economic tradition to create a mixed
economy/dirigiste culture. \Vhether companies are state-owned or not, the
state plays an important part.
The Conseil d:-1dminstration in traditional companies must have at least 3 and not more 15
members excluding up to four executive members. However, executive members cannot take
up more that one third of its membership. Since 1966 two additional members must be
appointed with one representing stafT and another the workers.
\Vhilc members of the Conseil d'Adminstration are appointed by the general meeting of
shareholders (Assemblees generales), "in practice, the PDG plays the key role in choosing
board members and it is extremely unusual for shareholder ratification to be more than a
fonnality" (Analytica 1992: 97). This situation is similar to that found in Anglo cultures.
French compames have a Comite d'entreprise to represent the interest of employees and
members arc entitled to attend but not vote at board meetings. In state owned companies up
to four employees are elected every three years to the Conseil d'Adminstration. State owned
companies arc much more closely watched and arc more accountable through the existence of
168
THE EVOLUTION OF CORPORATIONS ,\ND HOARDS
the (.'our des Comptes. Members of this watchdog board ar(! magistrates trained at the
Grande Ecoles who have access ro all documents for a thorough financial audit.
The ownership structure of French companies can provide support to tbc PDG, which is not
generally available to chief executives of Anglo companies, Unlike Anglo -corporations,
which typically bave a highly dispersed (4A) and passive institutional ownership, the majority
of French listed companies have a controlling shareholder (A2), French companies also are
likely to have trading partners as significant minority intcrl!sts as well as the investing public.
This creates a mixture of 2Aa and 2Ab ownership. Representatives of the significant trading
partners are provided with board representation (Analytica !992: 28).
French companies have n high degree of both interlocking directors and ownership. Just 20
pcoptc accounted for I J% of alt board positions of the top l 00 companies by capitalisation,
Only 797 individuals occupied all the l,l6l board positions in these top 100 companies
(Analytica 1992: 99). Many of the bigger companies have listed fess than l 0% of their
equity, "Of the largest 200 companies, 60% arc ti:trnily-controllcd, although many of these
an: at least partially quoted and some arc controlled by families holding fewer than 5% of the
shares", There <lre three devices to maintain tight control according to Analytica (1992: 100):
.autocontrolc, the reciprocal holding of shares with a parent company; in this
way, most of France's largest companies effectively hold shares in
themselves; the verrouillagc system, in which shares arc
1
parkcd' with
friendly companies; and the cascade system and the rus:,
both of which involve complex patterns of share holding designed to allow
control to be concealed or held via a very small stake. An estimated
thirds of the Paris Sours.! fb.lls under the vcrrouillagc system.
In 1966, the French introduced a supervisory board structure with similar distinctions found
in German companies. refer to Figure 4.2. There ls a Directoire consisting of two to seven
members appointed for renewable terms of two to six years by the Co1tseil de Strrveiflance, a
supervisory board of not fewer than three and nor more than 12 members who must be
!69
CHAI'TI::R 4
shareholders, The members of the Directoire need not hold shares and can be salaried
executives. No person can be on both the Directoire and Conseil de Surveillance, Unlike the
Gcnmm system, members of the DirL"Ctoire obtain some degree of independence as they can
only be removed by a meeting of shareholders rather than by the supervisory board.
A ccnscurs acting as a watchdog is created by the constitutions of insurance companies, banks
and financial companies. The corporate bywlaws define their role in supervising aspects of
operations. Censeurs can act on their own initiative or at the request of the board. Members
may attend board meetings but not vote. This provides a entry point for eminent persons to
become involved in the governance of the business.
The directors of major comptmics may also establish Comittis de direction as consultative
bodies with important shareholders and executives. Other specialised advisory stmctures are
also common in the larger French companies to provide guidance on R&D, technological
impacts, micro or macro economic developments and political issues, All listed French
companies tnust also appoint a Commissait aux comptes to check all accounts and infOrm
shareholders and the comirC d't.mter;mse and :he judicial authorities in the ens;; of
wrongdoing, The CommisstJir aux compt<?s i:s cntitkd to obtain any COf110rate document.
The buckground of the controllers is significantly different in French companies from those in
Gcnnany. Over half the directors of French firms are graduates of elite tertiary educational
institutions whereas 25% of Gcnnan directors started as apprentices (Analytica 1992: 93).
The elitism of French controllers is also illustrntcd by the fact that 36'%. enter the firm as
directors compared with only 16% in Gcm1any (Analytica 1992: Ill). The Germans arc still
behind their counterparts in Japan where nearly all directors arc S1.mior managers or fom1cr
company c:mployecs. The remuneration of PDGs is kept secret and it is permissible for them
to have private interests with the firms, which they direct.
170
TilE EVOLUTION OF CORPORATIONS AND CO:'\tPOUI"\D BOARDS
4.3.5 Japanese
As well as appointing a board of directors, Japanese corporate law requires shareholders to
appoint a kansayaku, which is a board of statutory auditors. The kansayal.:u is in addition to
the statutory auditor and any internal auditors, which are fOund in Anglo companies and from
which it will obtain reports (Charkham 1994: 92). Unlike Anglo statutory auditors, members
of a kansayaku have the power under Articles of the Japanese Corporate Code to audit
the execution of the directors' activities, attend directors meeting and report to shareholders.
This includes advice on the business being conducted in accordance with applicable laws and
the company's regulations and in the best interest of shareholders.
However, Charkham obtained evidence that while the kansayaku, like the AGM, has statutory
powers, it is considered "bad manners" tOr these to be exercised. However, some companies
take the role of the kansayaku seriously enough to appoint at least one member
to its board. Francis (1997: 58) reports that the Japanese Code was amended in
1993 to require that at least one member of the kansayaku be independent of the executive.
infom1ation and control arrangements of Japanese compames can be much
marc important. Sharehold!.!rs of an industrial group described as a keiretsu may meet
monthly or even weekly to provide advice to the chief executive who is described as 'the
president'. The keiretsu may be led by a leading bank or trading house. Its members arc
other lead suppliers and customers who have cross share holdings. The presidents of keiretsu
finns meet as a keirestsu council, which acts like a supervisory board. However, its members
have greater industry knowledge and authority of the business than members of supervisory
boards in Europe.
Analytica (1992: 130) states that: "It has become standard practice among Japanese
companies to exchange small amounts of stock with lenders and business partners as a gcsturc
of goodwill, sincerity and commitment". The cross shareholdings among business partners
(illustrated in Figure 4.4) cement good relations and provide a basis fOr mutual support and
growth. These shares are rarely sold creating a stable of block of shareholders that typically
171
CBAPTER4
own 60% to 80% of all shares. Only 20-30% of all shares tend to be in general circulation.
"Banks own 22% of Japanese equity and their strategic sharc:holdings in important and related
keiretsu companies is a key part of the keiretsu system" (Analytica 1992: 137). Analytica
goes on to state that "About 85% of bank stock was in stable share holdings, as against60A
for all Tokyo stocks, making the banking sector the least liquid in the market
11

\Vhilt: individuals arc by far the greatest number of shareholders, they are minority owners.
Many of the individual shareholders are past or present employees of the company. Around
90% of Japanese employees have shares in their employers, the highest participation rate in a
developed economy,
Employee participation is also part of the Japanese culture. Unlike all orher modem
economics, the Japanese belief system places its faith in hundreds of deities who are
interdependent Children grow up in a culture where the natural order of things is that there is
no central controlling deity except their Emperor. As a result, Analytica (1992: 133-4) states:
Long-!Cml planning reaches far down the organisational structure of
Japanese corporations because a consensus' method of decision-
making is almost universal among major Japanese fi1ms". While the ovcml!
direction is set at the top, proposals and ideas to implement these decisions
often emanate from lower-level meetings and must be 'approved' by all
members of the group before being up (approval if affinmHivc in
that each employee must afnx his personal stamp to the \\Titten proposal, a
system known as ringislto),
Figure 4.4, 'Anglo and Japanese dispersed ownershin and control constructed by
the author from information in Analytica (1992: 129-47). It shows the richness of the
information feedback and control channels of a keiretsu compared these with those in a
typical Anglo tirm with dispersed (4A) ownership. The nature of Anglo owners is as
principals (26} and agents (38) while Japanese owners are mostly trading partners {48) and
employees (I B). As a result, controllers of Anglo corporations are agents and fiduciaries (3D)
!
"'
,_
THE EVOLUTION OF CORPORATIONS AND COMPOUND BOARDS
and some executive directors ( 1 D), while Japanese controllers arc mainly operational
stakeholders (40) and employees (I D).
Figure 4.4, Anglo and Japanese dispersed ownership and control architecture
Anglo
(Owners not related)
'
0
'- -
not ilwohrd in
: owncn.hip or comrol :
;f!c: f_ai!u;c} _:
Sh311.'holders
Volatile l<itlmut
ind<tstry
knowledge.
rc"l\lrcc' ur
l<l
improve
:\b,cnce of huiltin douhlc ltl<)p <Nner,hip
and comrol networks or lOp level
of ional tra<Jc intcll igcncc
LC"gcnd
S ""Slflplicr Owncr,hir
Cmlol:ltcr - --
S<lurcc: Anal;tic:. 1991
Japanese Keiretsu
(Related party owners)
Bank or Trading
!louse servicing
all mcmlxrs
Shari."S to
cmp!O}'CCS 311d
"ill'
tradin): panncn;
,\lomhly aml ncn "cclly mcclinl;' OJf
keiretsu councils and a variety of other
nctw<lrb imohing from hank,
hnu\c. 'uflplic" "ntlcu,!<lmc".
The cybernetic and competitive significance of the rich information fCcdback and control
channels from operational stakeholders is discussed in Chapter 6. The relative richness of the
infomwtion and control feedback channels available in other countries is next considered 111
an overview of ntltional differences in architecture.
4.3.6 Overview
A summary of how the nature (Type B) of shareholders differs between the maJor share
owning cultures is presented in Table 4.4, 'Cultural differences in corporate ownership and
control'. The author constructed Table 4.4 from infonnation in Analytica ( 1992), \Vhyte
&Whyte (1988), FIVB (1999) and Tables 4.1 and 4.2. It identities how the nature of the
173
CHAPTER4
feedback infom1ation and control channels change between different cultures according to
both the nature of the shareholders and the extent they play an active role in corporate
governance indicated by bold type.
Table 4.4, Cultural differences in corporate ownership and control
Culture
Nature of owner'
Anglo French Gcm1an Japanese
NO. 0 tste compamcs J4,UUU' 14/
1uovemment ptlJ 1 tvegugwte 1 muucnt1a !'iODC
1 tsank(SJ (4tsb!J 1 None None lnttucnhal llnttucntlal
1 customers supp ters ew ommon Lommon 1 l\'1 aJonty
1 Corporate;nuntiy Jtta)Orlty maJOrity 1\'JajOrity ILommon
1 JnstJtullons & tunas (Jts) 1some Mmor Negligtote I
ma mvestors J iYJIJIOrl{_l' iYllllonty M/1101"/{_l' JHlnOrllJ'
ll:mployccs (ttl) !Some !Some Some 1 MaJonty
Notes:
Shareholders who take an active role in corporate governance in bold type.
Shareholders who do not take an active interest in corporate governance in Italics
Basqueb
_uu
1 one
l'!VOtat
Lammon
one
None
one
At!
aNumbers and letters in brackets refer to the ownership and control taxonomy
described in Table 4.1.
bBasque is the culture relevant to the MondragOn employee/consumer cooperatives,
none of which arc listed on a stock exchange. While suppliers and the MondragOn
bank do not own shares in the cooperatives, these stakeholders participate in the
govenmncc of the cooperatives through "rdationship associations" and "contracts of
association", described in Chapter 6 and analysed in Chapter 7 respectively.
"Details provided in Table 4.2.
<.JActivity of government in corporate governance may not be dependent upon share
holding but by industry networks and personal relationships.
'Porta, Lopez-de-Silancs & Schleifer (1999) found that only in the USA, Canada, UK
and Australia, block holdings by families and corporate interests \Verc in the
minority. Conversely, institutional investors collectively became majority owners.
Included for comparisons in Table 4.4 arc the 200 privately owned stakeholder controlled
finns established around the town of MondragOn. These arc described and analysed in
Chapter 6. The MondragOn fim1s were created in the Basque culture, which is shown in the
last column of the table. Seven types of owners arc listed with their category noted as per
Table 3.1. Each cell in the Table describes the degree of ownership for of each type and each
culture.
Table 4.4 shows that finns in all cultures typically have "relationship investors" who take an
active role in their control. It is only in the USA, Canada, UK and Australia that the extent of
institutional investment is sufficient for them to collectively own shares that represent a
174
THE EVOLUTION OF CORPORATIONS Ai'iD COl\IPOUND BOARDS
majority in publicly traded corporations. Influential sharcholdings by families and corporate
interests introduce the possibility of related party transactions to extract shareholder value.
On the other hand such shareholders in Anglo cultures may also act like a supervisory board
to reduce self-dealing by managers and mediate their conflicts of interest discussed in Section
3.7.
From a cybernetic perspective, Anglo tinns are at a disadvantage by not having the
involvement of shareholders that arc customers and suppliers to obtain feedback information
on their performance as discussed in Chapter 6. However, the presence of related party
activities with influential shareholders may also lead to extracting shareholder value. A
balance of interests is required like that found in Gennany and Japan which have both trade
related shareholders and banks or corporate block holders as shown in Table 4.4 to mediate
related party dealings.
The Table explains the finding of Porter ( 1992) who recommended that US finns involve
their customers, employee, suppliers and community in their ownership and control
architecture as found in continental Europe. This recommendation was made on the basis that
fim1s could obtain and provide infonnation by this means to improve their competitiveness.
However, the Porter recommendations of having stakeholder representatives on the board
would compound the conflicts of interest problem and be inconsistent with the observation
made by Williamson ( 1985: 308) who stated that, "Membership on the board, if it occurs at
all, should be restricted to informational participation". However, both Porter and
\Villiarnson were making their comments in the context of a unitary board. The use of a
compound board provides a way to manage the conflicts of interests constructively, as
suggested by Pound (1992: 83). It also allows the participation of stakeholder to be kept on
an informational basis as suggested by \Villiamson and demonstrated in the case studies
considered in following two Chapters.
The next Chapter 5 illustrates how it is practical to establish internal compound boards under
the laws of the leading Anglo countries such as the USA and the UK. All four examples
175
CHAPTER4
involve employee owned finns, which are confronted with the fundamental problem of
resolving conflicts between managers and the managed. The following Chapter 6 presents a
detailed case study of non-Anglo fim1s with complex internal compound boards. The case
studies arc used to illustrate and develop propositions for testing TBA in Chapter 7.
176
CHAPTERS
INTERNAL CO:>.!POUND BOARDS IN ANGLO NATIONS
S.l Introduction
The purpose of this chapter is to illustrate the various ways in which firms can
establish two or more boards and/or control centres in leading Anglo nations where unitary
boards arc the dominant form, Extemal(v created compound boards through one company
sharing control of another are not considered. Two case studies arc provided from the USA
and two from the UK. All four studies involve employee-owned firms. All have been have
existed for more than 30 years to prove their abHity to be viable and competitive. This also
has the advantage that all four examples arc well knovm and documented in the literature.
Besides illustrating the presence and diversity of internal compound boards in Anglo
countries, the case studies provide a basis fOr indicating how the cybernetic fOundations of
TBA can be illustrated with practical examples. The empirical examples also indicutc how
TBA can provide a wuy of investigating the governance of tlnns and provide insights which
might not be otherwise available.
This chapter consists of this introduction, a second section, which presents the two USA case
studies, a third section presenting the two UK case studies and a fOurth scciion, which
revjews the case studies and presents some conclusions. One case study in each country has
thousands of employees with the other having hundreds of employees. Common features of
each of the fOur examples are considered in the last section. Besides illustrating how a variety
of decision making labour can be though a compound board, the examples also
iBustrate a variety of information and control channels consistent with being self-regulating
and as suggested by that part ofTBA developed in Section 3. 7,
The existence of compound boards would appear to be a universal characteristic of labour
owned firms which are not professional partnerships. It would appear that all the htrgest
J77
CHAPTERS
manufacturing and trading labour-mvned firms in the world possess a compound board. Th!.!
possibility that a compound board is a condition precedent for such non-trivial labour-owned
firms to be competitive and sustainable is made even more compelling by their emergence in
cultures where unitary boards are predominant as illustrated in this chapter.
However, professional partnerships, such as found in accounting, law and engmeenng
practices exist without compound boards. Traditionally, these fim1s have taken the form of
unincorporated partnerships, but arc now more commonly found in corporate forms. In
Australia, an unlimited liability form of company is commonly utilised.
However, professional partnerships could be considered as networks of independent
contractors rather than firms in the sense that they do not have master/servant relationships
between contractors, which Coase ( 1 937) considered was the distinguishing feature of a finn.
In other words, professional partnerships can b!.! considered as an a network fim1 composed of
individual contractors that complement each other by fUnctional and geographical
specialisation while sharing common overheads, including employees.
A striking feature of an international survey of worker-owned firms by Bernstein (1980) is
that they all possessed compound boards. A particular striking feature is that this
phenomenon persists even in Anglo cultures where unitary boards arc the dominant forms.
No example has been discovered of a non-trivial worker-owned firm being sustained in Anglo
nations. This suggests the proposition that compound boards represent a necessary condition
for the viability of non-trivial labour-owned firms, which are not professional partnerships.
The proposition can be supported from considering how a compound board can create
different power relationships in a firm compared with one with a unitary board. If a labour-
owned firm adopts a corporate charter with a unitary board, the employees obtain the power
to dismiss the board. The board in tum has the power to dismiss employees to create an
intrinsically unstable situation with tensions and instabilities. Even the potential for
instability may inhibit management from making decisions, which may be unpopular with
178
INTER'iAL COMPOUJ'\D BOARDS IN Al'OGLO NA TIO:'IIS
their colleagues but arc essential to preserve the existence of the business. The lack of
viability and competitiveness of worker-owned firms and industrial cooperatives in Anglo
cultures may well be explained by the option of a compound board not being considered.
All the firms surveyed by Bernstein had corporate constitutions, which separated the power of
management from the power to detem1ine labour relations. In this way, the management
board may not obtain authority to delegate to the CEO the power to hire, remunerate or
dismiss worker-owners. This power is delegated to a special committee/council or board. In
this way a compound board structure is created. In smaller enterprises, the general meeting of
worker-owners takes on the role of secondary board and/or works council.
The need for "an independent board of appeal" was one of "the six minimally necessary
components" which Bernstein (1980: 9) identified as being required for a worker-controlled
finn to "sustain itself through time." Another condition was "that the system of governance,
too, must have its own viability: it must have a self-reinforcing, self-sustaining (cybernetic)
character" (8). Bernstein was one of the pioneers of applying cybernetic principles to
governance, a theme he developed in Guidelines fOr the Design of Economic Feedback
Systems, (Bernstein 1978) written after his 1976 first edition of Bernstein (1980). All the
figures in this chapter of the infonnation and control networks in each worker-owned finn
have been developed from those presented by Bernstein ( 1980).
5.2 US case studics:Z9
The American plywood industry and the American Cast Iron and Pipe Company provide
examples of internal compound boards created in firms within US laws. Each is described in
the next two sub-sections below.
5.2.1 American plywood industrv
During the emergence of the plywood industry in 1920s and 30s, worker-owned finns
developed in the States of Oregon and \Vashington on the US West Coast. Growth in worker-
179
CHAPTER 5
owned finns followed expansiOn of the industry which required little capital investment.
After the Second World War, the demand for plywood declined and the industry became
depressed.
The success of worker-owned fim1s provided a role model for non-worker-owned firms in
distress. This led to the first conversions of privately owned firms to worker-ownership to
prove that labour-managed fim1s were more resilient to an economic downturn. "The ability
of worker-owned mills to survive the severe price-swings characteristic of the plywood
market helped lead to the creation of over twenty worker-owned companies by the mid-
fit1ies" (Bernstein 1980: 14). In 1975, there were eighteen finns which had been in existence
from 19 to 33 years with 80 to 450 worker-owners in each finn. They produced over 12% of
the US industry output.
The information and control architecture of worker-owned plywood mills is illustrated in
Figure 5.1, 'US Labour-owned plvwood fim1s: Infom1ation and control architecture', as
developed by the author from Bernstein ( 1980: 16). To quote Bernstein ( 1980: 15)
The governing process in the mills is based on a circular pattl!m of
authority. The \VOrkcrs hire the manager, set his salary and make all major
decisions on the company expansion, modernisation, diversification and so
forth. Yet on a day-to-day basis they work under the manager's direction.
The directors, elected by the their fdlow workers, receive neither deference
nor extra pay, and continue to work in the plant while serving on the board.
Thus it becomes impossible for them to avoid suggestions from other
workers. Several directors commented on the number of times they arc
"told off' by their fellow workers in the course of a week. Worker-owners
feel tfce to walk into the general manager's office as well with complaints or
suggestions.
29 801h case studies arc based on the work of Bernstein ( 1980) and no updating has been undertaken as this was
JSO
INTERNAL CO:\IPOUND HOARDS IN ANGLO NATIOi"i'S
Figure 5.1, US Labour-owned plynood firms: Information and control architecture
Employees- Shareowncrs meeting
More than 80% of employees with numbers limited to hundreds
One-man one-vote: all hold equal number of shares.
Meets annually or semi-annually and special times.
'
" '
u
'
8
'
Non-cxctutive
'
Works
1\fanagcmcnt
'
"

0
1\lanagement u
Workers
8
Committee "
W Supervises
"
"'
"
"
"
Foremen u
=
u
0
"
Wsupervises
8
Special Company

'>"
0
Dctision Committees
"
<
"
Managers
For example, on
>.
"
" expansion
'\ u
"
.,
of company

"
"'
Admi isters
"
u
g.
Company Officers
-----1

"
(often from among directors)
"" Pres. ,V. Pres. Sec'y. Treas.
'
usually t year. terms

-
'
-
-

/
.
' \:_,y.:C
"<..,\'..':> ....
o_...:\ ....
.... 0
:.,.. ..... . ':}.\'\
Board of Directors or Trustees
,.tiit' .... ., ,ci
{Workers' Council)
:-...'\! . 'Vo
. c\"'
,
5, 7 or 9 worker-directors
with I or 2 year terms
Meet 1-3 times a month
A number of studies have been undertaken of the plywood finns and various degrees of
participation were found. "Much of the success or failure of the worker-owned mills depends
upon the general manager", Bernstein ( 1980: 17). Without exception, the general manager
was an employee, not a co-owner. Unlike traditional chief executives of investor-owned
finns, the general manager did not have power to hire or dismiss employees. The acceptance
of new employees as co-owners was subject to the approval of the members in general
meeting. In this way, a separation of power was created to provide checks and balances.
The general manager had short term decision making powers except over the employment of
the worker-owners. The board monitored the general manager. University researchers in the
not expected to be significant in developing a framework for analysing compound boards.
!81
CHAPTER 5
industry found that one of the most challenging tasks of the general manager was to educate
the workforce on the need to invest for the future rather than increase current bonus payments.
Direct conflict with the board by the general manager over whether to invest surpluses or pay
them out as dividends was ameliorated by a special standing committee to evaluate expansion
plans (refer to Figure 5. 1.).
Besides electing the board and a special standing committee to consider expansiOn, the
members would also elect a works management committee and sometimes also the company
officers. Directors obtained no special privileges or payments. All employee-owners were
paid at the same rate with everyone having the right to work as many hours as anyone else
was. To obtain and retain highly skilled key workers, like the general manager, electricians
or accountants, they would be hired as an employee.
Employee-owned plywood finns demonstrated substantial operating advantages:
(a) Workers' collectives have many times taken bankrupt or losing private
plywood finns and converted them into successful enterprises (Bcnnan 1967: 118-
121)
(b) The output of worker-owned fim1s during the 1950s averaged 115-120 square
feet of plywood per man-hour in contrast to that of conventional fim1s' 80-95 square
feet of plywood per man-hour. During the 1960s, they were producing 170 square
feet per man-hour compared to 130 square feet for conventional fim1s.
(c) \Vhen worker-owned firn1s were challenged by the Intemal Revenue Service
fOr paying their members higher than industry-level wages and for deducting those
as labour costs, the companies were able to demonstrate to the satisfaction of the IRS
auditor and the tax court judges that these higher wages were justified by the their
workers' 25 to 60 percent greater productivity than the plywood industry average.
(d) In general, worker-owned mills operated at a higher percentage of capacity
than do conventional mills.
182
INTER:'I,'AL COl\IPOUl'\D BOARDS IN ANGLO NATIONS
(e) Whenever the entire industry has suffered from a slump in demand and private
fim1s have thus had to lay off workers, worker-owned finns have been able to keep
their men on the job.
However, the success of worker-owned plywood finns resulted in a reduction of their
number. The more successful the finn, the higher became the value of its shares. This made
it difficult to find workers who could affOrd to buy shares. It also made it dinicult for owners
to retire and as a result more and more cash of the finns were being applied to buy back
shares of retiring members. Acquisition of the fim1 by a larger investor-owned company then
becomes attractive. The problem of providing continuity of worker-owners has been
overcome in the MondragOn worker cooperatives through the establishment of "internal
accounts" described later in Chapter 6 and finance from a bank owned by all the industrial
cooperatives.
The US plywood finns adopted some cooperative relationships between themselves, as found
in MondragOn, to provide competitive advantages. No US worker-owned firm grew to the
size of the investor-owned industry giants such as Weyerhauser, Crown-Zellerbach and
Georgia-Pacific. The research, development and quality control undertaken by The Amaican
Plywood Association assisted the ability of smaller finns to compete, which represented all
fim1s. This cooperative use of resources has been even more highly developed in
MondragOn. However, it should be noted that unlike The American Plywood Association,
each MondragOn firm was involved in a diftCrent business activity.
Some of the worker-owned plywood mills established joint marketing associations and were
considering extending this arrangement to all other collective owned enterprises. Joint
purchasing associations were also considered. However, concem over the US anti-trust laws
inhibited such cooperative pooling of resources to allow modest sized firms to improve their
competitive position against industry giants. Cooperative industry associations arc
183
CHAPTERS
encouraged rather than discouraged in non-Anglo cultures as described by Streeck &
Schmiuer ( 1985).
\Vhile there have been a few examples of workerwowncd mill spinning off from a parent
collective, there has been no institutional arrangement for firms 'to give birth' to whc.H will be
described as enterprises as found in MondragOn. However, Bernstein (1980: 14)
noted that
01
a curious new breed of business promoter cropped up" to form new
fim1s.
5.2.2 Tbc American Cast Iron and Pipe Companv
The American Cast Iron and Pipe Company (ACIPC) was fonned in 1905 to produce valves.,
tubes and large-scale pipe and pipe-fittings and industrial coke. The tbundcr provided for the
company to be turned over to the employees on his death in 1922 to serve both employees
and customers. Forty seven years later in 1969 the company employed 3,000 workers and
had made major advances in the iron and steel pipe manufacturing with annual sales reaching
SUS 80 million.
Figure 5.2, 'ACIPC: Information and control architecture', was developed by the author from
( 1980: 38). ft shows that employees elect six of their number each year in secret
balloting as representatives to the Board of Operatives (workers' council). Tht.! Board of
Operatives has a total of 12 members elected over t\\'O years, These twelve plus the five chief
otlicers of the company, \Vho iOnn the Board of :V1anagement, bt."Come the trustee owners of
the company. As trustees. the two groups of management and employee representatives
annually choose the company's board of directors from representatives of management,
factory, the cfcrical \\-orkcr.s and company branches. This board also hicludes outside
directors, in line with the founders intention that the company be ''operatt.!d equally in the
interest of the public" (Employees' Manual, 1969: 6 quoted in Bernstein 1980: 37).
lil.t
I:"'TERNAL C0!\1POUND BOARDS 1;'1; ,\.'\'GLO NATIONS
Figure 5.2, ACIPC: Information and control archit-ecture
3000+ Employees
"

