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12th Annual Meeting on Socio-Economics

 

Society for the Advancement of Socio-Economics

 

London School of Economics

 

Network H, Markets and Institutions

 

Sunday, 5 pm, July 9th, Session 2408

 

 

 

 

The competitive advantages of stakeholder mutuals

(Last revised September 20th, 2000)

 

Shann Turnbull

sturnbull@mba1963.hbs.edu

Macquarie University, Graduate School of Management, Sydney

 

 

ABSTRACT

 

This paper compares the competitive advantages of stakeholder mutual firms with firms that are publicly traded, family or government owned.  A stakeholder mutual is owned and by its employees, customers and suppliers.  These strategic stakeholders can have greater knowledge and commitment to the business than investors.  The efficiency and effectiveness of competition for control between stakeholders is compared with competition for control through the stock market in making a firm a competitive.  The empowerment of stakeholder constituencies to directly participate in corporate governance is identified as a means for reducing the need for detailed prescriptive government regulation to protect stakeholders.  The operating advantages, the flexibility and the competitiveness of a stakeholder mutual is compared with government or private ownership.  Examples are used to support the analysis that stakeholder governance can provide a superior approach for increasing efficiency and equity while creating a building block to develop a participatory stakeholder democracy.

 

 

JEL Classifications: D890, G380, H190, K290, L200

 

Key words: Governance, stakeholders, competitiveness, self-regulation, privatisation, ownership transfer, mutualisation, theory of the firm.

 

 

PO Box 266,Woollahra, Sydney, NSW, 1350

Ph: +612 9328 7466, Fax: +612 9327 1497, Mobile +0418 222 378

http://members.optusnet.com.au/~sturnbull/index.html

 

1.0     Introduction

This paper compares the competitive advantages of a stakeholder mutual firm with those publicly traded, family, or government owned in Anglo countries.  A stakeholder mutual is owned and controlled by its employees, customers and suppliers.  This creates distributed ownership among diversified stakeholders.  Each stakeholder constituency elects its own board.  These boards represent components of a “compound board”.  A compound board introduces distributed control but this does require a stakeholder mutual to have diversified accountability.

 

In Anglo countries publicly traded, family and government firms typically have a unitary board with homogeneous ownership by investors.  This form of governance is compared with distributed control provided by a compound board of a stakeholder mutual with diversified ownership. 

 

Conventional mutuals also have homogenous ownership but it is with a single class of stakeholder.  In Anglo cultures a conventional mutual is typically centrally controlled through a unitary board in a similar manner to investor firms.  The differences in ownership and control between conventional mutuals, investor firms and stakeholder mutuals are shown below in Table 1, ‘Typology of firms discussed’.

 

Table 1, Typology of firms discussed

 

(Heavy arrows indicate the two steps used in the analysis and for forming a stakeholder mutual)

 

 

Table 1 also compares the forms of governance used by each type of firm.  Hollingsworth & Lindberg (1985: 221–2) state that there are "four distinctive forms of governance ... market, hierarchies, the clan or community and associations"[1].  One type of associative governance is what Pound (1992: 83) describes as the “political model”.  Pound states that, "this new form 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 1980s".  Aoki (1998: 32) concluded “that the markets for corporate control cannot provide the best governance mechanism for every class of organizational coordination"”

 

No firm can exist without employees, customers and suppliers, including those providing infrastructure services in the host community.  For this reason these parties are referred to as “strategic stakeholders”. 

 

The distinguishing characteristics of a stakeholder mutual are:

1.      Ownership is only with those people on whom the firm depends for its existence,

2.      Control is decentralised but not diversified through a compound board.

 

Shareholders do not meet the test of being strategic stakeholders as they are not required when a firm becomes viable.  Viable firms are self-financing and do not need to raise funds from shareholders, as is the case for most publicly traded firms.  In some years, more money is distributed to shareholders in the USA from all listed companies through dividends, share buy-backs and management buy-outs than is raised by firms from shareholders.

 

Jensen (2000), Sternberg (1997) and Pejovich (1990) have noted the problem of firms being accountable to diversified stakeholders.  However, their concern does not apply to a stakeholder mutual as it introduces distributed control without diversified control or accountability.  Distributed control through a compound board is mandated in a number of continental European countries. 

 

Compound boards are found in all countries, as one company controlling another with outside shareholders creates constitutionally different components of a compound board.  This is the predominant control architecture found throughout the world as reported by La Porta, Lopez-de-Silanes, & Schleifer (1999).  Compound boards within a firm is a feature of non-trivial employee owned industrial firms throughout the world, even in Anglo cultures where unitary boards are the dominate form (Bernstein 1980).  Venture capitalists and leverage buy-out associations who establish over-riding powers for a unitary board through a shareholders agreement also create a compound board.

 

Ownership by diverse strategic stakeholders is not commonly found except in Japanese keiretsu.  Conventional mutual firms, worker cooperatives and professional partnerships have distributed ownership but it is homogeneous within a single class of stakeholder as shown in Table 2, ‘Examples of the different types of firms discussed’.