"
Gl w Non-cxecutin::
l\lanagement
Workers
Board of OpcraHves
Advises
Auxiliary Board
(Limited Workers' Council)
----
(12 3!ncks, imernal committees) W Supervises
12 (Black and White) 6 elected for two years p,a,
Foremen
lmcrnal committees I
6 ckctcd for two years p.a. ---
:CJ
"
Wsupcrvises
, __
'
---
-
4
!J.vhcS:
:;:: I
Mar.;;gers
""'
-'
<,
--
Works Oiscipline Council
-- Supervises
---.....
(9 Judici:ll) w

llc.'lrd of Management
"
"
Rules on violations of

company regulations
0 (Executive Commht1..>e)

Company officers: pres.,
-
2 from Board of Operatives
treat., sales dtreclor,
2 from Auxiliary Board
er.gi:lCCting director,
l Works manager
4 mhcr m.anagc-mcni
S::lt'C(S
works manager

Scle;!s
'
Trustees
"
'\
(shardmld;:rs Lrusl)
------
t 0'
! 7 persons as 2
Board or Oircctors
L2 Board of
2 Bo.ard of
!2- 17 (currently 14)
Operatives Mar .. 1gcmer.1
5 company officers
2 members of n. o( 0. v( Consumer::
l clerical \\Orkers' rep,
Rdig:iouo., soci;t!, cduculkmal
4 from omsidc
f<:- :nvested capital
...._Financial institutions
The directors meet monthly to review reports tfom each of the companis officers appointed
by the board, The directors set ovcraU policy on sales, finance; production, advertising, etc.,
or delegate such decisions to the board of management The Board of Operatives has acces,">
to the financial infOnnatton of the company and other information is circulated to all
employees on a regular basts through an internal newspaper. The Board of Operatives may at
any time on its own initiative advise management.
Through the Board of Operatives, workers participate on a joint basis with managers in the
\Yorks' Disciplinal)' Council shown in Figure 5.2. Profits were distributed quarterly to all
employees, including at amounts up to 6 percent of their income tOr that quarter.
ISS
CHAPTERS
Surplus eamed by the company beyond that amount and not needed tOr taxes or capital
expenditures is split between the company treasury and all employees.
5.3 United Kingdom case studicsJO
In the UK, The Scott Bader Commonwealth and The John Lewis Partnership provide cases of
finns in a nation dominated by unitary boards. As was the case with ACIPC,
their founders introduced In all these three cases, the founders gradually
devolved power on an experimental basis and introduced the division of power.
5.3.1 Scott Bader Commonwealth
Ernest Bader established the chemical firm of \Vollaston, Britain, as an
individual proprietorship in London at the age of30 in 1920. The firm established itself as a
leading producer of polyester resins and also manufactured other sophisticated products such
as alkyds, polymers and plasticisers.
By 1951, it was a prosperous business employing 161 people, with a turnover
of about 625,000 a year and net profits exceeding 72,000 (Schumacher 1975: 230). In
1951, Ernest Bader gifted 90% of Scott-Bader Company Ltd. to a holding company, Scott
Bader Commonwealth Ltd, which had its liabilities limited by guarantee rather than by
shares. This allowed employees to become members of the holding company without the
need to invest any money. The 10% interest retained by the family in the operating company
obtained 50% voting rights on all constitutional issues so as to protect their experiment in
common ownership.
The company doubled its size after 15 years of democratisation and to avoid getting too large,
it fOrmed Trylon Limited, a new company and commonwealth. This company is completely
30 Both case studies arc based on the work of Bernstein ( \9SO) with supplementary infonnation obtained from
each company. This included a \996 meeting with Godcric Bader at Scott-Bader, and meeting in 1998 with the
Registrar of The John Lewis Partnership.
186
INTERI'\AL CO;\fPOU:SD BOARDS IN ANGLO NATIO:SS
independent and has decreased in size over recent years. "It is still a profitable business
supplying predominantly into the educationalmarket"3l.
The Baders were Quakers and a number of their beliefs and values were enshrined in the 1951
corporate constitution. It expressed the need for " ... teamwork which is neither Collectivism
nor Individualism ... " and " ... leadership founded on approval rather than dictation ... " A
minimum of 60% of profits was to be ploughed back into the business for future investment
and development. Of the remaining 40%, a maximum of20% could be paid as bonus to staff
However, whatever percentage is set as a bonus, an equal or greater amount must be given to
charity. Over the years, substantial amounts of money have been allocated to charitable
purposes as part of this profit sharing process.
In 1963, the family transferred their residual I 0% of the Scott Bader Company Limited to
seven trustees of which two were Emest Bader and his son Godric, the five others being
chosen by the company's employees and their elected representatives (Jones 1991 ). These
arrangements arc shown in Figure 5.3, 'Scott Bader Commonwealth: Infonnation and control
architecture'. Bernstein (1980: 42) explained that:
Trustees of the company serve only as !ongteml guardians of its health.
The majority of the trustees Hrc chosen from outside the company for tcm1s
of fiveJ:! years by the community council and the board of directors. They
are selected for their individual interest in maintaining and furthering
democratic and communitarian modes of social life.
The role of the Trustees is to arbitrate on any serious differences of opinion that may arise
between any of the elected bodies. They are charged to take action in the event that the
company operates at a loss.
3l Letter to the author dated February 12'" 1996 from Mr. Michael Jones, Secretary of the Scoll Bader
Commonwealth.
3:! Bcmstcin (1980: 42) specifics ten years. This has been changed to five years on the advice ofGodcrie Bader
who was shown a draft of this Chapter during a visit by the author to the business on Ju!y 8th 1996.
187
CHAPTER 5
In 1972, a code of practice was adopted by a general meeting of Scott Bader Company L!d. It
prohibited lhc manuthcture of products for weapons and war. It also committed the company
to reducing any hannful effect of their work on the natural environment by rigorously
avoiding the negligent discharge of poiJutants and questioning constantly whether any of our
activities arc \mnecessarity wasteful of the earth's natural resources.
r







L
Figure 5.3, Scott Bader Commonwealth; Information and control architecture
Sctlit Bader Company Limited Genernl Meeting
All 300+ intludillg 1ho>e who ttre nN
Departmental Assemblies (S)
:>s 3 of the Scalt Badtfr
(All 300+ in ca::ll tk-p:mmcntl
Cnmmomn:a!(h Ltd d:.:ddc divbion of lhc surplus
'"'lary tcvds
C<ummmily
n' hJ.\i\ lhr !'mnlov '\
--
Council (l:l}
co join Comm1mwcalth
3 Y:!:lf ICITll Rcfcn::m::e C!}undl
with oo third "Judid,),ry" 16
t<!tfring p.rL S<:o1t nuder Commomm:dth L!d . S from dep!.
l2fmmCG,M. Gcucr.li :O.Jecting !----
- 2 by Board "Holding Company" wi!l1 200 '
-l fmm Dirl!::t!ln

I from the: local
RcC\)fil
members who elect trmii!C->, directN\ 4 wurkcn;.
_____ .,..

C(lmnmnity
, mcmh
ami 9 mcml}l!rs of Cunm:uuity CL>uncil
'
dcctcd by
'

nppoimcd hy
'
11011'<;.\<!C. IUJ;L
'

llw fint
'"
Cho-\.c:n by
"'

' '

! ! :mU BonrU
-:;.,'t<-c.,

( \ ...
' -::..;;.no;:
1'\Qilll.Xt:t:nlin:
J \
'
P:mcl of 12
"
'
"
"'

'
rcprcscntitins
.,,
Q!
Trn5H.'C-! (Stu 9)
'
S1
Worker!.
'
! "'
"'
(Cuan.lian.'> of
'
Approves in

"'
w
'
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o.
company and h11ard and/or ib
"

'
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'
ron.: men
'

2 t-mplo)t"t'
'


Wsu1x:rvises
' '

mcmbcn
'
s.


1-
3 from ouL>itk !Or 10
\
...
'


;-rs. joimly appoimcd '
Board of Diret:tors (9}
..,.,
"f' Supervises
by Con:rmmity
......_ Clminmm. M-u. Die
-
0YJn:il and Board
fro:n cmploycc-mcmhcrs
Officers, llcad I
...... 3 external <lPJWim::(! by .r\ppolt\ls
ofDcpar!ml.)nt.s
-- --
Cluimun and appmn:d by
Cornmun.itv C:Rmcil
Membership of the Commonwealth. and with it, co-ov;ncrship of the Company, is open to all
employees after a specified period of time. Membership is: by .application and the
Commonwealth Board of Management confirms the rights of membership. The Board has six
elected members plus the chairman of Scott Bader Company Ltd., a mcmbr of the local
community. The nine person Board of Scott Bader Company Ltd. is made up of the
1S8
COMPOUND BOARDS IN ANGLO l'i:ATIONS
clminnan, managing director. tbur elected members and three external directors appointed by
the chainnan subject to the approval of the Community Council and the members
of the board. The board appoints the chainnan and managing director.
The Community Council is a standing committee of all employees whether or not they are
memberS of the Commonwealth. Representatives arc elected by geographical area to enable
clcctc:d people to have regular contact with those they represent Counclllms arc elected tOr a
three-year term of office but half the Council retires at eighteen-month intervals to ensure
continuity. The remit of the Council is very wide and they can discuss any issut:S,
Recommendations can then be made to the Company Board. Since two members of the
Council are elected to the Company Board they have a strong input into policy making at
Board level (Jones !991 ).
The Council acts as an appeal mechanism in matters of discipline, which becomes binding on
both the appellant and management Besides working with management in ureas such as
\Vorking conditions and employee welfare, the Council raises its own budgets and administers
funds for social and educational functions. Bernstein ( 1980: 42) reported that:
The full-time managers are furthe-r supervised by the total Commonwealth
through a unique organisational mechanism invoked annually at the general
meeting. Twelve members are selected by lot, as a kind of jury, to approve
or s!ate reservations on the board of directors' conduct of company business
over the preceding year. Jf this panel of representatives should decide that
the board's performance has not been satisfactory the board is given three:
months maximum to take appropriate remedial action. Then it must report
back to the Commonwealth. which resumes its general meeting for this
purpose. Another twdvc persons nrc then selected by lot as representatives
of the whole Commonwealth and arc asked to render their judgment If this
panel approves, then business may procee-d. If not, then the task fRlls on the
Trustees to decide which directors may need to be replaced.
189
CHAPTERS
The first loss was reported tbr the financial year ended June 30th, 1994 (Scott Bader 1994).
However, since the company adopted a democratic constitution and the adoption of the
o\vncrs value system it has had a 45-ycar tmck rccord of prosperity and growth.
5.3.2 The John Lewis Partnership
This finn described itself in the Partnership Fact Sheet l ( 1995) in the following
way;
The John Lewis Partnership is one of tht! foremost retailing groups in
Britain. ln 1994/5 its estimated sales for 22 department stores, Ill Waitrosc
supennurkets, several factories and other interests was stg.2.58 billion with
117 million pre-ta.x profits_ The Partnership has no outside equity holdt.!rs
and 43.1 million was shared between its 40,000 or so members in a cash
bonus us a percentage of annual pay (l2%).
John Lewis founded the business. in 1864 as a small draper shop in Oxfbrd Street, London and
developed it into a full-scale department store. In 1 9 5 ~ he iook ov..:r the uiling Peter Jones
store in Chdsca where his son, John Spcdan Lewis first experimented with worker
participation during the war years 1914-JK By 1929 Spcdan had inherited both shops from
his father and began the proct.:ss of transferring his rights in the business to those working in
it Profits lfom the company were used to pay for the purchase of his shares over the next 21
years. As chaimmn, he also oversaw the profitable expansion of the business and its
diversification imo food stores trading as Waitrose. The \Vaitrose ehain began the transition
from counter to self-service "supermarkets" in 1950.
1t was in i 950, that Spedan completed the transfer of ownership and control to his partnt!rs
\Yith a second irrevocable Settlement in Trust. Under the 1950 settlement, Spedan transferred
his voting rights to Trustees with an information and control architecture, which included a
board and Central Council. A number of features and procedures evolved over subsequent
years and these arc shown in Figure 5.4, 'The John Lev.:is Partnership: Information and
control architcctl!.r.<;:' developed by the author ffom Gazette {1994).
190
INTERNALCO:\IPOUND BOARDS IN ANGLO
Figure 5.4, The John Lewis Partnership: Information and control architecture
"
"
8
"
-"
"'
u
"
E

(5.g
c'"
.22

Partners (over 40,000 in 1995)
'
'
'
Anonymous letter:s ----
(May pctition1'rJstces for reply}
:S,.;:t
:;:;;::.{;

.
Committees of Communication
(Shop grievance committees)
.. 10-18 representatives on each
Rank and
tile workers
---,
'


.





commiuee for one year
rc
: ,
1
u A 1
j \ 'I' I
: :
1
' Principal I
.Uranch CoundJs ' ' 1
Elected members with ""..... in trading divisions
! Heads. or branches


,
1
: i :
1
Directors of buying
A A!locarlon of ; l : l r=l Branch Rc istrur , 'b
: welfare funds ' '
1
- "- t '\ -k
! : l

, r;;
l l ! l E
1
The Principal
'
:
Central Council
Four-fiths -or more elected by Partners,
up to one-fifth appointed by Chairman
Budget of I% of )myron for own and
: I : : U 1 Executive Committee :!5
I I I I 10
: l : Advises I 6 Exccmives+ rc
4 Critical t
: J ; : I G II 1"1
branch council spending.
Three of its five nominee directors
can demand consuhation with the
Council on issues.
Veto po\ver on changes in
Anicles :md Rules.
,
1
, , { cnem nspccwr u
: l : l
1
Finance Oircctor !
1 l I I
1 '---------.-! Panners' Counsellor - -!
: L_.:._ _____ L__ -Chief Registrar) - :
: : I ,
' . '
' ' I
'


'
E'
U<
"'
""' .s:: :;,
"''

<:
-
t
Board of Dircctors
Chairman & Deputy Chair
L---f-i,.._ 5 Elected by Council
General Sccrcl:iry
Legal Adviser
General Ed.itor -,
Chief A::coumam
Head of lmernal Audit
5 Appointed by Chairman
ore "-),........JfL__J___J_
Trustees {5) r,.,.L. Chairman (CEO)
Gu.ard conslil.Ution for life unless
Chairman .;.
Deputy Council
(Appoiontcd by Chooses subject to
Chair) + r Council \'CIO

Past Chairmon I
The Ga;ctte, ( 1994) stnted:
11w Constitution of the John Lewis Partnership ensures that management
arc held accountable fOr their actions and must explain their decision to
191
CIIAPTER5
fellow partners in the various democratically clectt:d committees and
councils and in the Partnership's local and national journals. However,
managers have the n::sponsibility to manage and, parallel to the democratic
structure, a Partnership department store has a straightfonvard management
structure,
The Registrar is the only non-typical member of a "straightforv.'ard management structure''.
The Registrar is the editor of the weekly Chronicle, which carries local trading results, reports
on Council and Committe\! meetings and has a letters page. The Registrar is independent of
local management, being directly responsible to a central Principal Director called 'The Chief
Registrar' as indicated in figure 5.4. Her role is principally to sec that the Partnership's
constitution is upheld and adhered to in the fair treatm-.:nt of Partners in the Brnnch,
The Partnership has distinctive trading policies and business practices, which the finn relates
to its democratic constitution (Fact Sheet 22). are reflected in Partnership policies and
practices in markeling, advertising, pricing, store presentations, provision of credit, equal
opportunity, racial discrimination, environmental issues ;md giving to charity, The
democratic structure creates a manychannclled system for communicating employee views
upward at every level of management. While the managers accountable to their partners
their management peer group appoints them.
The partners eJect members to committees of communication for their branch, branch
councils and the Central Council. The Central Council with the Central Board and the
Chaim;an who is the CEO represent the three principal governing authorities of the
Partnership.
The Chairman, as a trustee, holds 40 A class shares and is n!SJ>Onsiblc for maintaining the
Constitution. Three Trustees appointed hy the Central Council hold 60 B class shares, which
only obtain a vote on changes in the constitution. The Central Board exercises financial and
192
iNTERNAL COMPOUND BOARDS li'\ NATIONS
budgetary considers all major developments and annually consjdcrs the level of
Partnership bonus,
The Central Council elects three of the five trustees and five of the twelve directors. Three of
the five directors can require the board to consult the Central Council on propos::1ls to
liquidate more that 5% of the Partnership's fixed assets; commit the Partnership to increasing
its total capacity by more than 5%; close a branch, or specialised department of 12 or more
Partners. The Council controls a budget entitlement of I% of p-ay sheet for its own branch
and council spending. No member of Council or any elected committee can be dismissed by
management while in office or for a year ufic-r their retirement
The Central Council has the power to discuss any subject and make recommendations to the
chainnan and the board. lt can veto changes in the Articles and Rules of the Partnership or
the appointment of the chninnan, The chaimmn can appoint five members of the board and
bis deputy and up to one-fifth of the members of the Central CounciL He has his job tOr life
or until he retires or is dismissed by a 75% vote oftbe Central Council (equivalent to 93'YO of
the elected members!),
The Chairman has five staff executives reporting to bim as shown in Figure 5.4 and presides
over The Principal Executive Committee. Beside the tOur "critical" members of this
committee shown in Figure 5.4, there arc six line executives in charge of: Rcscarch &
Expansion, Trading (Department Stores), Trading (Food- Wailrose)) Personnel, Management
Services and Building & Services.
The bottom level of employecwrcprescntation arc the committees of communication, which
meet every second month with the Partnership's cha!nnan or his representative and function
mostly as grievance committees. \Vcckly Chronicles are published locally at branch level
edited by a registrar not accountable to local management and a weekly Gazeue is distributed
to aH partners to keep them informed of operations and to allow them to publish their
grievances, complaints and suggestions anonymously. Management is required to answer .any
CHAPTERS
public gncvances m the publication. The Weekly Gazette provides independent feedback
infom1ation, which is a condition for achieving self-governance as identified in Table 3.6.
According to Bernstein ( 1980: 34) there is "even more complex system of checks and
feedback within the structure of management itself'. Bernstein ( 1980: 36) stated:
Under this complex system of democratisation the John Lewis Company has
fared exceedingly well economically, paying its partners consistently more
than the retail industry's average wage (evcn without the annual bonus),
growing yearly in sales about twice as much as the other stores, and having
become 'the standard by which the efficiency of other retailers is judged'.
The John Lewis Partnership, like ACIPC, involved thousands of employees, whereas Scott
Bader and the US plywood finns involved only hundreds of workers. Other differences and
common features of each of the four fim1s is next reviewed and some conclusion drawn.
5.4 Review and conclusions
Each of the tOur studies has several common features. Some of these common features
involve the nature of the finn and it operations such as:
(a) Shares not publicly traded;
(b) Full employee ownership and control;
(c) Sustainable tOr over half accntury to provide evidence of competitiveness;
(d) Created in countries where internal unitary control is the naturally accepted
system;
(c) A compound board as an internal part of its infOnnation and control architecture.
Other common features in each of the case studies illustrate some of the cybernetic principles
ofTBA discussed in Chapter 3, such as:
(a) Variety of dccision makers to improve 'reliability' of decisions to illustrate von
Neuman's principle;
194
INTERNAL COMPOU!'iD BOARDS IN A:'\GLO NATIONS
(b) Variety of infonnation channels to increase the 'accuracy' of information to
illustrate Shannon's principle and to improve the integrity of monitoring and
reporting to further 'control' and 'regulation' as required in Tnblc 3.7;
(c) Variety of control centres to more erosely provide 'r(!quisite variety' to match the
number of variables which need to be managed to illustrate Ashby's law;
(d) Distributed control to illustrate:
(i) The "Principal of Subsidiary Function'' and the ability to provide timely
response to facilitate 'timely control and regulation' consistent with the
need of as shown in Table 3.7;
(ii) a division of power to provide checks and balances;
(iii) a rational basis for establishing trust;
(iv) reduction in power differential to increase mutual dependency so as to
encourage co-operation rather than competition in operational activities;
(v) introduce competition tbr power in governance activities which with (d)(iv)
provides a basis for -
(vi} introducing 'tcnsegrlty';
(vii) decomposition of decision making labour to reduce infOrmation and
decision making overload and so 'bounded rationality':
{c) Decomposition of decision making labour to reduce infom1ation and decision
making overload or .. bounded rationality".
Each example also illustrates the six components that arc minimally necessary for workplace
democratisation as identified by Bernstein (1980: 1 16) in his global .study. These were:
(a) Participation in decision-making facilitated by distributed control;
(b) Economic return to the participants based on the surplus they produce;
(c) Sharing management-level intOnnation with employees;
(d) Guaranteed individual rights fitcilitated by distrtbuhxl control;
(e) An independent appeals system as facilitated by distributed control;
(f) A complex participatory/democratic consdousness.
195
CHAPTERS
The "complex participatory" architecture or compound board, introduces a division of power
to allow checks and balances not available in simple hierarchies. Beside providing distributed
control to decompose decision-making labour it introduces distributed collection and
dissemination of feedback inforn1ation to initiate timely corrective action consistent with the
requirements for self-regulation and se!fgovernance outlined in Table 3.7.
Distributed infcmnation and control also supports the s1x social and psychological
requirements for obtaining organisational advantages identified by Bernstein (1980: 98).
These were:
(a) The decomposing of decision making introduces a pragmatic need for
"reciprocity" instead of"paternalism'';
(b) Independent feedback channels makes people aware of "own fallibility" and so
open to admit errors and the need to change rather than "belief that leader must set
example by appearing infallible (tries to hide all mistakes)". This provides a basis
to establish trust, and -
(c) "Confidence in others - hence: willingness to listen and to delegate
responsibility" rather than being "mistrustful, feels others need 'close watching' -
hence: intense supervision, limits freedoms of subordinates";
(d) The sharing of control reduces the abilities of individuals to "maintain exclusive
prerogatives" to encourage more "egalitarian values'' and so;
(c) "Governing by merit, explanation, and consent of governed" rather than
"governing from position offom1al power", also encourages-
(f) A "policy of educating the managed: open access to inforn1ation" rather the
"Proclivity for secrecy holding back infonnation".
In other words, compound boards can promote and reinforce social and organisational
behaviour, which provide organisational advantages. Conversely, the concentration of power
and information of a unitary board with centralised control creates conditions to nurture the
six negative human traits mentioned in each of the six points considered above. The negative
traits arc associated with problems outlined in the bottom part ofT able 3.7, which provides an
"evaluation of hierarchies to control, regulate and govern".
196
INTERNAL C0!\1POUND BOARDS IN ANGLO NATIONS
Even more striking than their similaritil.!s arc the significant dinCrcnccs in the nature of the
compound boards adopted by each case study. The plywood firms hired !l CEO as a
contractor while at Scott Bader, the CEO is an employee. In the piywood companies the
hired CEO provides a counter to the direct election of all board members compared with only
a minority of the board being directly elected at Scott Bader. Other board members of Scott
Bader are indirectly appointed by the Community CounciL Indirect appointments occur with
both the larger examples of ACIPC and JLP. ACIPC is the least participatory and democratic
with the General Meeting appointing only two control centres, the Board of Operatives and
the Auxiliary Board.
The plywood firms and Scott Bader arc medium sized busim:sscs having only hundreds of
employees, Both ACIPC and JLP have thousands of employees operating m a number of
centres with their own information and control centres and directly elected "Branch Councils"
as each location. The creation of almost units is a feature of holonic
architecture. However, this dement ofTBA is muth more clearly illustrated by the far more
complex MondragOn Corporacion Cooperativa. wbich is considered in the following Chapter.
Beside the Branch Councils of JLP, employees also appoint the Central Council and
Committees of Communications and have an individual anonymous facility to criticise
management through their \Veekly Gazette. The Weekly Gazette provides independent
1Cedback infonnation, which is a con-dition fOr achieving self-governance as identified in
Tobie 3.7,
There are also many other detailed differences too numerous to list The most significant
differences shows that the operating advantages of compound boards as identified above can
be achieved from many difTerent d.!signs. h also demonstrates that the ability of compound
boards to achieve advantages is not dependent upon their detailed design. Put another \vay;
the advantages of compound boards are tolerant to diffCrcnccs in they arc constructed.
l\}7
CHAPTERS
This suggests that their ability to allow employee owned and controlled firms to exist and
remain competitive depends on general concepts and principles such as identified by TBA.
The next Chapter considers a much more complex system of compound boards contained in
the MondragOn Corporacion Coopcrativa. This case study is used to both illustrate and
develop clements of TBA. In particular it illustrates how TBA can identify patterns of
infom1ation and control which otherwise may not be recognised. More significantly, it shows
how TBA can identify cybernetic organisational structures, which relate to the limitations of
human information processing.
198
CHAPTER6
STAKEHOLDER CONTROLLED FIRMS WITH COMPOUl'iD BOARDS
6.1 Introduction
TllC objective of this chapter is to ilh.!strate with empirical examples how TBA can be used to
explain the architecture of compound boards identified by the research, Two case studies are
presented to demonstrate how TBA can contribute to filling a research gap in investigating
and comparing complex systems of governance from different countries,
Both case studies involve firms controlled by two nr more boards in non-Anglo countries.
Stakeholders in the form of employees, customers and suppliers participate in the control
architecture of both examples. Both cases have been researched and reported in the English
speaking literature_ Both examples have been recognised as being internationally competitiV(;
as reported by Thomas & Logan {1982:126-127) for the Spanish cooperatives and Porter
(1992) for Japanese keiretsu. \Vhik: the infonnation and control architecture of both cases
have been updated since: these studies, no more recent evaluations have: been dlscovcn:d.
Ho\vever, this is not signitkant for the purpose of this research to illustrate how TBA can
provide a framework of analysis of finns \vith compound boards.
The fir.5t case study involves the MondragOn Corporacion Coopcrotiva (MCC) located In the
Basque area of No11hem Spain which a complex system of intemal compound boards. The
second case study is a unitary board company where an extema! compound board is created
by it being a member of a Japanese keiretsu. The MCC may represent one of the most
complex governance systems in existence. This provides a basis to illustrate both the pmver
of TBA to provide a conceptual framework for investigating the governance of firms and a
basis to extend the ffamcwork by illustmting higher order structures such as "hoiarchies",
"integrity o l o n s ~ und '')atcral recursivity''.
199
CHAPTER6
Some of the unique features of the MCC arc identified in the next Section 6.2, Background
infbnnation on the fOunder of MondragOn is presented in Section 6.3 with a description of
how the structure evolved. A description of the internal and external governance structure of
MondragOn cooperatives is provided in Section 6.4. A view of these stmctures is then
presented through the lens of TBA in Section 6.5. This reveals the presence of cybernetic
principles in the information and control architecture and the presence of higher order
structures.
The architecture of a Japanese keiretsu is considered in Section 6.6 and compared and
reviewed with MondragOn in Section 6. 7 through the TBA framework.
6.2 MondragOn Corporacion Coopcrativa
The group of stakeholder controlled tinns located around the town of f\1ondrag6n in the
Basque region of Northern Spain present the most complex system of compound boards
discovered by this rcs..:-nrchcr.
At the end of 1992, there wen: 24,540 partners working in over 150 related cooperatives
(CLP 1992). Group sales for i 992 were USS3 billion, which was divided almost equally
between the industrial and distribution cooperatives with 25% of the industrial output
exported. Over 63% of the cooperators advanced industrial and consumer
products, are involved ln food distribution and production and 7% work in financial
services. Therli! arc 45 educational coopc<Jtivcs, 9 housing coopcrativcs
1
12 service and
suppon cooperatives in addition to one of the fastest growing and most profitable hanks in
Spain owned by all the cooperators.
The first cooperative was established in 1956 and only three have been dissolved in 38 years
(Morrison 1991: 174). Typically, over 75% of new business f.:1il during their first five years
\Vhen established by private entrepreneurs and invcs:tors
33
, but none has failed in this period at
Mondrng6n, Ellcnnm1 (1982: 4) quotes an 80% to 90% failure rate in the USA and goes on
200
STAKEHOLDER FIRMS WITH COMPOU.:o-;D BOARDS
to say, "Entrepreneurship has not only been successfully institutionalised and socialized in
MondragOn; it has been dramatically improved." This "quantum leap over the quality and
type of entrep-reneurship" sutlicient reason to analyse the MondragOn system of
governance. Hmvcver. besides the complexity of their compound boards, there arc five other
significant reasons, which makes the MCC unusual and need to be noted.
The second reason is that on a number of other measures; the perfomnmce of the cooperatives
has e:.:ceedcd that of conventional firms owned by investors, families or owner/managers.
Thomas & Log<m (1982: l 09) have shown that "the cooperatives arc more ctTicient than many
private enterprises''. and "'there can be no doubt that the cooperatives have been mon:
proH1able than capitalist enterprises". Thomas & Logan ( 1982: 126-127) stated that:
Various lndicators have been used to explore the economic efficiency of the
MondragOn group of cooperatives. During more than two decades a
considerable number of cooperative t3ctories have functioned at a level
equal to or superior in efficiency to that of capitalist enterprises. The
compatibility question in this case: hns been solved without doubt.
Efficiency in tcnns of the use made of scarce resources has been higher in
cooperatives; their growth mcord of saks, 1.!-Xports and employment, under
both favourable and adverse economic conditions, has been superior to that
of capitalist enterprises.
The objective of creating MondragOn firms was not to achieve sustainable competitive
advantages but to create jobs with a fUHilling qual tty of life according to \Vhyte & Whyte
(1988: 3), As a result, the control structures have been designed so that the cost of finance is
treated as a variable, not labour.
A third reason tOr studying MondragOn fimts is because they have introduced a number of
social inventions. Ellerman (J 982) identified four major social inventions: ( l) The legal
structure of the cooperatives; (2) The bank, C(lja Laboral Popular (CLP} which is largely
:nIna study of 113,780 new flm1s established in Australia from 1973 to 1985, Reynolds,
20l
CUAPTER6
owned by worker cooperatives; (3) The direct membership role of the staff
members in all the industrial cooperatives such as the consumer, agricultural. educational
and super-structural cooperatives; (4) The Emprcsarial division of the bank which became a
separate 'secondary' cooperative in 1991 referred to as LKS, The role of LKS is to sponsor
the fOm1ation of new cooperatives and reorganise failing cooperatives, To quote Ellerman, it
is a "factory factory", which has both "institmionaiised and socialised" entrepreneurship.
Other important innovative governance relationships are described within and between tinns
in the next section.
A fourth reason tOr studying MondragOn is that it shows how economic transactions arc not
governed just by markets and hierarchies, but also by "personal relationships" and
"associations'' Hollingsworth & Lindberg (1985: 221-2) as shown in Table 2.2. The
outstanding durability and growth of firms provide a more compelling case fOr
1
'relationship investing" (}.t1onks, I 994), than firms in a Japanese keiretsu considered at the
end of this chapter.
The Hfth reason for studying MondragOn is that it represents a system of social and political
governance, which is different from either socialism or capitalisffL It provides an operational
example of either ''Associational Democracy" (Hirst 1994) or "Communita.rianism" (Etzioni
1993) and another way of"Dcmocratising The \Vealth of Nations" {Turnbull l975.a}
A sixth poim of interest is that rapid regional economic grO\vth v;as achieved with-out
incurring the cost of servicing external equity or debt. l'v1ondmg6n illustrates a tecliniqueJ
4
ibr regions to develop on a self-financing basis without public or foreign investment or even a
stock market.
In summary, the MCC provides not only a complex example of internal compound boards,
but also one that i:; internationally competitive, without governing influences from either
investors or a stock market. It provides an illustration of firms being governed not just by
Savage & Williams (1994) found that around 74% of them had faik:d in five years.
202
STAKEHOLDER CONTROLLED FIRMS WITH COMPOUND BOARDS
markets and hierarchies, as assumed by leading theorists of the fim1, but by all four methods
of governing transactions identified in Chapter 2. As a "producer cooperative" the MCC
provides an exception to a general assumption of US based theories of the fim1, which
\Villiamson (1985: 265) recognises as a "dilemma". But just as important for this research,
the MCC provides rich illustrations of how its governance structures utilises cybernetic and
other principles which constitute the framework of analysis developed in Chapter 3 described
as TBA. In addition, the MCC shows the power of TBA in identifYing the reasons for its
complexity and its competitiveness while also showing how TBA can be applied to the
concepts to network firms.
6.3 The Founder of Mondrag6n35
A Spanish priest, Father Jose Maria Arizmendi who was born on a fann 30 miles from
MondragOn in 1915, created MondragOn. He died in 1976 having put into practice his social
philosophy based on his own interpretation of Catholic social doctrine.
Arizmendi was a prolific writer and teacher but he never articulated a vtston or wrote a
manifesto. I-I is native language was Basque and he spoke Spanish poorly. This made him an
inadequate Spanish orator who spoke in a "monotone" from the pulpit with "intricate and
repetitive phraseology difficult to understand" (Whyte & Whyte 1988: 28). In private
conversations he was a hesitant speaker, often unclear and ambiguous, yet at times he could
expound fundamental insights "in brief and potent scnh::nces".
The MondragOn inventions were produced by the original thinking of Arzimendi who
patiently and persistently harangued, cajoled and manipulated his associates into putting them
into action. Often, his associates would only understand and appreciate his ideas after they
had put them into practice! They 'learnt by doing' or in words of Arizmendi, "we build the
road as we travel" (Whyte & Whyte 1988: 241). One gains the impression that the process of
road building was more important than having a vision of where it Jed! While he saw
:3
4
Other techniques of l f ~ financing regional development arc described by Tum bull (1993a).
JS This section is based on infom1ation from Whyte & \Vhytc ( 1988).
203
CHAPTER6
coopcratism ns a 'third way' he was a pluralist who thought that 'isms imprison and oppress us
without providing any final answers' (\Vhytc & \Vhyte 1988: 237).
MondragOn is located in mountainous country 30 miles south of the Bay of Biscay and 40
miles south-west of the French-Spanish border. By the 17th century, MondragOn had
established a reputation for manufacturing swords and arms of all types (\Vhyte & \Vhytc
1988; I 0). After Franco came to power in 1939 the Basque language was banned until 1978,
Howevcrj 50% of the people were still competent in the language, which is unrelated to any
other. The Basques have always sought autonomy and had established democratic elections
for local government as early as the 16th century.
Basques atso had a tradition of sharing work on neighbouring agricultural land and through
their guilds \Vbich promoted collective production and provided health and welfare services.
Some of these traditions survived to the 20th century, Arizmendi grew up exposed to these
pr.:1cticcs and the presence of consumer cooperatives, fanner cooperatiw:s, and credit unions,
Although his family fam1 was privately owned it wm; part of a coiJ.cctivc described as a
"hauzoa" {Mollner 1991: 66), Producer cooperatives were not signiticant until tbc
establishment in 1920 of the Coopormive Corporation fOr Marketing and Manut11cturing
Fircanns, knmm as Alfa, Alfa was located in the commercial centre fOr the farm where
Arizmendi was born and its business to manufacturing sewing machines in 1925.
Because he lost the sight of one eye when he was 3 years old, Arizmendi was not accepted by
the Basque military for active service in the Spanish civil war against Franco. Instead,
Arizmendi edited Basque newspapers for the military. After he gave himself up in 1937, his
captors questioned him as to how he had been supporting himsd[ He replied that had been a
soldier in the Basque army .and so was classified as a prisoner of war but later released. Many
imprisoned with hJm were executed, including a work colleague who dcscdhed himself as a
journalist.
204
STAKEHOLDER CONTROLLED FIR.\1S WITH CO:\:!POUND BOARDS
In 1941 att the age of 26, Arizmendi took up his first duties as a priest. He was sent to
MondragOn where unemployment in the region wa."! 40-50%, At the time, MondragOn had a
population of around 9,000 mainly working class people, with the economy dominated by a
large foundry and metal working c-ompany, the Unil)n Ccrrajcm. Arizmendi was invited iO
provide religious instruction to their apprentices. Management rejected his request that the
company teaches industrial skills 10 other boys so he organised his own school, Escuela
Professional PolitCcnica (EPP) in 1943, The paren!s association, \Vhich he formed as p;1rt of
Acci6n CatO/ica, became incorporated as the League !Or Education and Culture (LEC} in
1948 and is now known as Hczibidc Eikartea. It created the knowledge, culture and
relationships to build MondragOn.
6.4. Building MondragOn
The first graduates of the EPP later became the tirst members of the working class in
MondragOn to obtain university degrees. Some obtained employment in the UniOn Ccrrajcra
1
which rejected Arizmendi's request, that cmp!oye<!s he allowed to purchase new shares being
issued to finance expansion. Arizmendi then organised his parishioners to provide the
relatively enormous sum, equivalent to USS361 ,604 In 1955, to finance the first \vorkl.'!r
cooperative caHed Ulgor. lt began with 23 members In 1956 making a paraffinMcooking
stove.
In 1957 the tinn established a "Social Committee". In 1958, the Franco government legalised
collective bargaining on the basis that this was negotiated through a Jurado de empresa (jury
of the finn), Fret: trade unions were banned. The jurado was chaired by management and
made up of no more than ten workers including technicians, clerical and manual workers in
proportion to their numbers in the finn. In 1958, Arizmendi drafted the constitution of the
first Social Council, which modified the concept of the jurado to allow the unique form found
in MondragOn to develop. The infom1ation and control architecture invented for Ulgor
became the model for aU subsequent industrial cooperatives.
205
CHAPTER 6
ln 1958, a second cooperative, Armsatc, was established to produce machine tools, some of
which were sold to Ulgor. The founders of Ulgor rejected Arizmendi's suggestion in 1959
that they fonn a bank t-o tinancc new cooperatives. In 1959 Funcor was formed in a nearby
town as a cooperative to produce fOundry products. Lata in 1959, Arizmendi forged the
signatures of his disciples in Ulgor to incorpomtc the bank (CLP) owned by the cooperatives.
Its original shareholders were the three newly formed worker cooperatives and San Jos.S, an
established consumer cooperative. As the Bank created new cooperatives through ils
Empresariai Division, the new firms became co-owners of the Bank. The Bank in tum kept a
watch on its clicntJowncrs as shown by the dotted lines in Figure 6.2.
Because members of worker cooperatives were not considered to be employees under Spanish
law they were not covered under the national social security system. The CLP began its
existence with two divisions of savings and social security, which operated through the
offices of Ace iOn Catcilica, and the Schools operated by LEC. The social security division
was spun off in 1967 as a separate cooperative called Lagun-Aro. The cooperatives that tnade
deductions as conttibutions to appointed its board.
By the early 1960s, Ulgor had grown to be one of the largc::;t l 00 industrial finns in Spain.
Besidl.!s sponsoring Arrasatc, it created Coprice to i)J'Oduce components for its oil stoves and
heaters and Ederlan to take over its foundry operations. Fagor Ekctroti:cnica was fom1cd to
produce electrical equipment for the first three cooperJtivesJ
6
In 1965 all five coop"Crativcs
fonned the first cooperative group, or relationship association, named Ularco. lt later
changed Jts name to the product brand name ofFagor.
When Arir.mcndi joined the Church be gave up his hereditary right to the f1m1ily farm to his
younger brother. In t 960, Arizmendi's brothet requested hiln to establish a cooperative to
market milk and timber produced by tbc farms. Arizmendi convinced the farmers that they
should not follow the traditional approach, which excluded workers but to fOrm a hybrid
36 Many exru11ples of how communities grew by this process of import substitution have been
identified by Jacobs ( 1985) and popularised by Porter ( 1990).
206
STAKEHOLDER CONTROLLED FIRMS WITH CO:\lPOUNO BOARDS
Figure 6.1 MondragOn Cooperative System: \Vith dates of establishment
I
<;ongrcss
Founder/ r\rchitcct I __ I __ _,.J-A;;;;;;;;;c;;;;;;;,;;;-:-:l
Don Jol> Marla t , :\cd6n Cut&Ec<!'
Ari1mcndi W ! {fitl\1 invo!vl!d In 1941) :
1915-197(, Council of Cooperative Groups
established 1987
Manage
l ,.-,--;-: .-;-;
1 Mon..Jrug6n
f-uml for lr,!crcoop>;:m.livc II CorpMociOn
Solidarid (FJSO} !9S7 I Coopctotiva
I !990)

fj r=--
c Central Social Gr<Hlp Governing
. --
c Cour.cils Cctlncils
_
<': Primary worker and
] hybTid I Gcn.::ral Manager
associated into (first
1970
) t-
f"C':::::C;::I;-2;-:g;::co;;u:;p':;:. :
11
. Gcm:r.:ll Asscmhly of Group. ail ot l

-
Lc:1guc for
Etlucation and
Cui !Ute (LEC)
(194S) liczih:de
Elknnca { l9SS)
'
.
.
.
.
.
.
.
,--;;---;:;---,:
tt.rmort Co-ons
Educat!oP (PPS}
lnihated hy LEC 194J.
-
So::ial Sceuri1y ..,...
(LagunAro} !959
\Vorl expcri,;ncl! ,..... :
(AICC\)f!) !966
ih:tail iEm,;ki} !969
'---+- R&D(lkerl.:l!l) 1974""' :
- pari of surpluses. Hrst 1960
-15 '---'---.-----,------,.---''--l Emreprenucr \959 .

'\._ _ r-- __ . Bank {CLf'J !959 ,...
==j G<:ncral of
Sccia! I I, 1 1 Wat<:hdog: s:uppon co-ops made Uj
Council f -... i 1 Council
o. , 1 ' General

'"'
. --.,.: t I M:,., f
0 i , I !vhmagcmcm j _,. o
!: Manager - 1 <l
;:: - 1 Council H 1'5: j Odcgatc (4}
11 : , ' o
:; l I Ext--cudves I ; ,;: ]. I . v>s:Y'
:::: 1 w z >.:.! / 1 Dek:gate{s) 1
_____ _. _. _...! 1/
5 __
'E
Work
lace units
of 10-20
General Assembly or e.1ch of cooprr:Ui\C dec!
to councils Df own Ci)op
& delegates to pmticipalc in Gcntr.:li Asse:nblics
of SL"Cond nrder coops and MondragOr: Congrt-"!'S:
First co-.op established 1956, with -o-ver 150 by 1992
I
Ci1izen;; who participate in MondragOn activities -i!S customers,
suppliers or .::ommunity representatives
National government, regional govemmcnt and town councils _II
Vote, appoint, delegate, manage:--- Advise or nominate: --- Start up: .._
l3n3cd em info:mo.tion from: Ci.P ( !992); MCC { 1992); l\.lollner ( !991 ); l'vlorrison (1991}; Whyte & Whytc(I9SS
207
CHAPTER6
governance structure in which workers would have equal rights to the fanners. Lana began in
1961 and by t982 it had 300 fam1crs and 120 \Vorkers.
A cooperative to provide married women with parHimc employment was tOrrncd in 1965.
Once again, Arizmendi mel with resistance from males who did not want the traditional role
of men being challenged. Titc cooperative now provides hundreds of w(nncn with parHimc
work providing meals to cooperative workers, cleaning and child-minding services.
When Arzimcndi suggested that USS2 million be spent to create an applied industrial
research laboratory in 1974 his suggestion was as usual, initially rejected. The laboratory
known as Ikerlan moved into its new building in 1977 and pioneered both the development of
industrial robotics in Spain and a new governance structure.
The rccess10n m the early l980s resulted in one third of the -cooperatives requiring
intervention by the CLP. While the bank continued to grow to become one of the most
profitable in Spain, there was some introspection on the overall financial stability of the
group. To provide additionai financial strength an Inter-cooperative Solidarity Fund {fSFO)
was cstabfish1..>d by placing a levy on all individual members, The MondragOn Congress and
ils executive ann, the Council of Groups were established in 1987 !0 manage this fund and
coordinate the whole system. It also created balance to the dominating power of the CLP.
An overview of all these stages of development arc presented in Figure 6.1, 'MondragOn
Cooperative Social Svstem: With dates of establishment' preparl.!d by the author from rhc
cited sources.
6.5 The governance of MondragOn firms
The infom1ation and control architecture within a primary worker cooperative is outlined in
the lower shaded box of Figure 6.1. The architecture is far more complex than the simple
hierarchical control relationships found in most entrepreneurial, family or investor-ow11ed
2:03
STAKEHOLDER CONTRO!.lEO FIRMS WITH CO:\!POUND BOARDS
firms
37
. However. most "primary worker cooperatives" do not have the added complication
of including representatives of key stakeholders on its supervisory board as provided for in
the "support cooperatives" shown in the right band box of Figure 6. l.
A number of the agricultural processing cooperatives have a supervisory board with equal
numbers of workers and fanners, \vho are the suppliers. The retail cooperative, Eroski, has an
equal number of workers and .customers with the chair being a customer representative. The
student work experience cooperative has a supervisory board \Vith an equal number of
students, staff and parents. While the pig f3nning cooperative has four different stakeholders
on its supervisory board represented in proportion to the value added by each class of
stakeholder (Turnbull I995d: 179). Th!.! general rule is that the key strategic stakeholders on
whom the finn depends for its existence have a constitutionally protected process to provide
feedback information and control as required by the cybernetic principles for
as was outlined in Table 3.7.
6.5.l
Details of the governance system of simple primary worker cooperative is shown in Figure
'lnfOnnation and control architecture of MondragOn Cooperatives', developed by the
author ifom the cited source.<- The constitution of MondrogOn producer cooperatives
decentralises control into four fOrmal org::ms: the General Assembly; the Supervisory Board;
the Watchdog Council; and the Social CounciL There is also an informal Management
Council (EIIcnnan i982: II).
The General Assembly, Supervisory Board and W.:1tchdog Council arc required by Spanish
coopeartive law (Thomas & Logan 1982: 26). The Management Council and Social Council
arc MondragOn innovations. The constitution or laws of cooperatives arc subject to the
approval of the bank, the CLP. Only cooperatives, which have a Contract of Association with
3
7
Chapter 7 shows how architectural complexity creates operational and competitive
advantages by allowing specialisation und the simplification of responsibilities and duties of
executives and directors.
:20(}
CHAPTER6
Figure 6.2 Information and control architecture of MondragOn Cooperatives
Legend: Advises - - - - ;>--
Elements of compound board in bold
Bank owned & controlled by all client co-operatives
+ + Othet co-optativJ
+
+ Othtr
+ +
Bank
Changes in intemal rules *General Assembly, SupervisOI)' board
'
'
'
'
- .SI:!,bject to approval of bank and Watchdog Council required by law
'
'
'-,
'
'
'
General Assembly*
'
1'----
'
Bank overvie\\\
Employees meet as shareholders at least once
of financial
' a year. Most finm limited to 500 employees
' Watchdog
perfommnce, '
' Half board elected for
Council*
'
operations and
'
'
4 years every two years
'
employment
'
3 members
' levels, etc.
Supervisory Board*
elected with 4
'
'
'
year tems
'
1'.-l:cets monthly and has all powers not '
'

'
retained by General Assembly or
'
'
Delegated to the President
'
' ,"f
'
"
'
'
'
'
Management '
President '
Council#
'
Chairs Supervisory Board
'
'
Directors, executives and General Assembly
'
and contract ex pens '
'
Market Forces
meet monthly '
CEO and Department Heads '

'
For:
Appointed for 4 years '
'
Raw materiab,
(cannot be on Supervisory Board) ' technology &
'
Controls enterprise '
'