 

Table 2, Examples of the different types of firms discussed

 

Nature of ownership

Examples

Control architecture

Private/solitary

Family firm

Government firm

Unitary in Anglo countries, compound boards (CB) elsewhere

 

Distributed &

homogeneous

Publicly traded firm

Conventional mutual

Professional partnership

Worker cooperative

Unitary and/or CB

Unitary board

Collective

Distributed through a CB

Distributed & diverse

Firm in a Japanese keiretsua

Stakeholder mutualb

Distributed through a CB but not diverse

Redeemable equity

Mondragón primary coop

Distributed but not diverse (CB)

Limited redeemable

Mondragón secondary Coop

Distributed and diverse (CB)

aPublicly traded        bPublicly traded and/or redeemable

 

The analysis of a stakeholder mutual firm with distributed control and diversified ownership is undertaken in this paper in two steps as indicated by the two black arrows in Table 1.  The first step is to compare centralised control with distributed control.  The second step is to compare homogeneous investor ownership with diverse stakeholder ownership.

 

The second section of this paper considers the ‘inherent problems from unitary control’ in publicly traded, family and government owned firms.  Unitary control introduces the corrupting influences of centralised power, the problems of information overload and degraded information and control.  This section identifies the need to recognise the limited ability of individuals to transact information, measured in bytes, on a reliable and consistent basis. 

 

In the third section, examples of distributed control are considered with a division of power, decomposition in decision making labour, distributed information feedback, and elements of self-regulation.  The examples include employee owned firms, the stakeholder-controlled firms found in Japanese Keiretsu and the stakeholder cooperatives located around the Basque town of Mondragón in Spain.  The examples provide a basis to compare the competitive advantages of distributed control with centralised control to undertake the first step of the analysis.

 

The fourth section describes how a stakeholder mutual can be formed through privatisation or by the introduction of tax incentives for shareholders to convert their firms.  The resulting information and control architecture of a stakeholder mutual is presented.  This provides the basis for undertaking the second step of the analysis in comparing homogenous and diverse ownership.

 

The fifth section introduces cybernetic principles to provide supporting evidence for the competitive advantages of stakeholder mutuals.  First, cybernetic principles identify how distributed control can be used to minimise the need for individuals to transact bytes/data/information/knowledge/wisdom, so as to reduce information overload and “bounded rationality” (Simon 1961: xxiv).  Second, they show how to introduce elements of self-regulation to reduce the need for government oversight.  The concept of “social tensegrity” is introduced as a method for efficiently managing the problems created by the limited, inconsistent and contrary operating characteristics of people.

 

The concluding sixth section reviews the competitive advantages of stakeholder mutuals and the introduction of cybernetic principles to the theory of the firm.  It recommends the introduction of distributed stakeholder governance before any government enterprise is privatised.  It also argues that unitary boards do not represent a competitive basis for the convergence of corporate governance regimes found in various countries.

 

If governments wish to raise funds by selling their enterprises then the paper argues that this be done on condition that diversified stakeholder ownership is introduced after the investor’s time horizon to introduce the foundations for “building a stakeholder democracy” (Turnbull 1994a,b).

 

2.0     Inherent problems from unitary control

This section considers the inherent problems of unitary control.  Firstly there is the ability of centralised power to corrupt directors and firm performance due to their manifold conflicts of interest.  Secondly, centralised control denies the ability of directors to obtain qualitative information about the business strengths, weaknesses, opportunities and threats (SWOT), independently of management who need to be a crucial element of any evaluation.  Thirdly, there is lack of information, independent of management, to monitor, control, direct, remunerate, and retire management.  Fourthly, unitary control introduces information overload on decision-makers and other shortcomings identified by the cybernetic analysis presented in section five.

 

Unitary control occurs when a single board or control centre governs a firm.  Many unitary board firms overcome some of the problems of centralised control by having a supervisory board such as is found in keiretsu, continental Europe and/or through an influential shareholder who carries out the role of a “watchdog” or supervisory board. 

 

2.1     Corruption of power

A unitary board has absolute power to manage its own conflicts of interest.  Table 3, ‘Corrupting powers of a unitary board’, explicates how unitary boards can lead to the corruption of both its members and the performance of the business by appropriating shareholder value.  Section A of the Table lists the powers of directors to further their own interests or those of their nominees.  Section

Table 3, Corrupting powers of a unitary board

 

Directors have power to:

 

A.   Obtain private benefits for themselves (and/or control groups who appoint them) by:

       (a)   Determining their own remuneration and payments to associates

       (b)   Directing business to interests associated with themselves

       (c)   Issuing shares or options at a discounted value to them selves 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 associates at inflated values

       (f)    Trading on favoured terms with parties who provide directors with private benefits

       (g)   Using firm resources and/or their status in other ways.

 

B.       Maintain their board positions and private benefits by:

(a)    Reporting on their own performance and influencing “independent” advisers by:

(i)             Selecting auditors and other “independent” advisers

(ii)           Determining their fees

(iii)          Controlling the process by which auditors are appointed by shareholders

(iv)         Terminating the appointment of auditors and other “independent” advisers

(v)           Paying additional fees for work which is not required to be “independent”

(vi)         Determining the terms of reference on which “independent” advice is provided

(b)   Determining the level of profit reported to shareholders by:

            (i)      Selecting the basis for valuing or writing off trading and fixed assets

            (ii)      Determining the life of assets and so the cost of depreciation

            (iii)     Selecting the basis for recognising revenues and costs in long term contracts

            (iv)     Selecting accounting policies within accepted accounting standards

            (v)     Selecting, controlling and paying “independent” valuers and determining the basis on which valuations are to be carried out

(c)    Not disclosing full pecuniary or non-pecuniary benefits even if required to do so

(d)   Determining how any conflicts of interest are managed

(e)   Filling casual board vacancies with people who support their own positions

(f)    Nominating new directors who support them at shareholder meetings

(g)   Controlling the nomination and election procedures and processes

(h)      Controlling the conduct of shareholder meetings

(i)        Appointing pension fund managers for the firm who also provide them proxies

(j)        Voting uncommitted proxies to support their own election

(k)        Not allowing the firm to compete with related parties who can vote for them.

 

 

B lists the powers of directors to maintain their board position and benefits for themselves and/or their nominees.  The natures of the eight conflicts of interest listed in section A can and have been used to destroy the viability of many publicly traded companies.  This should not be unexpected as it is widely accepted that power corrupts and absolute power can corrupt absolutely.

 

The inherent conflicts of interest in unitary boards are gradually being recognised by the growing practice of establishing sub-committees to consider the more contentious conflicts.  However, while such sub-committees acknowledge the problem they are not a solution, as boards cannot contract out of their intrinsic conflicts of interest.  The most common and contentious conflicts arise from directors determining (i) the accounting policies that determine the how their performance will be assessed by investors; (ii) the remuneration paid to themselves; and (iii) their self-nomination for re-election.  For these conflicts to be properly managed, a company requires a watchdog board or an active influential shareholder to carry out this role.

 

The appointment of a majority of non-executive directors (NEDs) to contentious board sub-committees does not remove the intrinsic board conflicts even if the directors are described as “independent”.  The term independent is generally misleading “double-speak”.  This is because the information available to NEDs to make decisions is prepared by management and so is not independent of the self-interest of management.  The information prepared for NEDs is commonly the principle source of information available to NEDs to direct, monitor, control, remunerate and change management.

 

It should be considered misleading and deceptive conduct under the law to describe any director on a unitary board as “independent” unless they can meet three conditions.  The three conditions are that the director has: (i) information independent of management on which to act; (ii) the will to act; and (iii) the capability to act in the best interest of the company as a whole.

 

2.1.1 To obtain the information to act, directors not only need management’s side of the story but any opposing views that may be held by employees, customers, suppliers and other stakeholders.  A “loyal opposition” and a vigilant “fourth estate” are commonly recognised as conditions precedent for good government.  As the ability to sustain any business depends upon its strategic stakeholders, it is simple good common sense for directors to establish processes for obtaining information from such people and to establish their long term commitment, support and cooperation.

 

2.1.2 To obtain the will to act, directors need to hold their board positions independently of those whose interest they may need to act against to further the interests of the company as a whole.  The membership of boards is commonly self-perpetuating.  This makes it difficult for any one individual to act against the collective self-interest of the board to maintain their self-serving and self-perpetuating power, status and privileges as listed in Table 3.

 

The method of electing directors is commonly controlled by the directors or by the chairperson.  This makes any individual director vulnerable to retirement if she is not a “good team player”.  The will to act independently can be encouraged by directors being elected by preferential voting.  This also protects minority interests as it allows them to be represented to protect them from being exploited by any “control group”. 

 

A form of preferential voting, which is mandated in some states in the USA, is described as “cumulative voting” (Bhagat & Brickley 1984, Dallas 1992, Gordon 1993).  Under this system, all directors are elected each year with each share obtaining as many votes as there are vacancies on the board.  Shareholders can then distribute their votes amongst the directors of their choosing.  If there are ten positions to be filled then each share has ten votes and a 10% shareholder can accumulate sufficient votes to ensure that at least one director of their choice is elected.  In this way minority interests can obtain some protection from what Hailsham (1978: 125) described as “elected dictatorship”.  Cumulative voting avoids boards becoming poorly accountable when they use the various powers listed in section B of Table 3 to make themselves self-perpetuating.

 

2.1.3 To obtain the capability to act, directors need a process to prevent unethical and/or counter productive practices before they occur.  In Anglophile countries directors are faced with the option of resigning and allowing undesirable activities to continue, or ignoring them as a “good team player”.  Regulators are of little help to prevent a problem arising.  Regulators normally take the position that they will only become involved once it is evident that “the horse has bolted”.  To close the stable door before hand, a director needs to obtain either a board majority to support preventive or corrective action or a watchdog board to veto the matter. 

 

Watchdog boards, described as “Cour des Comptes” are mandated in France for government owned firms (Analytica 1992: 104).  Financial institutions in France have watchdog boards described as “Censeurs” (Analytica 1992: 107).  Similar types of watchdog boards are mandated for cooperatives in Spain as found in the Mondragón Corporacion Cooperativa (MCC) described by Turnbull (1995).  The author has introduced watchdog boards to Australia in two start-up enterprises he formed to reduce the cost of raising high-risk funds.  They also and protected his reputation as a professional company promoter (Turnbull 1992b, 1993, 2000a).