'
'
'
'
'
Social Council#
l\.Icel-> every 3 months and detennines:
pay scales for all employees including directors; safety and
social welfare issues. Required by bnnk contract of
associaiton which defines rules of coop.
/
Delegates clected ro, 3 years
Delegate I Delegate 1 Delegate 1 Delegate I
Delegate Delegate
Meet weekly
Work Work Work Work
\Vork Work
group
group group
of 10-20 of 10-20 of 10-20 of 10-20 of 10-20 of 10-20
\ I I /
Employees meet as shareholders at least once a year as a:
General Assembly* (See above)
Based on information from: Ellerman (1982); Whyte & Whyte ( 1988); l"vtorrison ( 1991)
210
STAKEUOLDR CON'I'ROLLf..O fU{;\IS WITH CO:\ I POUND BOARDS
the CLP, are members of the MondragOn System, Membership of the MCC is voluntary
which provides a united interface with the external world tbr most of the MondragOn system.
The General Assembly of each cooperative must meet at least once a year and periodically
elects by secret ballot directors for fOur-year terms on a one-member/one-vote basis. Only
employees can be elected. To ensure that members have a choice, thl.!re must be three
nominees for each board position. Nominations arc provided by the Social Council, the
Supervisory Board and from the body of the General Assembly whose members vote on the
outcome (Mollner 1991: 145). Members of a General Assembly who do not have an excuse
tOr not voting are denied voting rights at the next meeting.
Half the sup!!rvisory board is appointed every two years. The board appoints the CEO the
Prcsidcntlchairman and the different department heads that cannot be board members. At the
discretion of the board, executives may attend board meetings and speak but not vote.
Governing powers not delegated to the President or reserved tOr !he General Assembly
devolve to the Board. The separation of the executive (CEO and department heads) and the
board, which appoints and monitors executive pcr!Omumcc, is in the tradilion of European
multiple boards described in Analyt!ca (1992). The Board is in tum accoumnhle to ihc
General Assembly, which examines and approves the accounts. any changes in the financial
or management structure of the business or the level of initial capital contributions by new
members,
The President legally represents the cooperative and chairs both the Supervisory Board and
the General Assembly which he or she may convene either at his or her discretion. A petition
may also call an Extraordinary Assembly from one third of its members or by the Board.
There is usually a 12 member Supervisory Board that must meet at least monthly and any two
members can call meetings,
211
CJJAPTER6
The Management Council is an infonnal advisory and consultative body, composed of
members of both management and the Supervisory Board. lt meets monthly and is composed
of the President, department heads and outsiders who may be contracted for their special
and skills.
The Social Council reports to both m;magemcnt and the Supervisory Board. It has wide
prescriptive and advisory powers in all aspects of personnel management. It has more power
than the workers councils found in Germany or the Comitti d'cmtreprise of French finns
illustrated in Figure 4.3 of Chapter 4 (Analytica 1992: I 04).
The Social Council decisions arc binding in such matters as accident prevention, work safety
and \vork hygiene, social security, wage levels, administration of social funds and welfare
payments. Sections of I 0 to 20 workers elect delegates for three-year terms. Delegates can
offer themselves for re-dection although are required to step down each year.
\Yorkers in each section meet with their delegate at least once a week and each cooperative
must hofd a general plenary session of the Social Council delegates at least once every three
months.
The manner in which delegates are appointed makes them relatively independent of the
supervisory board and even more independent of the executive. They may be constdcrcd as a
loyal opposition to management. As such they pcrfonn some of the functions that might be
the concern of trade unions.
A most Important activity of the Social Council is to determine the labour indices used to fix
the rate of pay of each \Vorker. Every job is evaluated on the basis of many characteristics
such as the necessary training and experience, decision-making responsibility, social
relational skills, physical and mental demands and special hardship factors such as danger,
noise, etc. The indices for all bJuc and white collar workers arc published jn a manual tOr all
to see.
212
STAKEHOLDER CONTROLLED FIR.,1S WITH CO.:\IPOUND BOARDS
All cooperatives restrict the ratio of top lo bottom pay ratios to the same figure; this was
initially three to one and has been increased to six to one with some exceptions (CLP 1991).
The Social Council is kept separate from senior management by a law, \Vhich requires its
members to be workers who have indices in the fo\ver levels.
The Watchdog Council consists of three members directly elected by the General Assembly
tOr a tOur-year term. lis function is to obtain, monitor and audit financial information or .any
other information requested by the Gcncrai Asscmbiy. The 'Watchdog Council also reviews
the ovcralt conduct of management, the Supervisory Board, the Social Council nnd "also
serves the role of ombudsman" (Mollner 1991: 154).
The Watchdog Council may cali in the CLP or the Lankide Suztaketa (LKS), an
entrepreneurial cooperative, to strengthen its position or to monitor and guide management.
The CLP has computer access to the accounts of each cooperative, which allov.rs it to monitor
operations continuously and evaluate operations with rights of intervention. The bank has an
lntcrvention Department for helping its cli..:nts. The Contract of Association requires
cooperatives to provide information>s to the bank and to place their funds on deposit with it
The functions of tbe \Va!chdog CounciP
9
are much wider thnn audit committees fom1cd in
unitary boards of Anglo firrns. it has a somewhat similar role to the Cows des Comptes in
French State-owned finns or Censeurs found in French financial institutions (Analytica 1992:
104),
Some cooperatives hnvc other operational stakeholders as members beside workers.
Individual fam1crs who supply produce to a processing and marketing operation bt.'COJUC
members with the workers to fom1 a 'hybrid' supplier/worker cooperative. The retail chain
store is a cooperative with 80.000 customers-members and 800 worker-
members. Unlike coopcmtivcs in the same type of business found clscwhcrc in the wortd,
3s The information required is set out in Appendix B of Campbdl, ct al. (I 977)_
39 The Corporate Senate developed in Australia was modelled on the \Vatchdog Council
(Tumbull 1992; 1993c; 1994c; 1998a).
213
CHAPTER6
hybrid cooperatives do not provide patronage dividends. Surpluses are distribu!ed in lhe
same way as in worker cooperutivcs except fOr the 'stakeholder' cooperatives that have their
representatives on their supervisory boards.
6.5.2 Distribution of cooperative profits
Technically, the workers are not paid a fixed wage but cam a share of surplus revenues over
all labour costs. An anticipated part of this surplus (amicipos) Is paid llkc a regular wage
during the year with a bonus paid at the end of the year after the actual surplus has been
determined. Up to 90% of the surplus is retained to increase the equity base of the firm. Tbc
levels of anticipos are established according to the prevailing wage rates in the region.
For the purpose of calculating net eamings: under Spanish law, the anticipos is treated as the
fUll wage paid to the workers whereas they arc entitled to I 00% of all net earnings:. However,
nl Jcast 10% of net earnings is spent on social and educational expenditures as a 'social
dividend' as is required by Spanish law. Of the 90% remaining, at least 20% is retained in a
colk"Ctivc account to create a reserve with the outstanding 70% allocated to individual internal
capital accounts. The allocation is proportional to the pay index established by the Social
Council for each worker.
That part of the surplus, whicb is not, considered a \vagc under Spanish la\v, can bi!' re-
invested in the cooperative to finance new investment or placed on deposit with the CLP as
required in the Contract of Association. n1e surplus retained in the collective account
increases tbe equity of the cooperative. Members can draw on their individual accounts on
and recoup the:ir t1xed membership subscription.
However, unlike a membership subscription to a traditional cooperative, the amount
accumulated in the internal capital account will vary considerably among members according
to their pay levels and length of service. Like some pension the individual accounts
are portable between firms, an important feature as diversification and gro\\1h in the
214
STAKEHOLDER CONTROLLED FIR:'\ IS WITH COMI>QUNIJ BOARDS
MondragOn system is achieved through additional activities to new cooperatives.
Portability is. also required to f'acilitate job rationalisation \vithin the MondragOn system.
Traditional cooperatives, non-protit and common ownership firms do not allow 1.vorkcrs any
right to retained can1ings. The traditional approach creates an incentive io distribute all
profits and so deny equity financed growth, Nor docs the MondragOn approach create a
barrier to entry for new workerS, as they do not need to purchase shores at a value, which
reflects retained earnings. The share price increases with the success of the finn in adding
value. Besides creating a barrier to entry, this creates a liability ibr US ESOP companies,
which arc required to purchase back the shares of departing employees at a fhir market price,
6.5.3 The Bank and other second order coopcmtivcs:
40
1
Second order' or 'super stnH.:tural' coopcrotive 1s the term usually used to describe
cooperatives formed by other cooperatives so that no individuals arc members. In
MondragOn, this tenn is used to describe fimts, which have both workers and other
cooperatives as members. The second order cooperntives in MondragOn arc involved in
banking, entrepreneurship, industrial research and development, education and work
C!'pcriencc, retailing, fOod production and the provision of social security and hc:1lth care
services.
The bank {CLP) has a similar architecture to tht! producer cooperatives with some
A distinguishing difference is that besides its I ,300 or so worker members, the bank has 150
or so customer coop members \Vbo arc party to a contract of association with the bank.
The cooperative members may also contribute to both sides of the balance sheet of the bank
through their deposits andior loans. [ts l-ead stakeholders who have an operational interest in
its activities as workers, suppliers and/or customers thus control the bank. Of its 12 directors,
its workers dcct S ut its General Assembly by member cooperatives and 4 with half this
number being appointed every year for a two-year tem1. The distribution of the 8 cooperative
40 In this section, 1 um indebted lO Ellerman {1982} and MCC ( 1992).
215
CHAPTER6
representatives is usually 5 or 6 from the industrial cooperatives, I from the consumer
cooperative and 1 or 2 from the other second order cooperatives.
\Vhile the principle of one member one vo!-e is used to elect directors within the two
categories of members, the proportion of directors represented by either category is fixed and
so not dctcm1ined by either the relative number or relative size of the tlnancial stake of either
category. Nor arc the considerable surpluses generated by the bimk shared with their
members in proportion to their patronage as is practiced with traditional ngricultural and
consumer cooperatives. Instead, allocations to the internal capital accounts of CLP workers
art:: made according to the average profits allocated to a!l members in their client producer
cooperatives according to their respective pay index. This approach is also quite different
from the practice of credit unions, banks and corporations that distribute profits to their
members according to the size of their investment.
The sharing of client profits by CLP employees creates an incentive to establish new
cooperatives. support th.:m and enhance their profitability. [t explains why interest payments
of cooperatives with trading diflieultit:s may be waived and why this may be extended to
principal rcpaymems. \Vhen the CLP was founded it was only authorised to make loans to its
shareholders and this reinforced the incentive to creatt.: new client cooperatives.
The incentive to make the cost of finance a variable instead of the tevc\ of employment is
by the cost of unemployment b<.!:nctits. being a cost to all cooperators participating
in the voluntary social security and health coopcr.ttivc, Lagun-Aro. The internal accounts
of Lagun-Aro workers are based, hke the bank, on the average net surpluses of the primary
cooperatives. This is also a stimulus for their pr\!ventivc medical programs, in the early
l970s the bank hived off Lagun-Aro into a separate cooperative and in 1991 the
entrepreneurial department was spun off into Lankide Suztaketa (LKS).
By I 992. the CLP bad over 213 branches and held regional assemblies for its depositors. In
ils fom1ative stages, it also provided membership to its individual dcpusitors) but this was not
216
STAKEHOLDER CONTROLLED FIRMS WITH CO:\IPOUND BOARDS
continued. Rapid growth of the bank has been achieved even though its branch operations
were limited to the four Basque Provinces. In 1991, the bank obtained the authority to
operate on a national basis (CLP 1992).
The supervisory board of the student work expenence cooperative, Alecop has equal
representation of its three principal operational stakeholders - the students, permanent statT
and the customers who purchase its output.
The League for Education and Culture (LEC) oversees the education system, which now
encompasses many schools including a polytechnical school, business school and a
professional college. LEC provided the technical knowledge, cultural values and social
networks which created MondragOn.
In 1948, LEC obtained a charter with four classes of members: individual supporters; active
members who contributed services or monthly dues; business sponsors who made annual
subscriptions; and elected community oflicials. Each class elected ten delegates to a General
Assembly who in tum elected a fourteen-member school board. Six board members were a
representatives of business sponsors and one was the Mayor of MondragOn (\Vhyte & Whyte
1988: 30).
6.5.4 lntcr-fim1 governance
The control relationships between the cooperatives were indicated in Figure 6.1 above. This
illustrated a holarchy of nested and recursive holonic components described in the next sub-
section. The infom1ation and control architecture of a primary worker cooperative shown as a
shaded area at the bottom of the Figure is replicated in the Relationship Association or Group
shown in the shaded area in the middle of Figure 6.1. Another way of showing the
relationships of the various entities is presented by the author in Figure 6.3, 'Control network
of MondragOn activities'. This Figure omits the individual primary cooperatives and
highlights the support cooperatives in the right hand box of Figure 6.1 as a circle surrounding
all the individuals they service. The individuals are shown servicing their primary
217
CIIAPTER6
cooperatives and support entities. The primary cooperatives in tum service higher levels of
the holarchy shown in the centre ofFigun:: 6.3.
Figure 6.3, Control network of MondragOn activities
-B-_:
/// , / ~ ~ = = ~ /
/ f 3 , ~
/y
I
2s
3
J
, -o
1 In \992
-8
More than 150 primary worker and hybrid co-ops are
associated into 12 groups or relationship associations
Totall992: Assets US$6.3 bn.; Sales US$3.0 bn.; Exports US$380m.
Based on information in: Whyte & Whyte (1988); Morrison (1991): MCC (1992)
The 12 'groups' or 'relationship associations' formed by the primary cooperatives produce
related products or shanv a common geography. Some of these associations represent
'offspring' cooperatives fonned to take over products or services originally produced by an
21R
STAKEHOLDER CONTROLLED FIRMS WITH CO:\lJ>OUNO BOARDS
existing cooperative, This process is assisted by LKS, which provides a padrino or "god-
father" (Elicnnan ! 982: 29} to act protectively for new ofiSpring41, The CLP acts like a 'rich
uncle' providing finance and the relationship association provides 'family' support.
Relationship associations provide a basis to obtuin "some of the advantage of both large scale
and small-scale operations" (EIIcmwn 1982: 9). Ellennan goes. on to explain that the
Association:
... allows small or cooperatives to have common sales and
marketing arrangements, common planning of product development and
market strategies and risk-sharing by a degree of income pooling and job
pooling.
As a result. relationship associations blur the boundaries of MondragOn firms. Firms in a
relationship association or conglomerate arc likely to be suppliers and/or customers with each
other as fOund in Japanese kewersu as illustrated in Figure 4.4.
The General Assembly of an association or group is made up of individuals of the supervisory
boards, watchdog committees and management councils of its members. The Assembly
approves accounts, budgets and membership of the Association and elects a govcming
counciL The govcming council of a group establishes common accounting, legal and
administrative systems, negotiates new manufacturing licences and relationships with outside
firms and oversees the creation of new cooperatiws. The plans of the govcming council is
evaluated by a Central Social Council made up of delegates from each of the Social Councils
of each member.
Representatives of the 12 congloml.!ratcs or groups meet every three months with
representatives. 1Tom the retail coopcrativ<:, educational Social S<..--curity Service

4
l The word "offspring" is used in the same sense by Turnbull (I99la) when describing how
Ownership Transfer Corporations (QTCs) would finance new activities and/or perpetuate
their own activities at the end of their licence to exist The offspring finn would typically be
owned and controlled by the individuals who were its operational stakeholders rather than by
the parenting enterprise.
219
CHAPTER6
and Industrial Research Institute as a Council of Groups. This provides a forum for furthering
cooperativeeration between the groups and with the otlwr support activities.
Over-arching the groups in a similar manner as the boards of individual cooperatives over-
arch their social councils, there is a MondragOn Congress (Figure 6.3). The 350 members of
the Congress nrc appointed by proponional voting by all members of each of the
cooperatives. The Congress meets every two years and appoints a Standing Committee of the
MCC, which could be viewed as a holding company. MCC publishes an annual report which
provides a "balance shcetn (MCCt i 992) with consoltd;:ucd figures of all related cooperatives
and the total number of workers, sales and exports.
Like a holding company, the MCC reports on the activities of its members on a divisional
basis. They arc grouped into three divisions: Finance with 8 cooperatives; industrial with 73
cooperativ<.'"S; and Distribution with 10 cooperativ.;;s, Them is also a 'corporate' group of 11
cooperatives involved in tertiary activities like education, social security and industrial
research.
65.5 Holo_n_jc nrchitecturc
The qualitative description of the complex MCC structure presented above provides a
challenging basis iOr undertaking its logic or comparing it with other fim1s. TBA with its
concept ofholons and holarchics provides a basis to achieve both objectives.
The information and control architecture of the MCC illustrates both strong and complex
holonic architecture. Each industrial fim1 and each relationship group mpmsents a "sub-
asst!mbly" or "stable intermediate forrn
11
to quote Simon (1962: 472-3). Each industrial firm,
group and the MCC are
11
ablc to mainiain a separate existence" and so represent "viable
systems" (Beer 1985: 1) and so also represent holonic components of a holarchy. The suppon
organisations such the PPS, LEC, Lagun-Aro, Alccop, Eroski, lkcrlan. LKS and the CLP each
contain similar holonic components but arc not pan of the holarchy. However, their
220
STAKEHOLDER CON'I'ROLU.:O FlR.MS WITH CO:\IPOt:ND BOARDS
interactions, or "system dependencies" (.Yfathews l996a: 39) make the whole more
sustainable then the individual parts.
\\<11He all primary cooperatives are a member of a relationship group, they are fiee to exit the
MCC system and some occasionally do. This proves that each cooperative has autonomy.
\Vithin each finn, pmvcr is divided into five centres: (i) General Assembly; (ii) Work group;
(iii) Social Council; (iv) Supervisory Board; and {v) \Vatchdog Council m shown in the
bottom three rows of the second column in Table 6.1, 'Hoton tvpology of
created by the author. This division of power is replicated in relationships groups to iltustmte
Table 6.1, Holon typology of MondragOn
'-"Oncatcnateo no10ns mtegnty to assure .mtegnty llOIOnS
coord1nauon and mtcmal structure
support of all component possesses lateral
Productive vertical recursivity ho!ons in the system (with rccursivity
recursive intra-support)
25.320 Biological components

(Hczibidc Elkartca)
uencra! t\sscmmy
Work groups
Individunls (brain, nervous system Schooling (EPP) Social Council
(MCC 1992) and other support Social security (Langun Supervisory Board
organs) Aro) Watchdog Council
Retail store (Eroski}
Retail banking (CLP)
t.u:mera! AsscmoJy
Work groups Trade and proiCssional
Asscmoty
Work groups
!50 Fim1s Social Council schools {EPP) Social Council
(MCC 1992) Supervisory Board Work experience (Aiecop) Supcnisoi)' Board
Watchdog Council Wholesale banking (CLP) \Vatchdog Council
R&D (lkcrlan)
I_- uroups or
'Relationship
AssemoJy
of groups Entrcpencur and imprinter
1 venera. Mscmmy
Work groups
Associations' Group Social Council of'holonic architecture' Social Council
(MCC 1992) Group Governing (LKS) Supervisory Board
Council \Vatchdog Council