 

Watchdog boards have limited roles.  Their main role is to avoid the situation of directors setting, marking and reporting on their own exam papers.  This can occur because directors establish their own profit objectives and have considerable discretions under accepted accounting standards to determine the reported profit as discussed by Bazerman, Morgan & Loewenstein (1997).  Their findings support the view of Tricker (1994: 246) that directors are in the position of “marking their own exam papers”.

 

The watchdog boards that were established by the author mediated any conflicts of interest, including those commonly managed by the audit, remuneration and nomination committees.  In one situation the watchdog board also had the power to stop the author and his co-directors from over-borrowing by having the name of the watchdog board chairman on the title deed of the land owned by the business.

 

2.2     Lack of independent feedback information on performance

A fundamental flaw in the Anglo system of corporate governance is that directors can be given the “mushroom” treatment by management.  That is, they are kept in the dark and given informational manure.  There are two reasons for this state of affairs.  Firstly, in Anglo countries, institutional investors, who in aggregate may typically hold a majority of the shares in publicly traded companies, do not have any firm specific knowledge or authority to provide meaningful oversight, alternative intelligence or assistance to the directors. 

 

Secondly, the unitary board structure in Anglo countries means that directors become largely captive to the information provided by management.  Compare this situation with that of a company in a Japanese keiretsu as illustrated in Figure 1, ‘Anglo unitary control compared with Japanese distributed control’.  Figure 1 illustrates Japanese diversified stakeholder ownership, which is created by firms issuing shares to their supplier and customer corporations to consolidate their relationships with them.  The chief executive officers (CEOs) of these strategic stakeholder companies meet once a month, or even once a week to discuss operations.

 

The feedback information that these CEOs obtain from their subordinates provides the other side of the storey of any operational problems in the procurement or marketing of goods and services.  The resolution of any problems or shortcomings in the quality or terms of trade can be crucial in obtaining competitive advantages.  News of problems may not be reported or be reported slowly, by subordinates, especially when they think management could regard the problems as reflecting on their own performance.  It is a case of subordinates fearing that managers may “shoot the messenger”.  By providing access to both sides of the story, a keiretsu council is more likely to hear about problems, which might not otherwise be identified.  As a keiretsu council meets frequently, problems can be both identified and corrected expeditiously.  Formal communication between suppliers and customers also allows both parties to contribute to resolving problems and developing cooperative relationships for increasing efficiencies.

 

Figure 1, Anglo unitary control compared with Japanese distributed control

(Anglo investor ownership compared with Japanese diversified stakeholder ownership)

 

 

Without a self-correcting feedback information from informed and committed diversified stakeholders as illustrated in Figure 1, a firm governed by a unitary board is subjected to jeopardy from a lack of information or self serving biased information on its operational performance.  This is a common problem in all public and private sector command and control hierarchies. 

 

Without independent qualitative and quantitative feedback information, directors of a unitary board do not have a creditable basis to direct, monitor, control, remunerate or change management or undertake a SWOT analysis of the business.  In such situations there remains little operational reasons for a firm to possess a board.  In the larger companies the role of the board becomes one of  providing privileges of power, status and influence and maintaining these by distributing such benefits to those who support the self-perpetuation of the practice.  However, Bhaghat & Black (1998) provided evidence that the value of external directors was to influence or capture regulators.  Also, to allow CEO’s to spread the blame when performance declined.

 

2.3     Loss of information and bias

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 very best of intentions.  When these people are in a management hierarchy, it is rarely in their self-interest to report to a superior, information that may reflect adversely on their own performance.  This provides an incentive for biases, distortions and omissions in communications.  The need to interpret information sent down a chain of command and condense information reported back up increases the problems of control and monitoring.  These problems are common to hierarchies in both the private and public sectors.  They have been analysed by Downs (1967: 116–8) and illustrated along the lines shown below in Table 4 ‘Loss and distortion of information in a hierarchy’.

 

Table 4, Loss and distortion of information in a hierarchy

 

HIERARCHY

INFORMATION UPWARDS

EMPLOYEES

(public or private sector)

Volume

Correct

Missing

(span of 5)

Legislature

(50% lost/

(85% of

or wrong

per

accumulated

Minister/shareholder(s)

level)

lower level)

meaning

level

total

Board of directors

3.1%

1.4%

98.6%

 

 

Chief Executive Officer

6.3%

3.3%

96.7%

1

1

Senior management

12.5%

7.7%

92.3%

5

6

Middle management

25.0%

18.1%

81.9%

25

31

Team leaders

50.0%

42.5%

57.5%

125

156

Workers

100.0%

100.00%

0.0%

625

781

 

Downs assumed that the biases of officials resulted in 10% 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 lost from errors in transmission.  The loss of meaning and errors reduced the correct information by 15% per level.  Correct information would only represent 85% of that which was condensed by 50% at each level.  The cumulative compounding result in a hierarchy of five levels each with a five person span of control is shown in the "correct" and "missing" columns of Table 4.  The table highlights the possibility that even the chief executive officer (CEO) may not have the information required to regulate the organisation and illustrates the point made by Jensen (1993: 864) that, "Serious information problems limit the effectiveness of board members in the typical large corporation".