Corporac1on
Lon gross
Central Social Council
.runa mr
sohdanty
Coopcrativa Council of Groups
the property of rccursivity, l have described this as '"vertical rccursivity"' in the Table to
distinguish it from the "lateral recursivity" tOund in each support organisation at each level of
the holan:::hy. In these ways, holons in the MondragOn system meet the Mathews tcsl of
221
CHAPTER6
"holonic autonomy, system dependence and rccursivityu. In addition each holon is "endowed
with its own processing ability, its own autonomy, its mvn 'mind' or intelligence".
The "mind or intclligcncc
11
of each cooperative is represented by its compound board, Every
MondragOn industrial cooperative, secondary cooperative and support organisation has a
compound board. In this way each organ of the MondragOn system obtains greater variety in
control, i.e. obtains it own "mind" or "intelligence". Compound boards create architecture of
"distributed intelligence" which is the strategy used by computer engineers to increase the
speed and capacity of computing. Compound boards also allow the parallel processing of
diflCrent infonnation to provide quicker decision making and responses to changing
circumstance,
The fCedback and control infonnation which needs to between lower and higher
levels is minimised by each cooperative being an "almost self-governing component" of its
group and each cooperative being composed of ,almost self-governing components or sub-
assemblies". These arrangements explain the "Principle of Subsidiary Function"
{Schumacher 1975: 203) which states that no higher ord.:r association should und..:rtake any
function which can be undertaken at a lower level. Father Arizmendi. who designed
MondragOn, was following the principles set out in the Encyclical Letter of Pope Pius XI
( 1931: 40) which stated:
Just as it is wrong to \Vithdraw from the individual and commit to the
community at large \Vhat private enterprise and industry can accomplish, so,
too, it is an injustice, a grave evil and a disturbance of right order for a
]arger and higher organisation to arrogate to itself functions which can be
perfom1cd efficiently by smaller and lower bodies. This is a fundamental
principle of social philosophy, unshaken and unchangc(\ble. and it retains its
full truth today, Of its very nature, the true aim of all social activity should
be to help individual members of the social body
1
but never destroy or
absorb them.
ST AKEIIOLDER CO:'IITROLLEO fiRMS WITH COMPOUND BOAJIDS
To nchicve this objective the size or each industrial coop in MondragOn is limited to 500
employees. The size of the fim1s is Jimited by spinning off a section the business as n
separate cnt!ty when the size limit is approached. By establishing new holonic units.
MondragOn exploits their "prodigious ability to the transaction of bytes, It
resul!s in increasing the degree of distributed intelligence and paralld intbm1ation pmcc:ssing
as the size and complexity of operations increases. The offSpring firm would become a
supplier or customer of its progenitor to allow the system to grow by the process of
autopiesis. The offspring firms create a network of stakeholder relationships in a somewlun
similar manner as found in Japanese keiretsu us illustrated in Figure 4.4. However, finns in
Japanese keiretsu \vould have only one control centre and may have many more than 500
employees. MondragOn "relationship association" or "group" would possess greater
dh;:tributed intelligence parallel information processing. By ke-eping firms at a "human scale-\
MondragOn fim1s make greater utilisation of the richness of interpersonal communications
discussed in Sections 3.3 and quantified in tcm1s of bytes in Table 3.l.
Each industri11l firm is part of a group and each group is part of the :V1CC to create a hierarchy
of holons or a 'holarchy' as indicated in row i 1 of Table 3.8, analysed in Table 6.1 and
illustrated in Figures 6.1 and 6,3. Each primary cooperative is made up of a self-managing
"work group", a "social council" and "General Assembly" as noted in row I 0 of Table 3,8
and shown in morl! detail in Figure 6,2, As shown in Figure 6.1. the infOrmation ant! control
structure of an industrial fiml with its president, board, social council and General Assembly
is mirrored in the stn1cturc of a group with, respectively, its general rnaoagerj Governing
Council, Central Social Council and Assembly of Group. This "self-similarity" or
11
recursivity" (Mathews l996a: 38) is again replicated by the MCC President. MCC, Council
of Groups, and MondragOn Congress. Mathews ( l996a: 40) described "these three
characteristics - holonic autonomy. system dependence and recursivity, as the defining
features ofholonic organisational architectures".
MondragOn also illustrates a feature not analysed by Mathews but which is found in nature.
That is, lateral integrating support and service holons to assist in the coordination and
223
CUAPTERU
operations of tho holarchy. The author has described these as "integrity holons" in Table 6.1
because they carry out the role of the blood supply in the human body, which maintains the
lntegrity of operations, by supplying energy and matter. The nervous system also carries out
a slmilar role by activating both tactical and strategic reactions to sustain life.
The two columns of Table 6.1 list three levels of organisational "concatenated
holons". They arc described as "concatenated" because tbcy create a nested linked chain or
"holarchy''. A top and so fOurth level is included at the top of the second column to illustrate
the ubiquitous presence of biological holons in nature and how an organisational holarchy
shown in rows 10 and 11 of Table 3.8 represents an extension of the holarchy found in
The left-hand columns show the recursive pattern of information and control found in each
level of the concatatcd holons from which the MCC holarchy is constructed. This r..x:ursive
pattern of infonnation and control also appears again in the integrity holons shovm in the
right hand column of Table 6.1. According to Mathews (1996a: 39): "sys<cm integrity calls
for tbesc holons to be structured along similar lincs
1
so that there can be meaningful
aggregation from level ;o level" and that ''self-similarity provides the technical foundation fOr
systemic These properties arc demonstrated in Table 6.1 where the pattcm of
control centres shown in the second column ure replicated in the last column.
The compound boards found in each hoionic cnmponcnt, be it in a primary cooperative,
group, support entity or the MCC, represent the "mind or intelligence'' which is a feature of
holonic architecture as noted by Mathews ( 1996a: 34). The MCC illustrates the other
characteristics of holonic organisations as discussed in the development of TBA in Section
3.9.2. The superior pcrfonnance of the MCC compared with hierarchal fi:nns as noted in Sub
section 6.2 is consistent with Mathe\vs' ( 1996u: 41) observation that "holonic systems exhibit
superior performance on these points than conventionally structured finns".
It was the superior performance of Japanese firms that concerned the USA in the 1980s. This
lead Porter (1992) to investigate how they were different tl:om US finns. Porter concluded
that it arose from a number reasons including the abHhy of Japanese firms to obtain
FIRMS \\'ITH CO-:\lPOVND BOARDS
infOm1ation which provided competitive advantages from employees, customers. suppliers
and the host community. To provide both the incentive and facility for these strategic
stakeholders to provide competitive infonnation for the longer term he n.::cornmendcd thz1t US
firrns seek to involve their employees, customers, suppliers and host community in their
ownership and control system (Potier 1992: 17).
The invo-lvement of strategic stakeholders is an intrinsic feature of the MCC and its
components groups and tinns. The similarity between the MCC and Japanese keiretsu is
considered in the next section.
6.6 Japanese Keiretsu
Many companies in Japan arc members of a {Charkham 1994: 77). There arc two
types of keiretsu, which operate in quite different ways. A horizontal Keiretsu is based
around a major trading house or bank and a vertical keiretsu is based around a major
manufacturer such as found in the auto and eketronic industries. Both types have quite
ditTerent operations and relationships and both types arc held together by a complex web of
relationships. Tesuka(l997: 87) states:
Every large industrial tirm, such as Toyota or Matsushitu., is the parcm firm
in a complex, layered group of firms; some un.: suppliers and sub-suppliers,
other are sales and distribution companies, still others arc spin-off fim1s
in engaged in related businesses.
Tcsuka {!997: 87) goes on 1.0 say that through these relationships: "Americans st!c Toyota
out-sourcing more than 60 percent of its parts and sub-systems or Canon nearly
90 percent of the value added in its copiers". A vertical keiretsu has a number of similarities
to .tlrms in a Mondrag6n "relationship" group. As some of these are formed by cooperatives
spinning off part of their operations into a separate business to nvoid growing too big with
more lhan 500 employees, one firm becomes a supplier to another and/or produces allied
products to share suppliers and! or marketing effort.
125
CUAPTR6
There are six horizontal kcirct:sus in Japan. Four arc built on the pre-war Zaibatsu groups of
Mitsui, Mitsubishi, Sumitomo and Fuyo. The other two arc centred on the Sanwa and u i ~
Ichi Kangyo banking groups, The horizontal keiretsu share some operations and rclatkmships
t:Ound bchvccn MondragOn groups, the MCC and their support organisations, To quote
Analyticn ( 1992: 130):
It has bl.!come stUJldard practice among Japanese firms to exchange small
amounts of stock with lenders and business partners as a gesture of
goodwill, sincerity and commitment. Although the amounts exchanged arc
usually small, many such exchanges are made and they account for a
significant share of the company's outstanding shares.
These share exchanges are fOund whether or not the company is a member of keiretsu. They
arc rarely traded and so "form a block of friendly and stable shareholders that represents
between 60% and SO% of all shares" (Analytlca 1992: 130),
Thl.! resulting paaem of ownership, control and trading relationships is shown in Figure 3.4.
These shows that while a bank may be the largl.!st shareholder, both it and management have
access to feedback infom1ation from strategic shareholders to provide a basis for
constmcrivcly exercising control and regulation to improve operations. These feedback loops
are missing in the Anglo system with non-rdated party ownership and controL Japanese
shareholders obtain information independent of management on the perfonnance of
management from committed and knowledgeable sources. The opposite situation exists in
many Anglo countries. as indicated in the lctlwlumd side of Figure 4.4.
As noted cariicr, over 60% of the shares of publicly traded corporations in countries like the
USA, UK and Australia, arc typically held by institutional investors. However, unlike t h ~
60% or so stable investors in a Japanese firm, institutional investors rarely have any trade
related activities. Nor do institutional investors commonly become actively involved in the
nomination and retirement of directors. Institutional investors are mainly passive without
industry knowledge, relationships or high-pmvered incentives to improve the pcrfonnancc of
the compzmies Jn which they invest Indeed! the cost of getting involved provides them the
226
STAKEHOLDER IitR;\1$ WITH COMPOUND BOARDS
incentive not to take any action except dispose of their shares ('do the Wall Street \Valk') in
the event they arc not satisfied with the operations of their in vestee companies,
Because suppliers, customers and employees collectively hold the majority of shan.:s m
Japanese companies, the shareholders have the knowledge, and long t.::rm incentive to
improve the operations of the company. However, as individual small minority shareholders
they do not have the power to take action. This problem of diverse ownership and control
analysed by Serle & Means (1932) is ov(..-rcomc in a keiretsu through a 'President's Council'.
The President's Council is made up of the chief executives of suppliers, customers and the
main trading house and/or bank. It typically meets monthly, but in some cases even weekly
to exchange businr:ss intelligence, facilitate coordination and quality assurance processes.
The President's Council as a component of a compound board. provides feedback information
in a manner consis!cnt with the view of Williamson ( 1985: 308) !hat s!akcholdcrs should only
participate on an infonnariona! basis.
The lend shareholder is in o position to mediate the inherent contlicts of interest of the rdated
party interests. A situation is created where shareholders obtain the three conditions
identified by TBA at the end of Section 3,5 for self-regulation and self:.govemancc as
incorpomtcd in Tabl;; 3.6. That is, shareholders obtain (i) the infonnation, (ii) will and (Iii)
capability to act, which is not available with mosl Anglo finns shown in the left-hand portion
offigure 4.4.
Articles of tbe Japanese eorporate code requires that firms establish 'statutory
auditors' or kansa.rakrt. The kansayaku is not just concerned with accounting matters but is a
general 'watchdog' board as found in MondragOn and in France. Charkham ( 1994: 82)
describes its functions:
The basic role of the kansayaku is to monitor the entire scope of company
operations and if he tinds any problems or wrongdoings, to advise the
directors on a timely basis. The kansayaku must report at the shareholders'
227
CHAPTER6
meeting whether or not company business was carried out properly and
whether or not the agenda proposed by the directors is appropriate.
However, Charkham reports that the reality of their functions docs not match the statutory
requirements except in some of the larger companies. The most meaningful interventions
arise from the keiretsu council as for example with the re-organisation of companies under
financial stress as discussed by Kester ( 1991 ). While individual members of the council may
only represent a minority sharcholding, the collective has a majority to provide the power for
corrective action to take place.
Even when a company is not suffering distress, the keiretsu council can provide operating
advantages through the supply of business intelligence and evaluation of perfonnance by
people with inside expert knowledge which is independent of management. This is a
requirement for self-governance as indicated in Table 3.7. It also provides what Williamson
(1985: 382) describes as "secondary (or strategic) feedback loop" [of information] to provide
what Mathews ( 1996b: 120) describes as "second order economic learning" being learning
that take place between finns.
The architecture of a keiretsu and of MCC groups illustrates what Mathews (1996b: 120)
describes as "third order economic learning". This is "knowledge concerning how to fonn
inter-finn networks and alliances". However, in a keiretsu, this knowledge is embedded as
structural infonnation implicit in the culture of the country while in the MCC it is an explicit
variable subject to change by the MCC 'Council of Groups' shown in Figures 6.2 and 6.3.
There is no facility for an explicit manager of the structure of keiretsu in Japan unless this
occurs through a government initiative.
6. 7 Review of compound boards with stakeholders
MondragOn finns have survived and prospered during the recessions of the mid-l970s and
1980s (Whyte & Whyte 1988: 158 & 162). The industrial finns have illustrated their
intt.:mational competitiveness by exporting around 25% of their output. The competitiveness
228
STAKEHOLDER CO!'<TROLlEO FIR:\ IS WlTH CO;\IPOUNO DOARDS
of US firms in relation to those in Jnpa.tl and Germany has been analysed by Porter. Porter
(1992: 13) found that:
The US system may come ctoscr to optimising short-tenn retums,
HO\vevcr, the Japanese and Gcnnan systems appear to come closer to
optimising long-term private and social retums. Their greater focus on
long-term corporate position and an o\vnership structure and governaJlce
process that incorporate the interests of em1)loyecs, suppliers, customers,
and the local community allow the Japanese and German economics to
better capture the social benefits that can be crcah:d by private investment
As a result of his findings. Porter { 1992: 17- I 8) recommended that US finns modify their
own<!rship and control structures by 'encouraging long term ownership' and to
1
nominatc significant owners, customers, suppliers, employees and community representatives
to the board of directors'. Implicit in Porter's findings and recommendations is the view that
corporate governance is a determinant of competitiveness. The outstanding pcrfonnance of
Mondrng6n firms and their unique system of governance support rhc irnplicit hypothesis of
Portl.!r.
The participation of employees, customers, suppliers and community in the governance of
MondragOn tim1s atso supports Porter's findings and recommendations for improving the
competitiveness of US finns. However, Porter made his recommendations in the context of
unitary boards which are found in countries with an Anglo culture. \ViHiamson (1985:
325) describes why 1hc presence of operational stakeholders such as employees, customers
and suppliers on a unitnry board would be counter-productive. By only recognising the
types of owners and controllers and the not the ditferenccs in their control systems,
Porter's recommendations become flawed. ln Porter's (1992: 14) own words, '"Many current
proposals for improving the US systems are counter-productive. They suffCr from a partial
view of the problem and address its symptoms rather than its
229
CHAPTER6
However
1
\Villiamson (1985: 305) recognised the possibility ".,.to invent a governance
structure that holders of equity recognise as a safeguard against expropriation and egregious
mismanagement". The MondragOn inventions support the speculation by \Villiamson and
demonstrate a control system, which would allow Porter's recommendations to be effective.
The way in which the control architecture of MondragOn firms was custom designed to suit
both their activities and the nature of their principal operational stakeholders was summarised
in Section 6.5. The way in which the MondragOn system grew and changed over time is
parttally revealed from the dating of various devdopments in Figure 6. l.
Growth of MondragOn is fundamentally diflt:rent from the grmvth of firms with non-active
shareholders. MondragOn has grown through the creation of nc\v finns not through the
growth of individual firms. Many of the nC\V finns an! 'offspring' created by people and
assets being transferred from one or more existing finns. In this way, existing finns arc kept
to a "'human scale'' which is generally accepted to be around 500 employees (Morrison !991:
SO}. This is consistent with the limitation of the human brain to maintain "social cohesion' as
reported by Dunbar, (1993: 687) in Chaph.:r 3. The incentive and support structures of the
MCC facilitate this process of spinning ofl' parts into smaller units. Support is specifically
provided by the entrepreneurial experience of the LKS, the finance avnilablc ifom the CLP,
and !he sharing of operational services of the sponsoring group.
Besides creating new firms, the system intervenes to finns that may be tailing
even to the extent of 're-birthing' them into a completely new business (Ellernnm 1982: 36).
The description by Kester ( 1991) of how Akia Electric, a major Japanese manufactur..;:r of
audio and video equipment was re-organised by other flm1s in its. keiretsu led by Misubishl
bears a striking resemblance to how MondragOn finns in distress are re-organised as
described by Whyte & Whyte ( 1988: 175-183).
The process of re-allocating people and other resources is not determined at am1s length
solely by market tOrccs or by creditors and their agenis but through dir(.>ct negotiation
no
STAKEHOLDER FIRMS WlTH COMPOUNH BOARDS
between the principals as occurs \Vhcn professional partnerships merge or divide. However,
unlike traditional partnerships, there are agents like the CLP, LKS, Lagun-Aro and
representatives of the local cooperative group to mediate conflicts and between the
various parties who may have to make sacrifices.
Wi1ilc the various types of basic control architecture of).-1ondrag6n fim1s may not change, the
structural relationship between fimls and their support organisations continues to evolve.
Mondrng6n lS .still 'learning by doing'. Arizmendi imparted cultural values to his students,
which guided the 'trial and error' development of the Mondrng6n social inventions (Simmons
& Mares, 1983: 140). He believed that 'it is better to make mistakes than to do nothing'
(Whyte & Whyte 1988: 241 ).
Both a keiretsu and MondragOn share holonic architecture as found throughout nature as
indicated in Table 3.8, lines 9, lO & l J. In Japan, the strategy of managing complexity
through creating holonic structures is applied in designing robots and manufacturing
processes {Mathews 1996a: 30, 33). The existence of holonic institutional relationships
between tirms would nppear to be contingent on Japanest': history and culture rather than on
design. While the relationships of MondragOn firms were designed, it was without the
knowledge ofhokms.
However, the design criteria used by Arizmendi is remarkably consistent with tbe criteria
used by Dee W. Hoek, the founder and CEO Emeritus of VISA. Hock ( 1994: 7) described
VISA as "nn inside out holding company in that it does not hold, but is held by its functioning
parts. The 23,000 tinanciai institutions which create its products arc, at one and the same
time, its owners, its members, its customers, its subjects and its superiors." This also
describes the 24,500 partners in MondragOn.
The five basic principles which Hock used to design VISA International. also describe the
MCC. The principles established by Hock (1994: 6) to "re-conceive" the role of a global
credit card organisation are- set out below:
231
CHAPTE:R6
(a) It must be equitab(v all participams. No ml.!mbcr should
have intrJnsic preferential position, All advantage must result from
individual ability and initiative.
(b) Power and fimclion mus! be distribwed to the maximum degree. No
fimction should be performed by any part of the whole, which could
reasonably be done by any more peripheral part, and no power vested ir1 any
part, which might reasonably be exercised by any lesser part.
(c) Governauce mus! be distribwhe. No individual, institution, and no
combination of either or both should be able to dominatl.! deliberations or
control decisions.
(d) It must be infinitely malleable yer extreme(v durable. lt should be
capable of constant, se}f .. gencratedj modification of fOrm or fUnction wilhout
sacrificing its essential nature or embodied principle,
(e) it nwsr embrace diversify and change. lt must attract people ::md
institutions comfortable with such conditions and provide an environment in
which they can flourish.
However. nine guiding principles identified by Whyte and Whyte {1988: 259) for the design
of Nfondmg6n an:: not necessarily applicable to ViSA. The principles were:
(a) Balance: bct\\ecn: interest and needs; technological im!>ttativl.!s and
social needs; financial needs of the iirm and economic needs of members;
members and management; cooperative and cooperative groups; cooperative
groups and the host community etc.
(b) Future orientation: Planning must be orientated towards a future well
beyond the time when the immediate problem has been solved.
(c) Organizational se/j:evaluatiou: Nothing is ever perfect. Frequent self-
critical evaluations need to be institutionalised into the structure.
(d) Openness: Non-discriminatory. Membership open to any person who
can contribute as a stakehoJder.
232
STAKEHOLDER CONTROLlED WITH COMPOUND BOARDS
(c) Pluralistic political orientation: Avoidance of identification with any
political party or ideology by any member organisatlon. Individual
members can freely express their views.
(f) Freedom of il!formalion: for members on all matters relevant to
making decisions on their rights and responsibilities.
(g) inter-cooperative complememarity: Individual cooperatives should
buy and sell to one another provided no seriDus sacrifice is imposed on one
of the parties.
(h) Formation of cooperatim groups: To achieve l.':conomy of scale and
provide solidarity.
(i) Si;e limr'lation This principle is based on the assumption that it is
difficult for an organisation to remain flexible, di.!mocratic and efficient
when it grows beyond a certain size.
Both the VISA and MondragOn design criteria follow the principles of cybcmetics of
rl.!quisite variety discussed in Chapter 3 of creating 'distributed infOrmation collection'.
'distributed decision making labour' .and 'control'. This minimises errors in transacting bytes
in communications, decision making, and managing complexity. The case studies also
illustrate hotonic architecture that demonstrates the Principals of Subsidiary Function, The
combined rcsult being to minimise individual responsibilities, complexity and information
overload to allow individuals to operate closer to their limited ability to transact bytes. A
feature made possible through compound boards_
The students of Arizmendi were in 'action learning' or 'action research' and operated
in a 'phenomenological paradigm' as described by Eastcrby-Smith, Thorpe & Lowe, ( 1991:
27) rather than the traditional
1
positivistic' approach. The need for phenomenological research
or what Gummcsson (1991: 15} describes as the 'henncneutic' (interpretive) approach
becomes particularly relevant when qualitative rather than quantitative measures of
performance are involved. 1t is the qualitative factors, which Porter ( 1992) identified as being
the most important for finns seeking competitive advantages. The motivation for creating the
233
CHAPTER6
MondragOn system was to improve the quality of life. SustainHb!e business success was a y ~
product.
Academic research into the theory of the finn has developed in a positivistic paradigm while
Arizmendi and his colleagues learnt about the theory and practice of tinns using a
hcm1encutic paradigm all identified by Gummesson ( 1991: I 53). The MondragOn experience
suggests that action science offers a promising approach ibr developing the theory and
practice of governance.
234
CHAPTER 7
UTILITY OF TRANSACTIO:-< BYTE ANALYSIS
7.1 Introduction
This Chapter has two objectives. The first is to provide evidence of how the TBA framework
makes a contribution to understanding firms controlled by two or more boards. This
objective ls approached in three parts. First, in Section 7.2 by considering the cybernetic
foundations on \vhich TBA is based, Second. in Section 7.3 by illustrating how TBA can be
used in analysing complex compound boards and how it allows them to be compared with
unitary boards. And third, in Section 7 A by how TBA both relates and subsumes other
theories of the finn to provide insights. which other theories do not provide.
The second objective of this Chapter is to show the significance of the TBA framework and
identify proposition in Section 7.5 to test it Some wider implications of the TBA framework
are then considered in Section 7 .6, in relation to the role of government in regulating society.
Limitations in the research are then discussed in Section 7, 7 wi!.h n ~ s for future research. A
review of the research is then presented in Section 7.8 with some concluding remarks.
1.2 TBA grounded in science
\Veincr (1948) coined the word "cybernetics'' when he founded the science he defined as '"the
study of information and control in the animal and the machine". Cybernetics provides a
basis tbr linking the information and control systems within people with those betwC<.:.m
people: as found in organisations.
By using bytes as a unit of analysis, TBA links th\! lntbrmation and control systems within
people to those found in firms, organisations and society in generaL StaftOrd Beer pioneered
the application of cybernetics to management systems whhin a firm but he did not apply
cybernetics to the study of how the firm was controlled and so it's governance. No evidence
was: discovered to contradict the .advice ofBcerto the author jn note I that cybernetics had not
235
CHAPTR7
been applied to the: study of corporate govemance. It is by filling this gap tbnt this thesis
makes a contribution to knowledge by applying cybernetics to the study of corporate
govemancc.
InfOm1ation always has a physical form. This may be in the form of writing on paper,
magnetic dipok:s in a computer disk or states in the connections of a brain.
\Vhik: tbc properties of the material infonnation is embedded will be subject to the laws of
physics. chemistry, biology or other sciences, the behaviour of information is not so
constrained. Ashby (1968: l) slated that: "The tnllhs of cybernetics are not conditional on
their being derivedjiom some other branch of science. Cybernetics has its own fOundations"
(emphasis in original). Ashby, (1968: 5) went on to say;
Cybcmetics otTers one set of concepts that, by having exact correspondences
\Vith each branch of science, can thereby bring them into exact relation to each
othcr ... cybemctics is likely ro reveal a great number of interesting and
suggestive parallelisms between machine and brain and society. And it can
provide a common language by which discoveries in one branch can readily be
made use of in the othcrs ... Promincnt among the methods tOr dea!ing with
complexity is cybernetics.
This means that the validity of cybernetic principles on which TBA 1s based arc nol
dependent upon other sciences. This would allow TBA to b0 used to develop \Vhat
\VB Hamson ( l991a: 12) describes as the .. elusive science of organisation".
TBA is also grounded in psychology and physiology and so connects cybernetics to these
sciences. Cybernetic principles identify strategies for managing the variability in the
psychological and physiological characteristics of people. This includes strategies based on
the work of von Neuman, Shannon and Ashby to manage errors in deci5ion making,
infOrmation transmission and managing complexity respectively.
All human information channels have limited band-\vldth with limited capabilities to transact
bytes as outlined in Table 3.5, This creates limits on the ability of any one individual to
236
UTILITY OF TRANSACTION BYTE ANALYSIS
manage complexity. However, cybernetic principles identifY how individuals can be linked
together to manage greater complexity than they can individually. The linking together of
individuals establishes an organisation and the pattern of the linkages defines its architecture.
As nil coordinating activities between individuals must involve the transmission, reception
and processing infonnation, TBA is universally applicable tO all types of institutions,
organisations and firms in any culture. The: cybernetic principles of TBA are universal to
provide a way of relating the architecture of organisations to the information and control
architecture fOund in living things. This in turn provides a way of rdating the evolution of
organisations to the evolutionary processes found in nature.
Both the evidence found in nature and the case studies support the analysis of Simon ( 1962)
that setf:.managing components. described as holons, provide the most efficient organisational
architecture for managing complexity. As identified in St.'"Ction 3.9.2, '"'nny organisation,
which is made up of holonic components, wili possess lwo or more boards". This supports
the conclusion that compound boards provide an architecture for people and
organisations to manage complexity. However, the use of bytes all-ows tirms, with or without
a compound board, to be investigated using the principtes developed in the science of
cybernetics.
The physical limitation of pcopJ.c to receive, store, process and transmit bytes creates the need
for economising bytes in organising cooperative activities. The physical limitations and the
variability in the charnctcristics of people, as detem1incd by psychologists and physiologists,
pro.,lidc the fundamental criteria for jnvestigating all types of organisations, including finns
with one or more boards. In this way, TBA makes a contribution in grounding organisational
analysis and in cybernetics as a basis to develop the '"elusive science of
organisation".
TBA creates a rich area for "normal science" (Kuhn 1970: JO) to determine the details of how
to improve the effectiveness of organisations. This thesis has only presented generalised
237
CHAPTR 1
guiddim:s. 1l1c compound board found in a MondragOn cooperativl! was used to illustrate
how the decomposition of decision-making into almost self-governing holonic units reduced
information overload and created a division of power to f.1cilitatc trust and interdependency,
They aiso illustrated a diversity of information and control channels to both correct
communication errors ;md provide requisite variety to allow individuals with limited
infbnnation handling capabilities to manag(! complexity.
Application of tbc TBA framework to the case studies indicated a number of advantages of
appropriate power sharing. \Vhen this was achieved through involving the strategic
stakeholders, it was noted that a compound board provided:
(a) A basis tbr establishing trust and so infOrmational efficiencies m governing
transactions;
(b) Advantages from speciaiisation in decision making labour;
(c) Reduced information overload and "bounded rationality" tOr individuals;
(d) Improved accuracy of information;
(e) Quicker responses to opcmting variables from control;
(f) ]mproved capability of individuals to control the variables affecting both
themselves and the business:
(g) A basis for constructively utilising the contrary attributes of individuals lo be
altrulsticJsdfish, trusting/suspicious or coopcrativc:/compctilivc to increase the
efficiency of a firm without the need to rely on markets for corporate control;
and
(h) The ability for corporations to become self-governing to reduce the cost of
regulation in both the private and public sectors.
Just as incrr::ases in tbc size and complexity of businesses required fim1s to change from U-
fonn ro M-form e-arly in the 20
1
h ccnturyt TBA indicates that additional increases in
complexity will encourage the adoption of holonic architecture in the 2! century. Holonic
architecture depends upon a compound board, so as tbc complexity of business increases, the
adoption of compound boards can be expected to increase. As a corollary, competitive
233
UTILITY OF TR:\NSACTIO/\< BYTE ANALYSIS
advantages can be expected for those finns introducing compound boards to govern their
operations as the complexity of their operations and output increases.
An incentive for a much more detailed research cffon in TBA is provided by the
proposition that it wiH become more important as the complexity of society increases as it
moves ffom an infonnation age to a knO\vledgc age.
7.3 Application ofTBA in investigating Mondragbn compound boards
The MondragOn CorpomciOn Coopcrativa (MCC) provides the richest and most complex
system of compound boards discovered by the research. As such, they provide the most
challenging example for illustrating: the power of TBA to investigate compound boards. As
the MCC also represents a network" (N-fonn) finn and could be considen.'"<i a micro-social
system it aiso illustrates the potential fOr TBA to be used in the analysis of social systems
when considering its ''\Vider implications" in Sectlon 7.6 of this Chapter.
7.3.1 Minimising: bvtes and bounded rationalitY throueh holonic subsidiarit.v
The infonnation and control structure of a MondragOn producer cooperative wen: illustrated
in Figure 6.2. The figure was not developed by the author to show holonic architecture but as
part of the material presented in The Company Directors' Diploma Course (Turnbull 1975b).
It was used to illustrate one approach in providing participation in decision making and a
division of pO\vcr to provide checks and balances. Hmvcvcr. the complexity of the
architecture generally raised questions from pt::oplc as to both its usefulness and relevance in
current competitive enterprises.
Figure 6.1 was created as part of the research work tbr this thesis to explain both the
development of the MCC and the architecture of its information and control system. This
figure is even more complex and pcrpJexing than Figur...:: 6.2. Again
1
it was not constructed to
illustrate either holons or a holarchy. It \Vas only a year or so into research for the thesis, after
reading the paper by Mathews ( l996a), that order was perceived in the complexity of both
Figures 6.1 and 6.2. Indeed, a systematic and rigorous order was discovered as documented
239
CHAPTER 7
in Table 6.1. This revelation providtd the basis for including the concept of holons and
holarchy to become part ofTBA in Chapter 3. The nature of organisational ho!ons with their
need for a compound board and their role in creating or managing complexity in turn
encouraged the fonnulation ofTBA.
TEA provides a basis for understanding the operating advantages of holons from their
prodigious reduction in data transmission and data complexity as explained by Mathews
(l996a: 30). Without TEA, compound boards required to establish holons arc seen as
introducing unnecessary complexity. TEA allows cybernetic principles to be introduced to
explicate the operating advantages of compound boards, especially when they arc part of
holonic architecture. TEA allows the principles identified by Neumann, Shannon and Ashby
to become part of organisational analysis. Specifically, compound boards can be seen
respectively as way of providing: (i) Distributed intelligence to decompose and/or cross check
decision making; (ii) Additional feedback channels to correct errors in communications; and
(iii) Providing requisite variety in control.
TBA allows holarchies to be seen as a way of introducing the Principle of Subsidiary
Function into complex organisations as well as introducing the cybernetic concept of
supplementation in their control and regulation. They illustrate what Hock (1994: 7) refers to
as the "second law of the universe: Nothing can be made simpler without becoming more
complex". Both the evidence of evolution and the analysis of Simon (1962) provide evidence
that holonic architecture provides the most robust way to create or manage complexity.
The levels in the MCC also demonstrate the three levels of learning within
firn1s, between firn1s and the system as described by Mathews ( 1996b: 119). Each level of
learning and coordination being and mediated by the "lateral recursivt! support
holons'' as shown in the columns of Table 6.1. By identifying the holonic
structure of the MCC and a keiretsu, TBA facilitates richer insights into knowledge processes
in firms. TBA, with its concept of holons, provides the intellectual tools to understand both
the complexity of the MCC and why it can provide operating advantages.
240
UTILITY Of TRANS.\CTION HYTE ANALYSIS
7.3.2 ldentifving the operating advantages of a division of power
The context required tOr information to be effective in controlling; regulating and self-
governing firms was summarised in Table 3.7. A basic requirement for self-government
being: the establishment of "independent processes for the governed to reward or penalise
controllers" and for the governed to appoint and retire the controllers", neither of which can
be provided by a unitary board because of its comtpiing powers as outlined in Table 3.6. In
this way TBA !!Xplains another operating advantage of compound boards.
Another operating advantage of a division of power identified in Section 3.5 was that it coutd
be used to increase thi! welfare of all stakeholders (Persson, Roland & Tabellini !996}. The
analysis of Person, Roland & Tabcllini showed that a division of power provided a rational
basis for developing trust as power differentials were reduced and g ~ n t s became more
interdependent Trust introduces operating advantages by allo\ving monitoring and agency
costs to be reduced. Nahapict & Ghoshal (1998: 257) identify trust as a basis for devdoping
social and intellectual knowledge and knowing.
A division of power within a MondragOn cooperative is achieved by each component of its
compound board having a diffen;nt constituency and/or being elected in a different manner,
By creating a division of power, a division of function is also achieved to increase
interdependency and so a more a persuasive basis for "trust building"' as discussed by Sabel
(1997: 154). Other writers such as Alstyne (1997); Helper, MacDu!lic & Sabel (1997),
Podolny & Page (1997) bavc identified the operating advantages of establishing trust with
other stakeholders as well as employees. The sharing of infonnation and power with
customers and suppllers is demonstrated in both a keiretsu and in MondragOn. This has the
effect of extending the boundaries of the firm by integrating activities with suppliers and
customers,
The substantial costs savings and competitive advantages which can be achieved through
'Just In Time' (JIT) delivery of supplies and 'Total Quality Management' (TQM} lor
241
CHAPTER 7
customers rcqmres rich and frequent communications as well as trust. Markets <.md
hierarchies do not provide sufficient information richness and arc inimical to developing trust.
This means that modem management practices like JIT and TQM require associative
relationships between suppliers, employees and customers to establish trust with rich and
frequent exchange of information. Wruck & Jensen (1994: 248) define TQM "as a science-
based, non-hierarchical, and non-market-oriented organizing technology that increases
efficiency and quality." TBA explains how "non-hierarchical and non-market oriented
organising technology increases efficiency and quality" through the richness in the
"Sensory" and "Semiotic" communication channels described in Tables 3.1 and 3.2.
The establishment of trust reduces transaction costs to improve the advantage of transacting
within firms rather than through markets. Trust between trading partners provides a way to
govern transactions through clans and associations rather than through markets or hierarchy
consistent with the recommendations noted in Chapter 6 of Porter, Blair and Fukao.
The Japanese practice of issuing stock to suppliers and customers was explicitly motivated to
establish non-market and non-hierarchical type relationships and these, with Gcm1an
practices, provid!.!d the role model for Porter ( 1992: 16-17) to recommend that US companies
involve stakeholders in their ownership and control. TBA explains how clans and
associations produced by such relationships provide richer information channels to establish
trust and how this is limited to around 150 p!.!ople from the limitations of the human
neocortex, as noted by Dunbar ( 1993).
TBA also explains the operating advantages of limiting the number of employees in
MondragOn finns to human scale with only around 500 people. The division of power into
numerous work groups and governing control boards within each finn of 500 individuals
means that the number of individuals each person needs to have a close trusting relationship
can be less than the 150 limit identified by Dunbar. It also allows the maximum usc of the
richest information channels shown in Table 3.1 to co-ordinate productive activities, through
learning by watching and doing. It also allows the implementation of Schumacher's (1975:
242
UTILITY OF TRANSACTION BYTE ANALYSIS
226) recommendation that, "It is nom1ally better to create semi-autonomous small units first
and then to centralise certain functions at a higher level, if the need tOr better co-ordination
can be shown to be paramount". Semi-autonomous work groups are established within
MondragOn firms, just as each finn is a sdf .. governing component of a group and each group
is a self:.goveming component of the MCC.
Dunbar (1993: 687) also reported research which suggested that 500 people represents a
.. critical threshold beyond which social cohesion can be maintained only if there is an
appropriate number of authoritarian officials". It was through practical experience that the
MCC anticipated the analysis of Dunbar, after they incurred their first and only strike in 1974,
by limiting the number of people employed by producer firms to 500 people (\Vhyte & Whyte
1988: 96).
7 .3.3 Identifying the decomposition of decision making labour
TBA reveals how the decomposition of decision making labour is achieved in MondragOn
firms by analysing them through the lens of their infonnation and control systems as outlined
in Figures 6.1 and 6.2. It was through the simplification of activities that ordinary people of
MondragOn were able to achieve extra-ordinary results. TBA also allows finns with a unitary
board to be compared with those with a compound board by fOcusing a finn's infOrmation
and control system.
Tricker ( 1994: 245 & 287) divides the functions of a unitary board into "conformance" and
"performance" functions as shown at the top of the two columns in Figure 7.1, 'Functions and
activities of a unitarv board'. The conformance role is divided into concerns with external
accountability and internal short-term supervision. \Vhile the perfommncc functions arc
divided into concerns with external strategic thinking and internal long-tenn corporate policy.
The four activities are shown in the two by two matrix of Table 7 .I which shows a fifth
function to appoint and reward the chief executive as shown in the box in the middle of the
figure.
243
CHAPTER 7
Figure 7.1, Functions and activities of a unitary board
(Source: Tricker 1994: 245 & 287)
wnctJons 1'cnom1ance runct1ons
ii CC0/111/a!Jiltl)' Stmtegtc tlunking
Reporting to shareholders Reviewing and initiating strategic
Extcma I Ensuring statutary regulatory analysis
compliance Formulating strategy
Reviewing audit reports Setting corporate direction
Appomtmcnt ana rcwaramg
chief executive
Supervisi011 L01porate potzcy
Reviewing key executive Approving budgets
Internal performance Determining compensation policy
Reviewing business results for senior executives
Monitoring budgetary control and Creating corporate culture
corrective actions
Short term Long term
The Tricker typology provides a guide for identifying the functions of the vanous
components of a Mondrag(m compound board, which arc set out in Figure 7 .2, 'Functions and
activities of Mondrag{m compound board' prepared by tht! author using information from
\Vhyte & Whyte (1988). It is the \Vatchdog Council, which is concerned with accountability
of the firm as described in the top left comer of the Figure 7.1. It may invite external
intervention in the management of the finn from the bank and/or the manager of the group. It
is on the supervisory board of a MondragOn finn where representatives of external
stakt!holders arc found to secure the involvement and support of strategic resources
as described for a unitary board in the top right comer of Figure 7.1. The activities of a
unitary board described in the bottom left comer of Figure 7 .l arc largely the responsibility of
the work unit of a MondragOn firm while the social council performs the main function listed
for a unitary board in the bottom right of Figure 7 .I. The allocation of resources in a
MondragOn firm is carried out by its management board which is shown in the middle of
Figure 7.2, where in Figure 7.1, the unitary board delegates these activities to a chief
executive.
244
UTILITY OF TRANSACTlO:--lliVTE A:\'ALYSIS
Fjgurc Functions and activities of:\'1ondrag0n compound board
(Jnfom1ation source: Whyte & Whyte 1988)
External Watchdog Council Supervisory Board
(Invites external intervention by bank {Strategic stakeholders appoint&:
and/or Group) direct maHagcmcnt board)
----------------
Management board
(Allocates resources)
Work lmu .JOcrm Council
Internal (Production & appoint (Working conditions:, pay
delegates to Sodol council) relativities and weifl\re)
::ihort term
...... [Cli1
g tem1
To indicate the degree of decomposition of decision making labour achieved by a MondragOn
compound board in comparison to an "Anglo' unitary board, the functions and activities in
Figures 7.1 and 7.2 have been combined in Figure 7.3, 'MondragOn compound hoard
compared with unitarv hoard'. third row of Figure 7.3 indicates the approximate-, or
Figure 7.3, MondragOn compound board compared with unitary board
(Degrees of decomposition ofinfom1ation processing labour indicated by allocations of "X'.)
tioara
MondragOn compound board Anglo
Contra! l':'atchd?g supervisory Management SOC!<!! Work ':'_mtary
ccntrcsa Council Board Board Council Unit Board
Memners j 4-6 -0-L). -IU-"0 -4-IL
Juncuon" vovcmancc Appomt
rroauctiOn.
Ntanage
processes Mgt board opcratlons welfare Elect Soc.C.
AC-tJVltJCS
tmcacy ""-
mtegra:c:- .::=-mcJcnt t:staottsn Joo organ- utrcct
mtegnty of stratcgtc allocation of workmg JsatiOn & &
processes stakeholders resources conditions evaluation control
ntcma A
"
" "
"
--
cxtema1 A A .i\i\
1 snort temr X X X XXX
1 Long term X X AA
"Omits the General Assembly, which elects Watchdog Council and Supcrvjsory board.
'Descriptions follow lYJlology of Tricker {1994: 244 & 287)