 

2.4     Information overload

It was to avoid information errors and overload that large US firms in the beginning of the 20th century changed from Unitary (U) form structures to Multi-divisional (M) form as discussed by Williamson (1985: 279–283).  Williamson (1985: 283) states that, “The problem of organization is precisely one of decomposing the enterprise in efficient information processing respects” and quotes Marschak & Radner (1972) and Geanakoplos & Milgrom (1984).  Williamson (1985: 282) recognised the cybernetic significance of technical and temporal specialisation of organisational information by quoting the work of Ashby (1960) and Simon (1962) who were pioneering scholars in developing the science of information and control described as cybernetics.

 

The science of cybernetics was established in the middle of the 20th century when Weiner coined the word.  Weiner (1948) defined cybernetics as “the study of information and control in animal and machine”.  Beer (1959, 1966, 1985, 1995a,b,c) pioneered the extension of cybernetics to management and the author[2] has been extending the application of cybernetic principles to the governance of organisations (Turnbull 1997d,e). 

 

All information has some physical form with its quanta measured in bits with eight bits described as a byte (Kurzweil 1999: 299).  The rate at which individuals can receive, process and transmit bytes is indicated in Table 5, ‘Human constraints in transacting bytes’.  The table shows that humans mainly receive information in the form of sight and sound.  However, the fastest rate at which individuals can transmit bytes is limited to speech and movement and so is around 10,000 times slower. 

 

Table 5, Human constraints in transacting bytes

 

(K= Kilobytes, M=Megabytes)

 

INPUT CHANNELS

Smell

Taste

Touch

Sound

Sight

CONSTRAINTS IN HUMANS TO TRANSACT BYTES CREATED BY:

Channel capacity in bytes/seca

 

<10

 

<15

 

<15

 

100K

 

1,000M

 

 

 

 

NATURE

OF

TRANS-ACTING BYTES

IN

HUMANS

1

RECEPTION through organs

Physiology

2

STORAGE through nervous system

Physiology

 

3

PERCEPTION/UNDERSTANDING through the activation and strengthening of neural networks which correlate current patterns with previous ones

Neurology, experience, training, motivation and psychological status

 

4

 

INSIGHTS/KNOWLEDGE through sequential processing in neo-cortex limited to around 200 calculations per second (Kurzweil 1999: 103)

As above plus size and architecture of neo-cortex and psychological status

 

5

 

EXTERNAL RESPONSES transmitted by movement and vocal chords

Proximity/distance, environmental conditions, culture, literacy & numeracy

OUTPUT CHANNELS

Touch

Signs

Writing

Sound

Speech

Information can be received 10,000 faster than the rate at which it can be transmitted

Channel capacity in bytes/sec

 

<15

 

<15

 

<15

 

<100K

 

<100K

aSources of channel capacity; Cochrane (1997, 2000)

 

In referring to the speed at which the human brain can process information, Kurzweil (1999: 103) states that, “a profound weakness, is the excruciatingly slow speed of neural circuitry, only 200 calculations per second”.  This compares with the hundreds of millions of sequential calculations per second (megahertz) of a desktop computer in 1999.  The need to limit the “span of control” of managers to between around five to ten people is a simple example of the need to design organisations to meet the limited ability of individuals to process bytes and manage complexity.

 

The limited ability of individuals to receive, internally transact and transmit bytes shown in Table 5 must necessarily limit the ability of individuals to communicate and process data, information, knowledge and wisdom.  This is because data is composed of bytes.  Information is meaningful data and so likewise is composed of bytes but requires more bytes to provide meaning.  Knowledge is useful information and so is also composed of bytes and likewise requires more bytes to determine usefulness.  Wisdom is in turn depends upon how knowledge is applied and so requires many more bytes to relate present situations to those in the past to compare how the application of knowledge may affect outcomes.

 

Beside the physiological limitations in transacting bytes, there are neurological limits.  These are described in the micro-economic literature as “bounded rationality”.  The term 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 individuals human beings are limited in knowledge, foresight, skill, and time that organizations are useful instruments for the achievement of human purpose” quoting Simon (1957: 199).

 

Williamson (1975: 140) noted that, "Imitation of the M–form innovation was at first rather slow" and that "prior to 1968, most European companies administered their domestic operations through U–form or holding company internal structures".  However, there was less need for large European firms to adopt M–form architecture because decomposition in their decision making was an inherent feature of their possessing multiple boards, described in the next section.

 

3.0       Distributed control

This section outlines the presence of compound boards throughout the world and considers their operations.  The ability of a compound board to decompose decision-making labour to allow ordinary people to achieve extraordinary results is examined by analysing the operation of an industrial cooperative in Mondragón.

 

3.1     Anglophile countries

Firms governed by more than one board are commonly found throughout the world, even in Anglophile countries where a unitary board is almost universally adopted.  Even in the USA around 20% of the Fortune 500 largest companies have a compound board.  This is because they are controlled by a dominant shareholder/investor (Zey, 1999) who acts like a supervisory board.  In some cases like Microsoft and News Limited, the dominant shareholder may also be on the operating board. 

 

The presence of an influential active shareholder can simplify decision making labour by managing the most contentious decisions which involve the inherent conflicts of interest in a unitary board such as listed in Table 3.  However, if the influential shareholder has related party dealings with the business, then some other types of decision making may be simplified because the directors are not encouraged to consider any course of action, which is not in the self-interest of the dominant shareholder!  This reinforces the need for an independent watchdog board.

 

Compound boards are prevalent in most Anglophile countries (La Porta, Lopez-de-Silanes & Shleifer, 1999).  In many countries the dominant shareholders is a multinational corporation, which has established a local publicly traded affiliate.  In emerging economies the dominant shareholder is typically the founding entrepreneur.  In the more developed economies, second or higher generation descendants and their families are the dominant shareholder.  The Berle & Means (1932) stereotype of publicly traded corporations being widely owned represents a minority in most countries of the world.  This also applies to the most industrialised countries of continental Europe (Brecht & Roell 1999, ECGN 1997, Bianchi, Bianco & Enriques 1999) and in Japan (Analytica 1992) where cross and block shareholdings predominate.

 

Compounds boards are also commonly found in firms not publicly traded in Anglophile countries.  Non-trivial employee owned firms have more than one board to create a division of power and checks and balances required to sustain them as analysed by Bernstein (1980).  However, the most common examples of compound boards in Anglophile countries are in start up firms where a shareholder’s agreement establishes supervisory powers for the venture capitalist.  Compound boards are created with leverage management buy-outs (LBOs) when an association of investors supervises the operating board of employees.  Jensen (1993: 869) noted that such arrangement provided “a proven model of governance structure”.  However, the existence of compound boards is not generally recognised by scholars.  Kuhn, (1970: 24) explains this because “normal science” does not "call forth new sorts of phenomena: indeed those that will not fit the box are often not seen at all".

 

3.2     Non Anglophile countries

Unlike in England, where firms evolved under civil law in the 17th century, firms in continental Europe evolved under common law.  To avoid personal liable to creditors, lead investors did not become involved in management.  Instead they formed a supervisory board who appointed the managers who incurred personal liabilities through the purchase of goods and services.  To protect managers form personal liability, the deed of formation specified that the firm would be dissolved if its equity was impaired by a specified amount. 

 

The managers formed an executive board who carried out the day to day operations while the supervisory board concerned itself with what would be described today as strategic issues.  The decomposition of decision making labour being somewhat along the lines of the multi-divisional (M–form) firms which developed in the USA during the early 20th century.  The separation of many of the decision making powers in European firms with a supervisory board being defined in the corporate charter and/or the law (Analytica 1992: 82, 86, 101)

 

The simple two tiered supervisory board system is found in Holland and in some of its former colonies like Indonesia.  In Germany, half the members of the supervisory board in the larger companies are employee representatives (Analytica 1992: 87).  German companies also establish a works council (Analytica 1992: 82).  In France, employees are not found on supervisory boards.  However, there may be a third tier board created to carry out “watchdog” functions for shareholders as noted in Section 2.1.3.

 

A third tier watchdog board is also mandated for cooperatives in Spain (Whyte & Whyte 1988: 37).  The cooperatives located around the Basque town of Mondragón have introduced a fourth tier of control described as a “Social Council” (Whyte & Whyte 1988: 38) as shown in Figure 2, ‘Information and control architecture of Mondragón cooperatives’.  The Social Council determines relative wage levels, safety, other working conditions and welfare issues.  In this way it greatly simplifies the role of management and the CEO by removing one of the most important and contentious items from the function of managers. 

 

The Social Council is made up of a delegate from each work group of 10 to 20 people and meets once a quarter.  It reports to both the management board and the supervisory board.  Mondragón firms limit their size to 500 employees[3], which limits the size of the Social Council.  All the employees meet once a year as a General Assembly to appoint members of the supervisory board who appoint the managers who cannot be on the supervisory board.  The General Assembly also appoints a three person Watchdog Council, which has wider powers than an audit committee as it monitors the integrity of the governing processes.  It may call for outside assistance from the group banker who is owned by all the primary cooperatives in the Mondragón Corporacion Cooperativa (MCC) or from the management of the group in which the firm is a member (Turnbull 1995).

 

Thomas & Logan (1982: 109) have shown that "the cooperatives are more efficient than many private enterprises" and "there can be no doubt that the cooperatives have been more profitable than capitalist enterprises".  Mondragón demonstrates how the complexity of modern business can be decomposed into simpler units to allow ordinary people, with little or no management education, to achieve extraordinary results.  The way in which a Mondragón compound board decomposes the function and activities of a unitary board into its component parts is illustrated in Figure 3, ‘Function and activities of a unitary board’ and Figure 4, ‘Functions and activities Mondragón compound board’ respectively.