typical number, of people involved in each control centre or board, The Tricker typology is
used to identify with an "X'' those components of a MondragOn compound board \vhh.:h arc
involved in "Internal", "External", .. Short tenn and "Long tenn" activitie;L Ali
components arc involved in two aspects except the watchdog council, which is involved in
three. As an Anglo 'Unitary' board needs to be responsible tOr a!t activities, its number of
activities relative to all the components of a MondragOn compound is eleven being the sum of
those carried out by the comp-onents of the comp-ound board.
\Vhilc such an analysis can only be indicative, the degree to \Vhich a compound board
decomposes decision making labour and reduces infonnation overload on individuals is
considerably greater. Williamson (1985: 383) noted that "the problem of organisation is
precisely one of decomposing the entire enterprise in efficient infom1ation processing
.aspects". The degree to which this is achieved in MondragOn is shown Figure 7 .3. As .all
members arc involved m the general assembly of each cooperative which appoints the
supervisory and watchdog boards and all ml.!mbers arc involved in work units et't?lJ
1
member
of an industrial firm is directly involved in both short and long h!ml decision making.
Employees of capitalist 11rms are involved in neither. In addition, the work load of
MondragOn directors is further reduced by many of their responsibilities being distributed to
the Social Council, Watchdog Council and Management or Supervisory Board. While this
aHows greater participation in decision making it also introduces self-interest such as
identified in Table 3.6. However, the division of power establishes processes fOr
conflicts within the organisation.
Figure 7.2 shows the activities of a unitary board decomposed into five different control
centres of a compound board. Unlike the sub-committees found in the unitary boards of
Anglo cultures, the control centres of a MondragOn compound board arc appointed by
dinCrcnt constituencies to create a division of power as well as function. ln this way, power
difi'erentials arc substantially reduced to facilitate self-regulation without relying on the
idiosyncratic behaviour of individuals to act as self-less stewards rather than as self-interested
246
UTILITY OF TRANSACTION BYTE ANALYSIS
agents. Th(! separation of power also allows customers, suppliers and employees, to provide
feedback information in a manner so that their conflicts of interest can be managed.
In this way, a compound board introduces a "loyal opposition" within a fim1 to introduce
"independent processes" as specified in Table 3.7 for achieving self-governance. It also
creates what Pound (1992: 83) described as "this new fonn of governance based on politics
rather than finance will provide a means of oversight that is both far more effective and far
less expensive than the takeovers of the I 980s". The division of power also provides
incentives for more considered analysis within each control centre as explained by Diermeicr
&Myerson(1999: 1195).
Both MondragOn and Japanese firms do not rely on independent directors as promoted by the
US Council of Institutional Investors (Cll, 1997), Cadbury (I 992) Committee, or the
Australian Investment Managers Association (AlMA, 1995). MondragOn, other continental
European fim1s (refer to Figures 4.3 and Table 4.4) and Japanese fim1s provide evidence of
the value of involving related parties with inside expert knowledge and authority with a long-
term interest and commitment to the business. It is the existence of a compound board which
allows such related party interests to be used constructively by constraining their power for
promoting conflicts of interests.
A problem commonly perceived in multiple centres of control, is a concern that managers
would be involved in endless meetings to coordinate their activities as occurs in "matrix"
control systems found in some large multinational companies (refer to Figure 4.1). But this
concern is based on traditional command and control hierarchy, where managers are
responsible and accountable for all subordinate activities. The reason why managers form
joint ventures, alliances and other forms of network relationships is so they can focus on their
core competencies without distractions of other activities carried out by trade related entities.
Similar advantages of specialisation arise with a compound board as illustrated in Figure 7.3.
247
CHAPTER 7
7.3.4 Evaluating self-governance
By allowing the principles of cybernetics to be applied to finns, TBA reveals the ability, or
not, of finns to become self-managing and self-governing. The conditions required for self-
governance were identified in Section 3.5 and outlined in Table 3.7. The conditions for self-
governance required "independent" processes, which necessitate the separation of powers to
make a compound board an inherent requirement.
A holon has been described as a "sub-assembly", "stable intern1ediate tOnn" or an "almost
self-governing component". Compound board becomes part of an holonic organisational
architecture. Self-governing components of an organisation in tum meet the test of being a
holon. So the MCC, its groups and finns represent self-goveming entities.
Self-governance of the whole MCC system is dependent upon building-in self-regulation into
its constituent groups and their constituent finns. The sharing of power in MondragOn fim1s
also introduces the sharing of responsibility and accountability which introduces self-
management at all levels to reduce the work load at higher levels, much in the same way as
M-fonn tim1s provide advantages over U-fonn finns (Williamson 1985: 281-283).
For example, the evaluation and remuneration of workers is not the responsibility of line
managers as this is self-managed by work groups and the Social Council shown in Figure 6.2
and shown in Table 7.2. This process illustrates "self-organisation" of networks and business
alliances analysed by Richter (1994) and the observation by Ashby (1968:264), who stated
that:
the provision of a small regulator at the first stage may lead to the final
establishment of a much bigger regulator (i.e. one oflarger capacity) so that
the process shows amplification. This is the sense in which "amplifying"
regulation is to be understood.
This observation is diametrically opposed to the way in which govemments seek to regulate
finns, organisations and activities in society generally as noted by Beer (1987).
248
UTILITY OF BYTE ANALYSIS
Both the MCC and Japanese keiretsu provide examples of involving strategic stakeholders in
providing feedback infonnation to control operations, which is independent of those in
control of the operations. The exchange of infOnnation, influence and power between
stakeholders introduces stakeholder governance as illustrated both in a keiretsu and
MondragOn firrns, their groups and the MCC. Strategic stakeholders provide infOnnation and
sdf-intcrcsts which arc different fonn those of the finn, its managers and employt.:es. These
difference provide a basis for establishing a loyal opposition within and between
organisations by sharing infonnation, influence and power through a compound board. Like
VISA international, both keiretsu and MondragOn fim1s illustrate this process of creating
cooperation between organisational units, which also compete, to illustrate the TBA concept
of social tensegrity.
Stakeholder govemance also introduces social tensegrity within fim1s through competition
between stakeholders to be nominated and/or elected to boards and councils so that they can
represent and further the interests of those against whom tlu::y competed to get themselves
nominated and/or elected. Persson, Roland & Tabellini ( 1996) provide a mathematical model
of this process, which recognised the possibility of people volunteering their personal
resources to get e!ectt.!d. Many examples of stakeholders volunteering personal resources to
establish a "watchdog" in the tOnn of a Citizens Utility Board (CUB) are reported by Givens
(1991). TBA reveals that stakeholder governance and social tenscgrity support sdf-
govcrnancc both within and between finns.
7.4 Relationship ofTBA with other theories
7 .4.1 TBA based on power model rather than efficiency model of the finn
A fundamental part ofTBA identified in Section 3.4 is based on people having "the power or
capability to act" so TBA is based on the "power" model of the fim1 as was outlined in Table
2.4. Economic theories of the finn, such as agency theory, residual rights and TCE are based
on the efficiency model of the fim1 (Dallas 1988: 49,65,69) as shown in Table 2.4.
249
CHAPTER?
In the eniciency model, scholars assume that activities of finns are constrained by contracts
and/or market forces rather than managers being in cstabiis.hing power coalitions to
control their enviromnent to further their autonomy as indicated in the firSt row of Table 2.4.
lt is because managers seek to control markcis that and fair trading laws are
required. Finns do not just react to their environment; they seck to control it By their role,
managers arc usually dominant members of the controlling coalition of a finn. \Vhen there is
no control group, they are not subject to continuous and active control of shareholders and so
they obtain control as noted by Bcrle & Means { 1932).
Scholars usmg the efficil!ncy model assume managers seek to ma.xmusc profits and/or
minimise costs, Hmvcver, even in this model scholars have recognised that managers have
cognitive limitations to achieve these objectives which let Aldwin (1950: 306) to state that,
"profits maximisation is not a guide to action". The power model recognises {refer H> the
third row of Table 2.4), that a finn can have multiple inconsistent goals consistent wilh the
behaviour of individuals noted in rmvs 3 and 7ofT able 3.4,
Evolutionary theories of the tlnn (Aichain 1950; Hirshlcifl::r t977) have cn::ated a belief with
many scholars that the survival of tirms is dcp-:ndcnt upon their adopting a structure and
behaviour which is most eftlcient in coping with competitive market forces. In other words,
fimls with best fit to their environment survive. Finns arc implicitly assumed to be
passive reacting to their environment (as noted ln the first row of Table 2.4). However, the
power model assumes that finn structure and behaviour is pro-actively modified so that
markets and competition can best be controlled or managed. Monks ( J 996) provides
evidence of this in his analysis of the US Business Round Table influencing the setting of
accounting practices and laws to further the interests of 'management', An example is the
accounting practice of not recognising the granting of options to managl.!rs as a cost to the
business.
In the 'efficiency' model, managers arc seen to work for shareholders pursuant to a
contractual relationshJp. \Vith a nexus of contracts perspective there is no longer any
250
UTILITY OF BVTE ANALYSIS
boundaries to a firm \Vith some activities being carried out 'inside
1
the firm and others
'outside'. This obscures the discretionary authority of management and avoids asking the
question why firms exist The power model n.:cogniscs the "legitimizing myths ensuring the
political acceptability of power widded by managers" (DaHas 1988: 26). Examples of these
legitimating myths tOr coopting shareholders is their legal right to appoint directors and
auditors. In practice, managers subvert shareholder power through having "a first m1.wcr
advantage" supported by numerous procedural devices. These were discussed in Section 3.7
and set out in Table 3.6.
The board of directors is seen as a "monitoring deviccn in the efficiency model whereas in the
power modct it is a "tool" of the internal coalition. There can be no internal perspective when
a firm is seen a<; nexus of contracts. \:lanagers control the board through control of tbc
information \vhich they obtain. This can frustrate a detailed or short tenn umonitoring" role
assumed to exist with the efficiency modeL These problems of information and control arc
recognised in the bottom half of Table 3.7.
7.4.2 TBA as a micro-clement and extension ofTCE
TCE is part of the cftlciency model of a firm as it is ba..-.cd on minimising costs, {rcfCr to row
3 or Table 2.4). The leading exponent of TCE is O!ivcr Williamson who built on the
pioneering \vork of Roland Coase (1937). Coasc provided an explanation of why firms exist
but his analysis was based on an ethnocentric perspective of US finns as described in Section
2.5.
Coaso (1937: 94) limited his analysis to finns where there was a "master and servant or
employer and employee" relationship. As a result, both Couse (1937) and Williamson (1975)
limited their analysis to "markets and hierarchies." However, economic transactions can also
be governed by social relationships established through communities (and famllies!clans) or
associations as described by sociologists Hollingsworth & Lindberg {1985: 22l). This
explains a major limitation of economic analysis undertaken by many ccomonists, which is
avoided hy using bytes instead of costs"
25!
CHAPTER 7
All fom1s of coordination must involve bytes, but they need not involve the social constructs
of costs, prices and money, which may not be directly involved in the governance processes
of one or more boards. The usc of bytes allows some of the insights provided by TCE to be
extended into such situations, non-profit organisations and the public sector.
Cease ( 1937: 83) noted that, "The most obvious cost of 'organizing' production through the
price mechanism is that of discovering what the relevant prices arc. This cost may be reduced
but it will not be eliminated by the emergence of specialists who will sell this information."
In other words, firms exist because markets fail to provide the bytes required for governing
production transactions as efficiently as an authority system.
A corollary of Coase's insight is that markets exist when social organisations arc not as
effective in providing information for governing production. This view is supported by the
work of Hollingsworth and Lindberg (1985: 224) that found that business associations in
Europe govern more transactions than in the USA where markets play a greater role. Support
is also provided by Porter ( 1992: II) who noted that, "Both Japanese and German companies
practice a fonn of decentralisation involving much greater information tlmvs among multiple
units in the company, as well as with customers and suppliers." In recommending ways to
make US firms more competitive, Porter ( 1992: 16-7) specified changes in their ownership
and control architecture to involve their "customers, suppliers, employees and community."
These recommendations were supported by Blair ( 1995: 322) and Fukao ( 1995: 74, 77-8).
While customers, suppliers, employees and community mentioned above may all have inter-
related interests in costs, prices and money, the means by which they look after their interests
is through various inforn1ation and control networks. Bytes are universally involved. As
argued in this thesis, bytes make both a compelling unit of analysis and provide a basis for
developing a science of organisations grounded in cybernetics.
2:52
UTILITY OF TRANSACTION BYTE ANALYSIS
TBA is relevant to all types of organisations whether or not they are concerned with costs.
When costs arc relevant, they act as a proxy for transaction costs as these arc created by the
need to "discover prices" as noted by Coase (1937). In the special case when information
about prices or costs are involved, TBA becomes limited to the infomwtion of economics. In
this way, TBA both subsumes TCE and becomes a microclement of it while also having the
ability to take into account non-economic information on which markets arc based.
Costs are social constructs. The measurement of any transaction cost depends upon
separating the set up cost from re-occurring costs. Even when costs arc identified they arc
measured in another social construct called money. Money, unlike bytes, has no relationship
to any physical quantity. So even if it may be impractical to identify the number of bytes
involved in the transmission and reception of information between individuals, they exist as a
physical manifestation in matter, which could in theory be identified and measured. In any
event there arc physical limitations on the volume bytes that can be transacted by any person,
organisation or machine available at the time of writing. This makes bytes a more rigorous
unit than costs to investigate operations within fim1s and they ways in which they arc
governed by one or more boards. Perhaps most importantly, th!.! usc of bytes provides a way
to investigate the limited ability of individuals to process inforn1ation and so 'bounded
rationality' which is responsible for" the problem of rational economic order" as noted by
Hayek (1945: 527).
The economic literature recognises what is described as the "economics of information"
(Molho, 1997). In this literature the units of analysis are costs not bytes. The economics of
information is based on the normative view that costs should be minimised. The need to
minimise bytes is because individuals arc subject to physical limitations in their ability to
transact bytes as identified in Section 3.6 and shown in Table 3.5. TBA is thus grounded in a
physical or instrumental constraint. However, TBA can also be used to support the normative
considerations of the economics of information based on the social construction of transaction
costs. As noted above, in the special case when only TCE information is involved in
"discovering prices" and governing transactions, TBA becomes based on the "information of
253
CHAPTER 7
economics". However. because bytes an:: involved in all other typt.:s of information, TBA can
also provide a way of comparing other theories of the finn as undertaken in the next section"
TBA provides a way to investigate hO\\' communications between people affects the
perfOrmance of organisations. TBA also sho\>v'S how cybemctic principles provide a basis for
identifying "organisational advantage" which Nahapiet & Ghoshal (1998: 261) say is "as yet
inadequately understood." It is argued in this Thesis that the TBA framework is universaL It
can be applied independently of organisational fbnn, structure, purpose or social context. For
instance this allows it to be used in evaluating privatisntion, By allowing organisational
analysis to be grounded in the physiological and physchological characteristics of people and
the laws of cybcmetics, TBA provides a basis for evaluating or designing institutions,
As infonnation can alter the behaviour of people, people become b01h a dependent and
independent variable. The variability of people and the variability in the ways in which
people transact bytes become the focus of conccm. Because people have limited ability to
I'Cccivc, store, rl!tricvc, analyse and transmit infonnation, the effectiwncss of firms becomes
dependent upon kct::ping the capacity of people to transact bytes within their capabilities. The
infOrmation and control architecture of fim1s also needs to compcnsatl! for any variability in
human capabilities and motivations. This makes the effectiveness of tim1s dependent upon
how well their infonmuion and control architecture al!ows individuals to within their
cybernetic limits and compensate fOr human variability.
\Vllile much of TBA is grounded in the work of Williamson, TBA creates a different
framework analysis. To usc the words of Kuhn ( 1970: 80) who was describing a "paradigm
shift", TBA "involves the same bundle of data as befOre, but placing them in a new system of
relations with one another by giving them a different framework". The TCE framework is
based on "tn:ms.action cosis" whHe TBA framework is based on "bytes". The differences
bct'\veen the TCE and TBA frameworks arc outlined in Table 7,1, 'Comparison ofTCE and
TBA boundaries',
254
UTILITY OF TRANSACTION BYTE ANALYSIS
TBA extends the boundaries of analysis ofTCE as shown in Table 7.l. Just as Newton's
"Laws" of motion arc relevant to only limited situations covered by Relativity Theory, so is
TCE relevant to only limited situations covered by TBA.
Table 7.1, Comparison ofTCE and TBA boundaries
t ramcw?rk ot