 

Figure 3, Functions and activities of a unitary board

 

(Source: Tricker 1994: 245 & 287)

 

 

Conformance functions

Performance functions

 

 

External

Accountability

• Reporting to shareholders

• Ensuring statutes regulatory compliance

• Reviewing audit reports

Strategic thinking

• Reviewing and initiating strategic analysis

• Formulating strategy

• Setting corporate direction

 

_____________

Appointment and rewarding chief executive

_____________

 

 

Internal

Supervision

• Reviewing key executive performance

• Reviewing business results

• Monitoring budgetary control and corrective actions

Corporate policy

• Approving budgets

• Determining compensation policy for senior executives

• Creating corporate culture

 

Short term

Long term

 

The functions and activities of a unitary board are divided into five components in the typology presented by Tricker (1994: 245 & 287) in Figure 3.  Figure 4 illustrates how each of these functions and activities are approximately allocated to the five components of a compound board of a Mondragón industrial cooperative prepared by the author based on the information of Whyte & Whyte (1988).  Table 6, ‘Mondragón compound board compared with unitary board’, compares the functions and activities set out in Figures 3 and 4.

 

Figure 4, Functions and activities of Mondragón compound board

 

(Information source: Whyte & Whyte 1988)

 

 

External

 

 

Watchdog Council

(Invites external intervention by bank and/or Group)

 

Supervisory Board

(Strategic stakeholders appoint & direct management board)

 

_____________

Management board

(Allocates resources)

_____________

 

Internal

 

Work unit

(Production & appoint

delegates to Social Council)

Social Council

(Working conditions, pay relativities and welfare)

 

Short term

Long term

 

 

Table 6, Mondragón compound board compared with unitary board

 

(Degrees of decomposition of information processing labour indicated by allocations of "X")

Board typeÞ

Mondragón compound board

Anglo

Control centres1

Watchdog Council

Supervisory board

Management board

Social Council

Work

group

Unitary board

Individuals:

3

5-8

4-6

~5-25

~10-20

~4-12

Function2

Governance processes

Appoint Mgt. board

Organise operations

Worker welfare

Production

Elect Soc.C.

Manage

Activities

 Efficacy & integrity of processes

Integrate strategic stakeholders

Efficient allocation of resources

Establish working conditions

Job organisation & evaluation

Direct & control

Internal2

X

 

X

X

X

XXXX

External2

X

X

 

 

 

XX

Short term2

X

 

X

 

X

XXX

Long term2

 

X

 

X

 

XX

1Omits the General Assembly, which elects Watchdog Council, and Supervisory board.

2Descriptions follows typology of Tricker (1994: 244 & 287)

 

The purpose of Table 6 is to indicate, in a very approximate way, how the number of bytes, which have to be processed by each individual member of a Mondragón compound board, is but a fraction of the number which directors of unitary board have to deal with.  The reduction is achieved by spreading the functions and activities of a unitary board over the five components a Mondragón compound board.  Each activity of a unitary board undertaken by a component of Mondragón board is marked with an “X”.  Only the Watchdog Council has three X’s, all the other components only have two.  In comparison, the workload of a unitary board is considerably greater with an aggregate of eleven X’s.  While only indicative, the analysis does illustrate how compound boards can make a significant contribution in decomposing decision-making labour to reduce information overload and “bounded rationality” (Simon 1961: xxiv).

 

Another advantage of a Mondragón compound board is that it allows all employees to participate in decision making as every employee is a member of a work group and each has the opportunity to be appointed or elected to the other control centres.  In this way a compound board allows greater participation in decision making which can lead to improve knowledge and motivation.  A compound board also provides a way of constructively involving the participation of strategic stakeholders as found in some “hybrid” Mondragón cooperatives detailed in the Appendix of Turnbull (1995: 178–9).  These illustrate both distributed and diversified control.  However, their equity is not negotiable and only redeemable by their employees.

 

There are some variations in the architecture Mondragón cooperatives.  For example, the retail store has a supervisory board made up of equal numbers of customer and employee representatives with the chair being a customer appointee.  The student work experience cooperative has a supervisory board with equal numbers of student, staff and parents.  Secondary cooperatives, like the bank, the R&D cooperative and the social security cooperative have supervisory boards with half the members representing employees and the other half representing respectively, borrowers of the bank, users of R&D and contributors to social security. 

 

The pig-farming cooperative has elements of a stakeholder mutual in that it has formal channels to provide feedback and control information from its strategic stakeholders.  It has representatives on its supervisory board in proportion to the value added by each of the four strategic stakeholders.  These are the employees of the pig processing business, contract pig farmers, customer (retail store) and suppliers of feed, equipment and veterinary services.

 

A Japanese keiretsu also has elements of a stakeholder mutual in that there are formal channels of information feedback and control from strategic stakeholders.  As indicated in Figure 1, a producer firm issues some of its shares to suppliers and customers to formalise its association with them.  The CEOs of the supplier and customer firms with those of the lead banker and/or trading house servicing all members meet as the kerietsu council.  While the suppliers and customers may have only a minor equity interest, any concerns and/or suggestions they may have to improve operations are shared by the major shareholders such as the bank and/or trading company. So while stakeholder constituencies may not have formal power to initiate change, they can play a pivotal role in improving operations without introducing diverse accountability that concern the critics of stakeholder governance such as Jensen (2000), Sternberg (1997) and Pejovitch (1990).  The involvement of stakeholders explains the recommendations by Porter (1992: 16–7) to corporations in the USA to include employees, customers, suppliers and members of their host community in their ownership and control.