_l_HA
(Developed by the Author)
I I ypc Ot SOCial t'or-protlt ttrms not Any socml orgamsatton, mcluamg any
institution labour managed type offim1
-
1 !SUbJect ot analysts 1 ransactmns ana 1 People ana the quanta (bytes) ot
their costs infom1ation they process
j
1 Kclatwnship ot or 1 Any tamily, cooperative, competitive,
people competitive assoctattvc, etc.
4 1 People behaviOur :Selt-mterest 1 Any e.g. altrmsttc, selt-mterest, etc.
'
I UOJCCllVCS t:conomtsmg costs 1 Anytlung. (t'or ttrms, econmmsmg t11e
transaction of bytes by people while
compensating fOr errors with redundancy)
b lli3SIS tor ObjeCtiVC Normative 1 PhysJOiogtcal limitS m transactmg bytes
I JVIOOCS 01 1 Any comnmatton orc_Jans/commumtJCs,
governance and hybrids of both associations, hierarchies or markets
,
1 Lommumcatton ana J\1arKclsano 1 semiotics, language ana numoers
control through: luerarclues
9 Firms exist because: Markets fail to Two or more people can reduce 'bounded
provide infonnation rationality' and allow specialisation in
skills and/or knowledge
Another limitation of TCE, noted in the first row of Table 7 .I, is that it assumes finns are not
labour managed. In an entry under "Theory of the firm", Archibald ( 1987: 357) states that,
" ... it is at least being implicitly assumed that the agent whose behaviour is to be examined is
a capitalist fim1". Archibald goes on to say, " ... the study of partnerships and cooperatives
(labour-managed) fim1s is conventionally filed under 'comparative systems"'. Williamson
(1985: 265) states that he, "is mainly preoccupied with assessing capitalist modes of
organisation". He acknowledges the existence of MondragOn enterprises but dismisses them
as an "experiment" but notes that labour managed finns require "further study". As indicated
in row three of Table 7 .I, the relationship of people is master/servant or competitive whereas
with TBA the relationship can be competitive and/or cooperative. This is consistent with the
observation of Wearing noted in row 5 of Table 3.4.
However, even with capitalist fim1s, Barney & Ouchi ( 1986: 8) note that there arc "theoretical
and empirical anomalies". They go on to say that, " ... the search is on for a more general
255
CHAPTER 7
framework, a framework that will include the insights of the traditional tht."'ry, but will place
those insights in a context that allows the theorist to explain a wider diversity of economic
and, particularly, organisational phenomena, They identified the need for "a new paradigm
for understanding and studying organi?..ations". TBA is presented as such a framework
grounded in the physiological limitations of people to transact bytes and the science of
cybernetics.
A fundamental ditlCrence the hvo fiameworks is that the subject of analysis ofTCE
is the social construct of "'transaction cost" while TBA is founded on the operating
characteristics of peopJe and their physical limitations to handle bytes of information us
shown in the second row ofTabk 7.1.
It wa-. Commons ( !934: +-8) who suggested, "that the transaction is properly regarded as the
basic numuire of analysis". This suggestion was made some 14 years bcf(Jre the science of
cybernetics had been Cf;tablishcd. In 1934, it was not then practical to consider bytes of
intbnnation rather than costs as. criteria fOr governing transactions. In any event the disciptinc
of economics is based on the social constructs of costs and prices, which are or
asserted to provide the basis tbr allocating resources - an assumption questioned by Dallas
(1988: 37) as indicated in row three of Table 2.4. Although bytes can be a sub-set of costs
and prices! they and may still be, considered to be outside the discipline of economics,
TCE is based on finns being an "authority system''. (row three of Table 7.1) as assum\.xl by
Coase (1937) and thnt they exist because they reduce the cost of governing transactions
through the market. TBA extends the type of relationships bct\veen people to any of the tOur
types shown in row three of Table 7.1, which arc based on the typology shown in Table 2.3.
This extension allows the relationship of people on boards to be analysed. In this way, TBA
provides a framework to undertake the objectives of this thesis to analyse finns controlled by
one or more board. The TBA framework also provides a basis for developing a mor-e
comprehensive, compelling and relevant reasons why finns exist as in row 9 of
Table 7.l discussed later.
256
UTILITY OF TRANSACTION BYTE AXALYSIS
The subject of analysis (shown in row 2 of Table 7. l) creates diftCrcnt objectives in row 5
with TCE interested in economising costs, while the concern of TBA in finns is to keep
people operating within their infommtion processing limits while compensating for errors.
TCE assumes that people arc opportunist and self"intcrestcd, while with TBA people may be
altruistic, self-interested or possess. any other type of behaviour shown in row 4 of Table 7.1.
As noted above, belief that costs should be minimised is a nonnative view of TCE, which is
questioned by scholars such as Alchian & Dcmsetz (1972) and Dallas ( l988) because of the
difficulty of senior managers in non-trivial firms lo possess the infOrmation or will to reduce
costs. This view is presented in row six of Table 7.1 which notes that the reason for TBA
objectives are grounded in the physiological limitations of people to transact bytes.
TBA recognises that transactions can be governed through four rather than two methods
recognised by TCE in row seven of Table 7.1. Communication and control in the
Coasian/Williamson framework is through "the limited institutional repertory" of markets
and/or hierarchies rather than the four types of institutions identified by Hollingsworth &
Lindberg. (1985: 221-2). These include associations, clans & communitit:s (refer to row 6 l)f
Table 2.3 & row 7 of Table 7. i) and their related tOur channels of communication and control
(rdCr to ro\v 7 of Table 7.1 and Table 3.2). The additional institutim1ui repertory is outside
the discipline of economics and commerce and so, like bytes, is outside the field ofYision of
theorists from these disciplines.
However, research into comparative corporate govemance by Porter, is supported by the
perspective of Hollingsworth, Lindberg, Schmitter & Strceck. Porter was commissioned by
the high level US Competitiveness Policy Council, which \vas fOrmed because there was
concl!m that US firms were not as competitive as those in Japan and Germany during the
1980s. This led US corporate governance scholars to study other cultures at the beginning of
the 1990s. One result was a report by Porter (l992: 16-7) recommending reform of the US
system of corporate ownership and comrol so that it would more closely fOllow the practices
257
CHAPTER 7
of other cultures, Blair (1995: 322} and Fukao (1995: 74,77. 78) of the Brookings Instinnion,
have since supported his recommendations.
In discussing the theory of the firm, \Vintcr (199i: 179} referred to thej "present theoretical
chaos". Chaos wa.<> noted by Kuhn ( 1970: 77) as a "."precondition for the emergence of novel
thoories ... and for the need for finding a new paradigm as proposed by Barney & Ouchi
(l986). Winter (1991: 193) went on to observe, "In the past half-century, it has been clearly
demonstrated that the economy is much better at changing itself than economists arc at
changing their minds". Williamson (199[: ll) slates: '' ... Winter, like Demsctz, also
emphasises the importance of kn-owledge acquisition and its utilisation in future work on the
theory of the finn", Williamson (1990: xi) supported the suggestion by Simon ( 1984: 40) that
theorists should, "find techniques for observing the phenomena at a higher level of
resolution", He then poses the question.
11
How micro is micro?" This thesis posits that
"bytes" present an answer to this question and provides a foundation fOr both estabiishing and
grounding a "science of organisation" in cybernetics.
Ouchi {1980; 137), a management scholar, described three mechanisms tOr mediating
economic exchanges: dans/communities; markets; and hierarchy or "bureaucracy", A table
presented by Ouchi to illustrate what he referred to as, "an organizational fhilurcs framework"
is reproduced and extcndt."<.! by the author as Table 7 .2, 'An Or2anisational Failures
Framework'. Ouchi identified hmv each "mode of control" has distinctive "infonnational
Table 7.2, An Organisational FaiJnrcs Frame\-vork
An urgamsattona: t' m lUres rameworK
'
'
-
~ ~ ; o ~ c ~ controo
r._.orma11vc requirements tn ormatsonat rcqmrcmcnts
T 1 ar et 1 K1.X:1procny .l:'nces
'
'
-
1 ts urcaucracy IKCClprocJty KUICS
,
1 uan "' ,
1 KCCtproctty,. Jeg1t1mate au.!nonty, 1 raunmns
commumty common values and bdict's.
q
.1' SSOCJallOIIS 1 ,;warea mtcn::sts voms ana strategws
Source; Ouchi ( 1980: 137, Table 2) with row 4 "Associations" added by awhor
UTJUTY OF TR.A..:"'\SACTION BYTE ANALYSIS
n:quircmcnls" as set out in the last column of table 7.2 to support the relevance of the TBA
perspective. The author has extended the Table presented by Ouchi to include "associations"
as an additional fourth "mode of control" with its distinctive infom1ational requirements.
\ViHiamson (1979: 9-9) recognised that
11
thc efficient processing of information is an
important and related concept" to transaction costs and stated in his note 4
1
"but for the
limited ability of human agents to receive, store. retrieve and process data, interesting
economic problems vanish". This statement supports the case fOr using in1bnnation, rather
than costs, as the unit of analysis.
The validity of using information rather tha11 cost arises from the foundations on \vhich Coasc
(1937: 83) established the theory of the firm. Finns exist because markets fail 10
communicate information as efficiently as organisations. This is rdCrred to as "market
failure"_ A corollary of Coasc's insight is that markcls exist when social organisations arc not
as effective in providing information fOr governing production as al!cmativc m..:chanisms,
However, tirrns with more than one individual cun exist when markets do not, as evident from
the experience of socialist countries and primitive society where production was achieved
without numcrucy and so a pricing systeni to create markets. TBA reveals additional rca.<,;ons
as to why fim1s exist. One reason is that the rdcvant bytes, data. infOrmation, knowledge and
\Visdom embedded in one individual for carrying out productive activities cun be
supplemented through n o n ~ market communications to one or more others to reduce colk-ctivc
"bounded rationality'. A second reason is that the presence of more than one individual can
introduce specialisation in physical skills and/or intellectual knowledge for the production of
goods m services.
The development of specialist skills and/or intellectual knowledge is dependent upon training,
education and experience. AH three processes change the physical state of mind and body
and all three cannot occur without the transaction of bytes between and within individuals.
259
CHAPTER 7
All three processes could be viewed as establishing proccdures
4
Z and so 'set up costs' of
forming a firm. However, these costs may be largely extcmalised into educational and
community processes. Such costs are ignored by TCE.
Even when pnccs arc "discovered", they cannot on their own communicate the qualitative
aspects of a transaction. Ouchi (1980: 130) states that: "Transaction costs arise principally
when it is difficult to detem1ine the value of the goods or service". Before a transaction is
executed or avoided, information is required about the nature of the goods or services, the
timing and tenns of the exchange and the trustworthiness of the parties involved as analysed
by Akerlof ( 1970). Ouchi ( 1980: 139) noted that, "Exchange relationships arc generally
subject to so much infom1ational ambiguity that they can never be governed completely by
markets".
Prices arc just a number and arc "efficient" because they contain so little infom1ation.
However, such efficiency is dependent upon a large volume of other infom1ation being
communicated in regards to the qualitative aspects of a transaction. As noted earlier, prices
haw no meaning without communication of contextual qualitative "first order" infOnnation.
TCE does not recognise the set up costs of communicating such contextual infOml<ltion that
allow prices to be used to reduce the cost of transactions. In this way, transaction cost
analysis creates a strong bias fOr transacting through markets, rather than through the three
alternative governance mechanisms shown in Table 2.3.
Williamson (1985: 7) pointed out that, "the seeds of a n::search ... " into "an economtcs of
information" had also been sown through concerns expressed over uncertainty by Hayek
(1945: 524); von Mises (1949: 112); Koopmans (1957: 162-63); Feldman and Kanter (1965:
615) and Johansen (1979: 511).
4
2 The procedures for designing, manufacturing and controlling a finely crafted missile which
would n::turn for reuse if it failed to hit its target could involve considcmblc computing power, trial and error.
But the business of manufacturing such a complex and sophisticmcd weapon was achieved without, computers,
the usc of or hicmrchics tens of thousands of years ago by Australian Aboriginals with the invention of
the boomerang!
260
UTILITY OF TRANSACTION BYTE ANAl,YSIS
However, the earliest contribution would not have had the benefit of the new insights being
developed in pure and applied scientists who wen! pioneering the new science of cybernetics
in the 194Qs such as Neumann (1947), Wcincr(l948), Shannon (1949) and others,
A quarter of a century later. Smith (1974: 321) predicted that a new micro theory would arise.
He staled that it, ''Will, and should, deal \Vith the economic foundations of organization and
institution, and this will require us to have an economics of infOI1TIOtion and a more
sophisticated treatment of the technology of transacting." Such technology must necessarily
involve the eapnbilitics of humans to transact bytes both within their bodies and bCt\veen
others as incorporated in TBA.
Eleven years after Smith, Williamson ( 1985; 281) used an "lntbnnation Processing
Interpretation" for eXJ>Iaining the development in the l930s of multi-divisional structures. He
dcscribl.'d such enterprises as M-form firms and followed the approach of Simon ( 1962) who
focussed on the nature and timing of information to explain their advantages.
BefOre the 1930s flnns were organlscd on c;:mralised. functionally d..:partmcntallsed or
unitary (U-form) structure. Chandler ( 1962: 382-83) described how the defects of this type
of structure arise when:
.,.!.he operations of the enterprise became too complex and the problems of
coordination, appraisal, and policy fommlation too intricate for a small
number of top officers to handle both long run, entrepreneurial, and short-
run operational administrative activities.
In the words of Williamson (1985: 281 ), uthe U-form structure laboured under a
communication overload ...
11
, The quanta of infbmmtion which had to be processed by top
officers became umnanagenble. The ~ f o r m structure rcUuced the volume of information
processed by top management by separating out the higher th:qucncy {or short run)
information which became the responsibility of the operating divisions. Top management
could then limit their inforrm.1tion processing to lower-frequency (or long run) strategic
decision information.
261
CHAPTER 7
Simon (1962) explained the advantage of M-fom1 structures in tem1s of the "division of
decision-making labor". The cybernetic significance of this technical and temporal
specialisation of organisational infom1ation was recognised by Williamson (1985: 282) who
stated:
Ashby established that all adaptive systems that have a capacity; to respond
to a bi-modal distribution of disturbances - some being disturbances in
degree: other being disturbances in kind - will be characterized by double
fCedback. The rudimentary model is shown in Figure 11-1. Disturbances in
degree arc handled in the primary feedback loop (or operating part) within
the context of extant decision rules. Disturbances in kind involve longer-run
adjustments in which parameter changes arc introduced or new rules are
developed in the secondary (or strategic) feedback loop. The second
feedback loop is needed because the repertoire of the primary loop is limited
- which is a concession to founded rationality. Evolutionary systems that
arc subject to such bimodal disturbances will, under natural selection,
necessarily develop two readily distinguishable feedbacks (Ashby, 1960:
131 ).
Humans provide an example of such evolutionary development. Local nerve centres
immediately activate limbs when exposed to pain with the "head office" in the brain
activating strategic avoidance action. In M-form firms, information processing is likewise
cconomiscd by the decomposition of decision making into short run operational and long
terms strategic conccms. Short run disturbances of degree arc managed in the appropriate
division. Different kinds of longer run strategic disturbances arc managed at head office.
The use of information allows observation of "phenomena at a higher level of resolution" as
sought by Williamson (1990: xi). It provides the "additional dimension" sought by North
( 1985: 572), gives "greater weight to infom1ation costs" as sought by Demsetz (1991: 159),
and is based on knowledge and know-how which conccmed Winter (1991: 184-192).
262
UTILITY OF TRANSACTION BYTE ANALYSIS
In the context of the Coase and Williamson framework, the governance of transactions
through a market or hierarchy is dependent upon obtaining the necessary infonnation to
organise the transaction most economically. In this context, transaction costs arc both created
and represented by infonnation. The social construct of cost represents a surrogate for the
physical capture of infonnation by decision-makers. Institutional arrangements, such as the
mix of communities, associations, hierarchies and markets which economise the need for and
capture ofinfonnation to organise productive activities will then also economise cost.
Costs arc defined in monetary units, which represent another social construct no longer
definable in any physical fbnn. Even if money could be defined in physical tenns, there
would be intractable difficulties in detennining the cost of any transaction. This arises from
the need to make an allocation between establishment, or set up costs, and activity costs.
Costs can neither be defined or allocated in an objective way and so provide an unsatisfactory
foundation for developing "science of organization" as proposed by \Villiamson ( 1991: 12).
Ouchi (I 980: I 30) states that, "Our interest is in the eniciency with which transactions arc
carried out between individuals who arc engaged in cooperative action". Costs may not be
relevant for many cooperative activities and so do not provide a satist1tctory basis for
extending TCE to organisations in general. Finns represent a sub-set of organisations where
costs are relevant. However, even in finns, costs may not be as relevant as the transaction of
bytes/datalinfonnation/knowledgc/wisdom between board members and between controllers
and their stakeholders.
Infonnation, rather than costs, provides a more fundamental answer to the two of three
reasons given by Coasc (1937: 86) to answer his question, "Why is not all production carried
on by one big finn?" The first reason given by Coase (1937: 87) was that "The costs of
organising transactions through the finn may rise"_ These costs arise from the need for
additional communications to direct, monitor and control productive activities as the number
of people in the finn increases. The second reason given by Coasc (I937: 87) was that, "The
263
CHAPTER 7
e-ntrepreneur rails to place the factors of production in the uses where their value is greatest".
This: again represents an information problem such as illustrated in Table 3.3. The third
reason presented by Coasc (1937: note 14} was not based on costs but the assumption that
entrepreneurs in small firms arc more motivated than managers in large fiml to etliciently
carry out their tasks.
From the above considerations it is evident that many of the leading workers in the field of
micro-economics have implicitly used infOrmation as an integral part of their analysis.
However, as economists, they have mainly focused their analysis on costs. \Vhilc some
recognition has been given in the and organisational 1itcmturc to cybernetic
concerns) this thesis argues that there is a far greater opportunity to usc cybernetics principles
tOr understanding finns and their structure, especially when they arc governed by more than
once board or control centre. While the 'economics of information'' is a recognised topic in
the discipline of economics, TBA makes a contribution by developing the "information of
economics" as basis for understanding the limitations, fOrm and structure of social
organisations and firms in particular.
7.4.3 Comparison with TCE, resource and cvolutionarv theories of the firm
Besides TCE, there arc a number of other theories of firms to which TBA can be compared
and related. 1\vo other theories of some prominence arc based on resources and evolution.
These two theories \\'en: compared with TCE in a paper presented by Bellon & Niosi ( 1997).
They produced a table to summarise the divergence of the thre-e approaches. Their table is
reproduced as Table 73, 'Comparison ofTBA with other theories of the finn' with TBA
added t(}r comparison as a fOurth column. The Bellon & Niosi Table compared the three
theories on eight different criteria as described in the bold italics listed in the unshaded rows
3, 7 i t & 14. The author has added six new criteria listed in the shaded rows 1. 4,
6, I 0, 12 & 13 to provide additional criteria tbr comparing all four theories.
The Bellon & Niosi analysis was limited to tirms. TBA can include all social relationships
and institutions (row 1) and so provides a common fOundation investigating firms or any
264
UTILITY OF TRANSACTION BYTE A:"<ALYSJS
other type of social institution or relationship tbr people to cooperate. ln this way TBA
provides a way of linking organisational theories to those that arc specifically concJmed with
firms as well a providing a basis for relating established theories such as TCE, Resource
Based Theory (RBT) and Evolutionary Theory (ET) as presented in Table 7.3. TBA can
achieve this while avoiding the problem of ncedmg to define the boundary of a finn.
To define a boundary, other theories need a "bundle" of somcthmg to define their ''Essence of
organisation" in row 5, whereas TBA is simply concerned with the capability of people to
transact bytes as set out in Table 3, 1. TBA subsumes each of the three theories of the finn, as
infbnnation is involved in each fOr their micro foundations. which involves transactions,
opp\)rtunism and myopia respectively as set out in the second row ofTablc 7.3.
The
11
Starting point of analysis" {row 3) identifies the defining differences between the
various frameworks of analysis, TBA is based on the physical capability of individuals,
rather than the intangible social constructs such as costs. resources and institutions. The
paramount concern ofTBA is the limited CflJJ'1bility of people to transact bytes as indicatt:d in
Table 3.5. All three theories of the firm list.::d in Tab-le 7.3 assume that individuals arc
competitive (row 6) whereas TBA can be applied whether or not people nrc compt:titivc.
cooperative or both as identified in row 5 of Table 3.4. Indeed, the concept of "social
tenscgrity" is dependent on the combination of these auributcs. Another distinctive
difference is that the role of families and clans (row JO) like that of teams, groups.
communities and networks (row 11) arc not recognised in the accepted theories of the finn
considered in Table 7.3.
Each theory -of the finn has markets undertaking a selection role in row 13. Markets are seen
as selecting transactions, resources or organisations respectively. With TBA, markets
introduce infom1ation degeneration by reducing intOm)ation to a number as noted in Table
This suggests that as the complexity of transactions increase, the usefulness of
degenerate market inf{mnation wiH diminish the role of markets as a govcming mechanism,
265
Table Comparison ofTBA with other theories of the firm
The type in bold am! ltttlies is taken from a Table contained in Bellon & Niosi ( 1997), with shaded extensions added by' the author.
Boundary of analysis _ttnns fLo11tnlJutlfluiJy_liellnu U: ;vw.n, I<J<JI) All orgamsat1ons mcnwmg
'n-c:::c:-r--,.,===+--'_:'T::..:l:.:_Ir,ee dirergeut analyses oftlte firm and ittter:firm coopermkm" (Contribution by author)
1 Row l ---r i ---- < j ------------ 4
J#crspcctJvc or 1 ransactum cost bmllltumary o} l'ransactton byte analys1s (I BA) ba.;;ed
analysis ecrmomic (TCE) theory ! theory of tiJe firm the firm (ET) on the science of
oftlte firm (RB1) infomwlion and control (cybernetics)
MOOcs ?l . _ Markets and lucrur<:htes mutvtuuaiS, r:un_111es, etans,
coopcratlon (Coasc, I 937) and hybnd hicmrchJcs and groups, assoc1at1ons, commututlcs,
l (Governance organisations associations alliances, nctworks
1
hierarchies,
paradigm) (Williamson, 1975) (Ouchi, 1980) markets etc. (Table 3.2)
--------upfiiiiiiiiJEiir------- --- Myopiit(Nelson (.r- lntormauo-n-rtiCUS\ifCO'iif"'bytcs"
2 i'J>Iicro-fmmdatious Transactions (Chi, 1994) ami Winte1; 1982) ami Table 3.1
mJopift (Conner, cowWainetf opportunism (Turnbull 1978b: 52; 1994c:
/991) (llrurt, /997) 329; l997a)
,)fartmg pomt OJ -cos-,:..,;- Kesource.o urgamstltums
1
m tn:msUCITilffbYtes:
aJ111J.f.">i<> iustitwt'mts (Turnbull 1978a: 1994a,b;l997b,e)
"+ uoJecttvc Mirilmisirig-costs ana Maxm11smg ot uttcst trilliSiiCiiOfi-ofbytCs:
opportunism resources Table 7.1, row 5. (Tumbulil i997c)
u-- ------Esser!ce ?! --Brmme OJ {1.\'.\'ets, 15Uiltlle! OJ tirqttttl.\'ltfu}IUI( t:apm:nllty to bY any
5 firgamsatum ctmtrat.'l.\' resources ami routmes means m 1 able 3. l
cmttpeteuciL's (Turnbull l997h,c)
1----r.- o-1-= n'"o "uTit"'cs' +---u""o"m"p"'c"tl"tl"v"'c ---t--'-F U<,;lll;-;-1p:Cc:i;,t';';ll';';l\2'c:----+---- -- -- it i vc COITfj)CTit 1 vc and/ or coopcrat ivc
(Refer Table 3.4)__ _______ \ 'uo1c 3.4, row 5)
I I<OJC UJ ana
I
IH/1111 Select i:J]iCiimt routmes Tii10nnatlon processmg! aeve.lopmg
malutgement coutntcts competmu:ws am/strategies and/or obtaining new knowledge
r2
__ I' trill t')'mmm.:s lJarginal

t..emrm Central
Nature o} auumces
?t.'lween
Kesearclt New orgamsatumal . Means to snare tac1t antl oU1er
9 markets ami !Jierarclties comp/euumwry routine related to infommtion, knm'lledge and wisdom.
assets change (sharing bytes as per Table 3.1)
I IV
MIC_Ol
--------NorrecognJsea --NQTfC-C{Ygil{SUa--
Not n.:cogmsco ---Siii1j)lifjTn10mlation and control
communities/clans through rich tacit knowledge and
and fam il ics bonding
-----
KoJc 01 tenms, Increased mformauon, kllowleagc-ana J(euuu opportmusm /{f!lWt.:f! xeauce myoput ana
II groups, alliances, oppMIWII's!tt am/ UIU.'CI"lflfttl)' control while economising indivjdual
and myopta information processing and exertion
networks
"
!'3
KOIC 01 mcrurcnH:s Reduces costs or.
1 inputs 01 and extend-
12 transacting through resources produc1ion control: Table 3.3 (Turnbulll997e)
markets

--- Kotc or marKets
urgantse wmsactwns 7\ffocatc resources I_CSS CliCCtiVC Comunicatcs ncCds at the cost of
13 between a large number of organisations reducing information, knowledge and
agents meaning: Table 3.2 (Turnbull 1997c)
Mam rott.!

-RCdi..iCC.S co-
14 competition stmtegic assets operation but encourages search for
superior knowledge.
CHAPTR7
TBA reduces the extent of the rt::liance on market mechanisms through its recognition in row
J that transactions cnn also be governed by associations, and communities/clans as well as by
hierarchies (refl!r also to Table 2.3}. It also reduces tbe role of markets by forcing recognition
of the time and energy (i.e. physical activities tbat introduce set up costs) to provide the
qualitative contextual information required to give meaning to pricing infOrmation.
Likewise, in row 14, the role of competition has as a negative aspect in TBA because it
reduces the richness of coordinating infom1ation as conside-red in Section 3.3. Other theories
of the finn treat competition only positively. However, the competitive advantages of
establishing cooperative relationships with strategic stakeholders provide the basis tOr modern
management practices. Examples arc Just In Time (JIT) delivery of products by suppliers,
employee self-managemem/autonmnous work groups and Total Quaiity Management (TQC)
involving customers. Again, the relevance of these practices increases in importance with
increasing complexity of the goods and services bcmg produced. As the degree- of knowledge
and complexity increases, so docs the need fOr richer and varied cooperative relationships.
This trend has produced network forms of firms in tht: InfOrmation Technology (IT) industry,
which also illustrates the emerging phenomena of firms having botb cooperative und
competitive relationships at the same time to illustrate the phenomena of" social tensegrity".
7.5 Propositions for testing TBA
To investigate finns with two or more boards, a framt:work of analysis was required .vhich
compared ditTerent systems of corporate governance in diiii.!rl.!nt cultures as sought by Dernb
& Neubauer ( 1992h)_ TBA provides a basis. to achieve this objective as indicated with Figure
7.3. The analysis of MCC and a Japanese Kerietsu in 6.6 illustrated how the
framework developed by TBA provided insights not available in accepted theories of the
tirm. Some propositions arc developed in this section to test these insights in a refutable way.
Tables 7.1 and 7.3 indicate how TBA both includes and subsumes oth!.!r theories. TBA
altows the various types of institutional arrangements found in an economy to be considered a
variable rather than a g1ven. TBA provides a framework tOr evaluating and designing
268
UTILITY OF TRANSACTION BYTE AN,\ LYSIS
networks of finns, as distinct from network firms with many centres of ope-rations as analysed
by Economides ( I996). Another application for TBA is the development of design principles
for creating organisations to fit their purpose and situation as suggested hy Hirschlcifer
(1977). This could lead to the suggestion proposed by Turnbull (1978a, 100; 1997d) of
designing self-regulating firms and social organisations to reduce the role of government
There is substantial literature on the design and evaluation of organisations based on the
assumption that all organisations arc ultimately centrally controlled. Within this paradigm,
Galbraith (1973), Egelhoff, (1982), and Dutl and Lengel, {1984), focused on the proposition
that organisational structures develop to fit thdr information-processing needs, The usc of
inforrmnion. rather than cost, provides: a way to shift the research paradigm to organisations
which are accountable and controlled by more than one constituency as found in MondragOn,
Japanese keirt:tsu. some European fimts, LBO Associations, ESOPs, venture capital firms,
aUianccs and network firms. it also allow the investigation of tinns with compound boards as
found in fully employee owned finns in Anglo nations or -elsewhere as considered in Chapter
5.
As noted in Section 5.4, TBA provides a way to explain some of the- minimally necessary
components fOr sustaining employee own..:d tlm1s. as identified by Bernstein ( 1980: 9). As
noted in that section, a compound board is requir..:d to provide distributed information and
controL Consideration of the case studies and analysis of the thesis lends to the following six
observations about compound boards as providing a way to:
(a) Decomposl! decision making labour to allow people to transact bytes within
their operating limits and permit specialisation of decision making knowledge
and abilities;
{b) Divid..: power and create interdependencies to provide a rational basis for
developing trust while allowing competition for power, prestige and intluencc
wit11in a finn and facilitate social tensegrity;
(c) Obtain a richer variety of information sources from relevant stakeholders to
lmprovc the accuracy and relevance of decision making;
269
CHAPTER 7
(d) Create a holonic architecture to economise the transaction of bytes and create
dynamlcally stable organisational structure;
(c) Introduce self-regulation and self-governance by allowing stakeholders who
are placed at risk, or art: involved with the finn, to participate in its control:
(f) AmplifY regulation by the process of supplementation.
These observations !cad to eight general propositions for testing tht.: enicacy of TBA as set
out below:
(a) Finns obtain operating advantages by adopting an infOrmation and control
architecture, which keeps the transactions of bytes wilhin the capability of its
personnel by decomposing decision making through a compound board.
(b) Finns obtain competitive advantages by adopting an infonnalion and control
architecture, which provides the richest informatinn to and from their
customers, employees nnd suppliers by involving them through as compound
board.
(c) Firms obtain operating advantages by introducing a plurality of:
{i) intbnnation sources to reduce errors in decision making data by
introducing stakeholder advisory boards;
{ii} computation centres to reduce infOm1ation overload and create
interdependencies to devdop trust while allowing for competition within
the finn from a division of power through a compound board;
(iii) control centres and processes with sufficient variety to manage the
complexity of their environment (e.g:. introducing stakeholder councils);
(iv) concatenated !mlonic components to provide requisite variety to manage
complexity (e.g. spin-off and/or decompose a finn into almost sc!t:
governing components on a recursive basis as much as necessary to
satisfy proposition (a) above);
(v) traits in its personnd, such as selfishness/selt1essness, trustlsusplcion and
competitiveness/cooperativeness to facilitate social tcnscgrity whh
remuneration and advancement dctcnnined by peer groups.
270
UTILITY OF TRANSACTION BYTE ANALYSIS
(d) Compound boards arc a condition precedent for sustaining non-trivial labour-
owned firms, which are not professional partnerships;
(e) Holonic architecture provides competitive advantages for finns dealing with
complexity by their ability to prodigiously reduce the transaction of bytes;
(f) Finns exist because markets fail to provide information for governing
productive activities as t!fficicntly and effectively as alternative methods;
(g) Markets exist to the extent that fim1s have not adopted the most eflCctivc and
efficient architecture for governing production;
(h) TBA introduces unique insights not available ffom other perspectives which it
may complement and/or subsume and allows the architecture, fOnn and culture
of finns to be considered a variable rather than as a given.
TBA raises a fundamental question if the most competitive fonn of corporate governance
requires a company to be publicly traded. The case studies and analysis suggest that privately
held entities could provide the most efficacious fonn of enterprise as indicated by th!.!
outstanding record of the privately owned MondragOn firms and VISA International. A
possibility supported by Jensen's ( 1993: 869) view that the two tiered compound board
created by a LBO Association represented "a proven model of governance structure". Gertner
& Kaplan (1998) have provided empirical evidence of this view. Alstyne (1997) and Podolny
& Page ( 1997) have also noted the comparative advantages of networks in relations to
hierarchies and markets.
Strategic stakeholders, with infom1ed expert infOnnation can provide management with an
"an opposition view" as sought by Pound (I 993a: I I). Pound advocates directors introducing
the prospect of "insurgency" and "contestability" to management to establish competition fOr
control through the boardroom rather than the much more expensive, slower and problematic
competition fOr control through the stock market.
Roc (1998: 4) makes the point that, "Information, particularly proprietary and technically
complex information, could flow better ffom inside the company to a holder of a non-
271
CHAPTER 7
saleable, HI-liquid block of stock than to scattered traders on tbc stock market". In other
words, corporate govcmance reform may lead to unlisti.!d firms, in 1.!ith0r the private or public
sector, to become more competitive than publicly traded corpomtions. This suggests that
privatisation may not be the best way to increase the cfticicncy of government owned
corporations. TBA indicates that a condition precedent for refonning any public Sl.!ctor finn
Js to first introduce an infOrmation and control architecture as proposed by Turnbull &
Guthrie (1994), Turnbull (1995a) and Guthrie & Turnbull ( 1995).
There arc tbeor..:tical grounds to suppon the possibility that privately held firms could be
made superior to publicly traded firms. Coasc ( 1937) established that firms exist because
markets fail to minimise the costs of govcming transactions. The advantage of using marke!s
rather than organisations to govern transactions reduces as the of organisations are
improved to increase their economy, efficiency and effectiveness. This suggests that the
prevalence of transactions governed by markets arises from the failure of organisations to
utilise holonic networks; that is, to utilise the most robust and economic me-thod of
communicating complex infonnation in the simple way as fOund in MondragOn, DNA and
throughout the universe.
Ashby ( 1960) pointed out thm, "prices represent second order infom1ation" dependent on tirst
order qualitative description of what is being transacted. Prices may also represent incf!:icicnt
communications because they may Jack credibility as analysed by Akerlof ( 1970). These
considerations explain the advantages of using non-market methods for governing
transactions as identified by Hollingsworth & Lindberg (1985). The introduction of holonic
organisations offers a \vay to increase the of governing productive activities by
reducing transaction costs and costs arising from 'bounded rationality'. This suggests that as
the informational emciency of organisations increased, the role for markers would decrease.
The current methodology utilised by many economists, management and corporate
governance scholars, is not suited for the evaluation of compound boards, inter-finn networks
272
UTILITY OF TRANSACTION BYTE ANALYSIS
and finns as it is bytes rather than costs which arc being transacted. Nor have the
operations of compound boards been analysed by system theorists.
The ne!!d tbr the separation of powers in corporate boards. has been noted by Tricker (191'}0,
1994: 6, 45-6, 75, 78, 156, 247--8), Hother1y {1994) and Dallas (1997), The writer has
demonstrated the ability of two tiered boards to reduce the cost of equity in two startMup
enterprises. In the second venture, a 'Corporntc Senate' was established as a shareholder
watchdog committee as reported by Turnbull (1992; 1993c; 1994b; 199Sb), Monks & Minow
(1995: 317) and Tricker (1996: The Corporate Senate was inspired by the 'watchdog
committees' established for MondragOn firms. Corporate Senates in turn inspired Murray
(1998) to propose in Parliament that all publicly traded Australian corporations establish a
"corporate governance board".
An appropriate separation of powers to create checks and bnlances provides a \vay to increase
the: welfare of all stakeholders according to Pcrss(m, Roland & Tabdlini (1996), They went
on to make the point. that negative welfare might result if the division of power is not
appropriate". An analysis of appropriate division of powers In firms has been made by
B<mstein (1980) and Turnbull (1978a: 100; 1993b; 1994b,c; 1997b,g; 2000b),
The sharing of pO\VI!r between different constituents of a firm is not an uncommon occurrence
in all cultures. But the generally accepted Jntellectual model by scholars that all firms arc
centrally controlled has resulted in the phenomena being poorly recognised. Shareholder
agrt:ements of venture capitalists divide power between the entrepreneur and investors to
Cr\!atc two tiered control structure. Likewise, agreements between management, equity
investors and bondholders in LBO Associations create an operating board \rith a supervisory
board of investors and b-ondholders. /hen one person or firm controls n publicly traded
company, a two tiered board is created. This has the practical result of creating a division of
power and roles even though the legal powers and roles may not change,
CIIA'TER 7
The case studies of the research were based on employee owned finns, They wen; selected
from the two most dominant Anglo cultures where unitary boards are the norm. Thi::::
demonstrated that compound boards; (i) Could cowexist with the unitary model; (ii) \Vcre
competitive with unitary fim1s; (iii) \Vere sustainable over the longer term; (iv) \Verc a
condition precedent for nonwtrivial worker owned iinns to s u r v i v ~ and (v) Could be designed
in different ways to achieve these resuhs. This last point demonstrates that the constitution of
iinns, which detennines how their information and control powers arc shared \vith
stakeholders, should be considered a variable rather than a culturally path determined
invariant. An example ofthis approach is provided by Tumbull (2000b).
7.6 \Vider implications ofTBA framework
The research developed and refined in this thesis was based on an approach used by the
author to investigate how traditional Australian Aboriginals made decisions to manage
complex activities involving over l ,000 people as may be found in a medium sized business.
Bytes were used in that analysis as many languages were involved, without writtt.:n words or
numbers (Turnbull1978b: 52).
The organisation of Aborigim1l activities revealed two important inconsistencies in the basic
.assumptions made by kading scholars of industrial organisations: (a) "In the bt.!ginning there
were markctsn (Williamson 1975: 20). This statement was consistent with the explanation by
Coasc (1937) of why tinns exist because of I he "supersession of the price mechanism", {b)
Transactions arc gove-rned by markets, hierarchies or by a '"hybrid"' combination of both
mechanisms (Williamson 1975; 1985; 1990: x).
Aboriginal society had limited numerncy and so no opportunity to establish pricing signals for
markets. So "in the beginning there were" no markets. Nor did coordination of their
activities outside their clan structure involve hierarchy. Even within a tribe a "managcr"
from a different clan or moiety mediated their most sensitive relationships. This is consistent
\Vith the findings of Bernstein for the need of'' an independent appeals system" to mediate
relationships.
274
UTILITY OF TRA.:"\SACTION BYTE ANALYSIS
ln anatysing North American indians, North (1985: 558} noted that: ''Trade evolved in the
context of dcvelopmg forms of communication that were embedded in religions, m.yths,
taboos, kinship tics etc," { l978) \vho described how clans could govern
transactions independently of markets or hierarchies also documents this process.
Markets evolved not from monetary exchanges and prices, but through bartering, Money
evolved from some bartered commodities becoming accepted as carrying out one or more of
the functions of modem money in providing a unit of value, medium of exchange nnd store of
value. Tobacco remained legal tender nearly twice as long a run as gold" (Galbraith 1976:
57). Hierarchies developed before paper money became generally accepted in the 17\R
ct:ntury. The development of the four channels of"' communication and control" outlined in
Tnblc 3.2 has resulted in the number of bytes utilised in each channel changing as diffl:!rcnt
fonns of society have evolved.
The qualitative and operating chamctcristics of society also change with the degree to which a
society utilises each channeL The effect ofthcst: changes arc shown in the last row ofTuble
7.4. 'Roles of commumcation chnnncls in governing socictv'. constructed by the author in
I97S anJ reproduced below. The percentage use of each mode fOr each society is shown in
Figure 7.4. 'Y1odes of gowmance in social svstcms 1978'. Table 7.4 illustrates how TBA
can be used to compare dinCrent types of societies.
The social systems have been listed in Table 7.4 in order of evolutionary development from a
socialistic perspective at the time the l!stimatc was made in 1978. This reveals. a consistent
change in the degree to which mode and so channel is used to transact bytes. The usc of
senses continually decreases to indicate a decline in the usc of family and peer groups for
goveming society, TI1e decline in the usc of senses is largely ofl:Set by a continuous increase
in tbe usc of voice/words in hierarchical authority systems increase. The proportion of
semiotic commurlication utilised in coordinating the various social systems decreases and
then increases as the use of markets increases and then decreases. This indicates a tall and
215
CHAPTER 7
rises in the avoidance of alienation with a rise and fall in the choice of material goods. In
these ways, Table 7 A indicates how TBA can be utilised to analyse, compare and e\'aluate the
operating characteristics of social systems as well as micro institutions such as firms. The
estimates of Table 7A bavc been tabulated to create Figure 7.4 to illustrate th!.'J consistent
chang..: of channels with the evolution of political systems.
Table 7.4, Roles of communication methods in governing society
indicative% of bytes used by cacb integrative method in cacb society
oT governance I i\Ssoclatlons: .;:'!ltnte IVJ3fKCt
(Refer to Table 2.3) (Family/clan) i (Hierarchy)
lV1ctnoa (1 ante j.l) ;:o:,ensory ;,crnmtlc : v mcctwora rnwcost 1 ota
1
197s'L
'
'
%of bytes %of bytes
'
%of bytes % ofbytcs % '
'
40 ou
'
'
u lUU
l-'nmJtJve agncuJturaJ 4U 4U JU lU IUU
"cuaa1
_,
5U
I
"u
D 1\IU
capnalJsm .lU 2) .) LV IVU
MOOCm Lapltal!Snl LO
"
j) .) JUU
Y ugosmvmn L\J LV 4)
,
lllU
Cluncsc communism JO 20 ou IV IVV
:SOCJ311St IU JU
,
)
IUU
""'"'u
uecune:
""" "' nsc
t<.!SC IOSC <liC tall
SIGNIFICANCE OF
ot
reliance on
tay
of avowmg
!'"" ?'
hierarchal
uu;
mcho1ceot
TREi-JD family and alienation authority material
peer groups systems goods
Source: Turnbull ( l978b: 52. 1994d: 328)
TBA has profOund implications for the macro structure of a society as more economic
activities involve the production and exchange of knowledge rather than other services and
goods. As the complexity of society increases the ability of central govcnunents to regulate
society will diminish bccrmse of the law of requisite variety unless the cybernetic principle of
supplementation is employed.
The US Vice President has articulated the need for the role of government to radically
change. In a speech to scientists he advocated that the role of government should be to
"imprint the DNA" of social institutions (Gore 1996). Ashby (1960: 135) observed that, "the
gene-pattern must act as a dctt.."lminant to the living organism's mcdmnism for adap!ation". In
276
UTILITY OF BYTE ANALYSIS
other words, genes communicate inf-ommtion on how an organism is designed to regulate
itself in the same \.Vay as corporate constitutions communicate how they arc to regulate
themselves. It is in this way that regulation can be amplified a'> described by Ashby (1968:
264--5) through "supplementation",
Figure 7.4, Modes of governance in social systems 1978
Legend a Sensory a Semiotic of>nce/cost
Types of social systems
The Gore strategy would not involve establishing government regulations on how tinns
should operate or behave. lt would not even involve the adoption of procedures and
processes as proposed by Cadbury (!992) or Hawley 'md Williams (1996: 71-84). Instead,
the government would act indirectly by specifying basic design criteria for corporate
constitutions. Investors and other stakeholders could custom design the protection they
required in l!ach particular corporation to further bolh their interesls and those of the finn
(Tumbuli J 999). To the degree this strategy was successiUI in inlroducing self-regulation, it
277
CHAPTER?
would allow simplification of corporate law through the need of governments and
regulatory agencies to adopt prescriptive lmvs and regulations.
The most eJl'ectivc, complete and etlicient regulation can be achieved by as much
selfregulation as possible in the basic units of socidy .!iUCh as finns" MondragOn Hlustratcs
how the Gore strategy of"imprinting thl.'! DNA" offinns could be achieved. The MondragOn
complex was developed by its banker who carried out the role of n "factory factory" which
"institutionalised and socialised entrepreneurship" (EHemm.n 1982: 3).
Finance to establish a cowop was provided by the banker on condition that the firm adopted a
constitution, which divided power into the tive centres shown in Tables 15 & 16. Details of
the constitutional arrangement required nrc presented in "Appendix B" of Campbell. ct. al.
(1977). Governments could likewise require their licensed banks to act in the sru:nc \vay for
their clients to adopt arrangements which met the self-governing criteria outlined in Table
3.7. As well as, or as an alternative to using bankers to ''imprint" corporate constitutions,
governments could provided tax incentives as describl.';d by Turnbull (1975; 1994c; 1997a).
Another approach is to simply make it a rcquirl.!mcnt of incorporation for nontrivial fim1s, or
a finn becoming a publicly traded as proposed by Senator Murray (1998:31 ).
However, govl.!mment has the power to directly introduce ho{onic architecture into the public
sector as described by Turnbull & Guthrie (1994), Turnbull (l994c). TBA makes it quite
explicit the imp-ossibility of governments to control and regulate society without
supplementation. Consum;;r protection is just not possible in a complex society through
ccmralised controL The citizen utility boards (CUBs) established ln the USA on the initiative
of Ralph Nader provide an example of how some self-protection can he achieved (Givens
1991).
Protection of consumers, employees, suppliers or other stakeholders requires supplementation
through the establishment of almost seJf.govcrning components. Operationally. this means
that govcmments must require organisations, which can exploit or damage stakeholders, to
278
UTILITY OF TRANSACTION BYTE ANAL \'SIS
share control with those who arc at risk. This could be achieved by the introduction of
"stakeholder governance" described by Turnbull (1997a,b,g) and Guthrie & Turnbull (1995)
in the private sector and in the public sector by Turnbull (1994c, 1995a). The introduction of
stakeholder governance would create a "stakeholder democracy" (Turnbull 1994c).
TBA indicates that the possibility of increasing the efficiency and effectiveness of
organisations by distributing decision-making so that it would also enrich the quality of
democracy. The analysis developed in this paper supports the statement by Hock (1994: 5)
who wrote:
Industrial Age, hierarchical command and control pyramids of power,
whether political, social, educational or commercial, were aberrations of the
Industrial Age, antithetical to the human spirit, destructive of the biosphere
and structurally contrary to the whole history and methods of physical and
biological evolution. They were not only archaic and increasingly
irrelevant, there were a public menace.
The insights of TBA have a number of implications for the structure of finns, organisations,
and government. As the complexity of society increases, so will the need to recognise the
limitations of governing society through hierarchies and markets. Neither markets nor
hierarchies have the capacity to provide requisite variety in infom1ation or control to
efTectively govern complex activities. Markets provide too little infomuttion and hierarchies
aggregate too much infOrmation for humans to either communicate or process reliably.
As the development of self-regulation requires the participation of all the stakeholders that
can be effected by the firm, the involvement of stakeholders in corporate governance would
enrich the quality of democracy in corporations and the broader society. The quality and
quantity of democracy would be increased by introducing the principles of self-regulation into
all other social institutions such as non-profit and community organisations. This would in
tum reduce the need and scope of public sector organisations which could likewise be
established with stakeholder participation to improve their ability to become self-governing.
279
CllAPTE.R 7
The degree to which any finn could become would be determined by its ability
to be sclt:financing. The operating discretions of lower levels of government arc typically
constrained by their need to rely on financial transfers from higher levels of government The
regulation of lower levels of government through the principle of supplementation v:ould
remove the need for central governments to usc the allocation of funds as a way to control
lower levels of government. This would provide an additional way of improving self-
detenuination at regional and community levels of society.
TBA provides a way to re-conceive the way society is governed and organised to maximise
participation and involvement of all stakeholders at the lowest level. but in a manner. which
can be co-ordinated with macro levels of society.
7.7 Limitations ofTBA framework and areas for future research
A!. a result of the limited choice of case studies, the framework developed in this thesis only
provides gcner<Jl guidelines tOr evaluating tUld designing organisations. The four studies
in Anglo countries all involved internal compound boards in work!.!r owned fim1s. No cnsc
studies of internal .comptlund boards uf LBOs or v.::nture capital groups \Vcrc considered in
detail. Neither was there a case study in an Anglo nation of an cxtcmnl compound board
created by a group controlling a publicly traded corporation as occurs in a keiretsu.
Comparative studies of firms with or without compnund boards <l:nd with fim;s with different
types of compound boards are required to get some indication of when they provide operating
advantages and how they may be most appropriately be established.
The dcvdopment of TBA has been limited to a few cybemetic principles as cnnunciatcd by
Neumann ( !947) variety in decision making to reduce errors. Shannon (I 949) - variety in
communication channels to reduce errors) and Ashby ( 1968)- requisite variety in control and
the use of supplementation to amplify regulation. The application of these principles to firms
and organisations with related concepts and principles represent core contributions of this
280
L:TILlTY OF TRANSACTION BYTE Ai"!!ALYSIS
thesis. The related concepts arc those of bolons, bolurchy and social tenscgrity. Related
principles being divided power and subsidiarity.
Research is needed into what other cybernetic principles can be applied and used in
investigating the operations of flnns and social organisations. How the relevant principles
might best be applied n;.quires much more investigation and/or experimentation. Many more
case studies arc required from a wide variety of situations. Different design details may be
required in different situations. The research program could occupy numerous scholars for
many years.
An important contribution made by the thesis is that it establishes st:veral new principles fOr
designing organisations. This provides opportunities for "action research" as described by
Gummcsson ( J 991: 178}. Just as there were compelling needs iOr organisations to change
from U-fom1 to M--form with increasing complexity carHcr this ce-ntury. so is there a need to
decompose- decision making even furthe-r with compound boards as complexity l!sc-alatcs.
This leads to the proposition that <L'> complexity in advanced societies increases from the
move from the "inforrnut!on age" to the- "knowledge- cconorny", then use of compound
boards will increase.
If the crmh of this proposition becomes evident then it wiH in tum introduce the incentive to
test and develop TBA as a research topic. Another incentive fOr scholars to investigate TBA
is that the most prevalent and important examples of compound boards were not investigated
as discussed below.
The most prevalent. yet invisible forms of compound boards are created when an individual
or finn controls a publicly traded company. Other common examples arc when venture
capitalists control their invcstcc companies with a shareholder's agreement and with LBOs,
alliances and joint venture operations such as arc commonly found in mining, fiJm and
comput..:r industries. There is a large number and a rich variety of compound boards to be
investigated. When research into compound boards becomes as extensive as investigations
281
CHAPTER7
into unitary boards, then detailed guidelines may emerge as to what arc the most appropriate
design details for a compound board in particular situations.
Compound boards could introduce disadvantages in some situations. The need to decompose
decision making to avoid overloading human capacities introduces additional people and so
costs. The need to improve the accuracy of information by introducing additional
communications channels may also introduce costs depending upon the technology involved,
In both situations there could be diminishing returns fOr the additional resources involved,
The need to establish requisite variety to regulate complexity compounds the costs of
government regulators and stock exchanges, However, the cost of insuilicient regulation by
either a stock exchange or government is most likely to be suffered by others, The
stakeholders who incur the costs of inadequate regulation arc the ones \vho have some
incentive to introduce regulation.
Governments could reduce the cost of regulating corporations and other institutions of society
by introducing dements of self-regulation as outlined in Table 3.7. in accordance with the
Jaw of requisite more effective regulation can be achieved, as more stakeholders are involved
w increase the variety of control infomwtion and responses. Govemment could reduce the
cost of increasing the variety of their infom1ation and control systems required tbr monitoring
and regulating complex corporate activities by supplementation. This would require that the
condition a government allowed a finn to exist is that they introduced clements of self-
regulation and sdt:govemancc as identified in Table 3.7, Research into self-regulation
through introducing requisite variety of regulation and supplementation is another area for
future research.
Research ts also required into the cost of changing the design of institutions and the cost of
changing the way in which they operate - that is to determine the cost of designing and
crealing new 'structural infom1ation' (refer w Section 3.2) and 'process infonnation' (retCr to
Section 3.2) as described by De Yancy (1998) and Simon (1962: 479). Aboriginal
282
UTIUTY OF TRANSACTION BYTE A.J-.;ALYSIS
communities only needed very elementary "message sticks" to arrange their various cmnplt.!x
ceremonies because of their very rich embedded and shared cultural knowledge. Market
signals communicate even less infom1ation but depend upon extensive institutional
knowledge <\$ \veil <l$ qualitative infomtatlon about the goods and being transacted. TCE
analysis is based on direct cost of the transaction not the set up cosls, which make the
transaction possible. TCE analysis is deficient in taking into account the full costing of
transactions.
An important cost in converting capitalistic finns to the MondragOn system was changing the
knowledge and behaviour patb.::rns of the people involved. Different institutional designs
involve changing behaviour patterns as well as educating people how to operate in different
institutional settings. MondragOn was created by and developed through the education
program organised by the League of Education and Culture {refer to Figure 6.2). This
supports the view that different institutional arrangements require an investment in re-
configuring hurnnn knowledge and behavioural patterns. Changes in human knowledge and
behavioural patterns require changes in how the neural network of an individual transacts
bytes and these changes in turn require the transaction of The question arises to what
extent and what is the "break-even,. point for the rate at which new arrangements arc
inlroduccd'! As noted in row nine of Table 3.4. pi!opk have ''limited intOnnation processing
C3paclty so prefers slow rates of change" (i.e. nearly stable systems"),
7.8 Concluding remarks
TBA provides a tbmcwork for providing insights into the operations of companies with one
or more control centres. Table 3.6 showd how the corrupting power of a unitary board
would be exacerbated in stakeholder controlled flnns unless there was a separation of powers
to meet the requirements for self-govcmance in Table 3.7. This explains the findings of
Bernstein ( 1980) who found that non-trivial industrial finns had more than one board.
4J The ways bytel' arc transacK>d in the brain is determined by the :<tructurc of its neutrnl networks. To change
the sune of1bese nerworks "process infonnation" infommlion is requlrt:d (0 Vany 199R: 3; Simon 1962: 479)
28:3
CHAl'TER 7
The conditions identified in Tnbh.! 3,7 explain \vhy and self-governance of
nonwtrivlal firms cannot be assured without a compound board. Figure 7.3 explicates the
ability of a compound board to simplify thl': roic. knowledge, duties and liabilities of directors
compared with those on a unitary board. This provides one basis tOr a compound board to
provide competitive advantages. A number of other advantages were identified in Section 7.5
such as developing trust, providing richer exchange of infonnation, diversity of views and
knowledge to facilitate self-governance.
TBA provides a basis to compare different ownership and control structures. Figure 4.4.
Illustrated a comparison of a widely owned unitary board of an Anglo company \Vith the
stakeholder owned and control tim1s in a keiretsu. The cybernetic principles identified in
Chapter 3 also introduced new ways of evaluating the operations of tirms with various
ownership and control architL"Cturc, whether or not they were in the private or public st.c.ctor.
To sum up the above points. TBA makes a contribution by assisting in the explication of:
(a) Why non-trivial employee owned industrial finns have more than one board;
(b) Why self-regulation sdf-govcmancc ofnotHrivial tlnns cannot be assured
without n compound board;
(c) How compound boards can simplify the role, knowledge, duties and liabilities
of directors;
(d) The competitive advantages of appropriate compound boords in relation to
unitary control systems;
(c) Hmv to compare and evaluate the relative advamagl':s and disadvantages: of
tim1s with different ownership and control structur.;;s; and
(f) How to compare the relative efficacy of hierarchical and non-hierarchical finns
be they in the private or public sector.
TBA provides a new perspective tbr invcstigating both the management and govemancc
architecture of organisations by practitioners. consultants and scholars, For CEOs, TBA
identifies the need for them to become "corporate architcct.s
11
as a basis for estabHshing
284
UTiLITY OF TRANSACTION BYTE Al'OALYSIS
competitive advantages. This could provide opportunity for management consultants to
develop their practice by identifying and implementing changes in corporate architecture and
educators in rnanagcment, public administration and poiitics to develop courses in the topic.
TBA identifies the inability of governments at national, regional, city and community level to
directly regulate society. Having each level of govl!mment independently elected is a
necessary but not sufficient condition to provide requisite variety in each level of government
to manage complexity. nu.:: need for governments to supplement regulation will become
more important as the complexity of society increases. This will require the empowerment of
stakeholders to participate more directly in each level of government in spl...oocialiscd ways to
decompose dt->cision making and provide requisite variety to manage complexity as suggested
by Turnbull (! 9 4 d ~
The process of supplementation has immediate political attractions in reducing the direct role,
size and so cost of gowmmcnt It also has attraction in reducing the compliance cost of f!m1s
and introducing competitive advantages 1fom deve-loping sdt:..govcmance. TBA provides
guidelines for developing selt:govcmance to enrich the quality of democracy (Turnbull
1994d, I 997i) at all levels of government and social orgamsations in general, including firms.
From the point of view of this thesis, TBA makes a contribution in offering a theory that has
general application for all types of firms and social organisations, including those governed
by one or many boards. A theory that has practical :1pplication ln providing guiddincs for
designing organisations and so one that c;m be subject empirical testing. TBA grounds
organisational analysis in the natural sciences and so it may also provide a way for
developing the elusive science of organisation,
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