 

The competitiveness and even sustainability of a firm can be jeopardised by the loss and distortion of information in its command and control hierarchy as indicated in Table 4.  Any deficiencies in operations in a keiretsu firm which is not quickly, accurately or fully reported up its hierarchy may be reported up the chain of command in the supplier or customer firm.  Employees in the supplier and customers chain of command have an incentive to report other peoples problems, while employees in the producer firm have a disincentive to report problems in units under their control.  Both chains of command could contribute to some problems, but in this situation separate reporting to the keiretsu council allows both sides of the story to be considered.

 

It is in this way that a compound board, representing separate constituencies, can facilitate the establishment of a “loyal opposition” to management.  It provides a basis to formally recognise the symbiotic interdependency of suppliers, producers and customers and their different needs and viewpoints.  It also illustrates the relevance of Shannon’s law used to improve communications in non-human systems as considered in the next section. 

 

Another advantage of distributed communication and control systems of a compound board is that by sharing information, power is shared.  The sharing of power and the resulting need to establish “power coalitions” (Dallas 1988: 34) and so interdependency, provides a rational basis for developing trust to facilitate greater openness and “richness” (Daft & Lengel 1984) in communications.  This explains the advantage of non-market and non-hierarchical systems of governance identified by Hollingsworth & Lindberg, (1985: 221/2) but neglected by economists and corporate governance scholars.  An exception is Wruck & Jensen (1994) referred to in the next section.

 

The development of trust in turn provides a way to reduce transaction costs, which can arise from the problems identified by Akerlof (1970).  As pointed out by Dallas (1988: 80), “It is better to have a number of constituencies present on the board rather than one, namely management.  Each constituency can then keep the others in check”.  This insight explains how a stakeholder mutual firm can introduce self-regulation to provide the basis for reducing the role of government regulation to protect employees, suppliers and consumers.  It also provides criteria for designing the information and control architecture of a stakeholder mutual firm as considered in the following sub-section.

 

4.0     Stakeholder mutual firm

The introduction of feedback information and control from strategic stakeholders could be introduced for firms publicly traded, family or government owned without changing their ownership.  However, the analysis of this paper is focused on distributed control with distributed and dispersed ownership.  How this situation might be introduced to create stakeholder mutual firms is next considered.

 

Privatisation provides one way of introducing stakeholder mutual firms.  Property rights in the firm could be transferred from the government to the strategic stakeholders according to the value of their services and/or purchases.  In this way ownership could be immediately or gradually transferred from the government.  It could be achieved in somewhat a similar manner to coupon privatisation but where only strategic stakeholders obtained the coupons/property rights.  However, this approach would deny revenues to the government from selling the business through the stock exchange and/or to a trade buyer. 

 

To avoid governments loosing revenue, the conversion to a stakeholder mutual could occur after the investment time horizon for the initial investors.  Private investors have financed many infrastructure projects on this basis described as (BOOT) schemes.  A BOOT scheme requires a firm to (B)uild an infrastructure facility, (O)wn and (O)perate it for a stipulated period of time and then (T)ransfer it free of charge back to the government authority at the end of the period.  However, to create a stakeholder mutual, the free transfer would be to the strategic stakeholders.  The allocation of ownership and control rights could be on the basis of the market value of their contribution to the value of their services or custom.  These arrangements create an Ownership Transfer Corporation (OTC) described by Turnbull (1975, 1991,1992a, 1994b, 1997d, 1998).

 

Strategic stakeholders replace investors and so can be described as “deferred residual claimants”.  In this way stakeholder mutuals meet the criteria of Jensen (2000: 16) for “enlightened stakeholder theory” by adding “the simple specification that the objective function of the firm is to maximize total long-term value”.  However, as stakeholders are not required to invest any of their cashflow to acquire ownership they are not subjected to an “opportunity cost” to provide them a basis to discount the value of future ownership.  This allows the present value of stakeholder residual claimants to be valued at ten or more times higher than that of the investors who are subjected to discounting over their time horizon.

 

The free transfer of equity to stakeholders of publicly traded or family businesses could be encouraged with tax incentives which increased the present value of equity for owners who transferred long term ownership to stakeholders.  The size of the tax incentive for owners to increase their profits by giving away a small amount of ownership each year could be quite small (Turnbull 1975, 1997d, 1998).  This is because the value of money in the future discounted for risk and uncertainty diminishes at compounding rate.  Equity discount rates are typically over 20% and can exceed 40%.  The value of the one time benefit that is required today for an investor give up 100% ownership after 15 years is 6.5% of current after tax profits with a 20% discount rate.  If investors have a 30% opportunity rate the one time tax incentive to offset the value of all profits after 15 years only needs to increase profits by 2% in the first year (Turnbull 1997d: 19).  No tax incentive was used by the UK government to attract investors to privatise water supply facilities with a 15 year operating licence and the government retained the right to replace a licensee on ten years notice without compensation (OFWAT 1995).

 

The loss in government revenues from the tax incentive can be more than offset from increases in revenues from the tax base transferring from corporations to individual stakeholders who are likely to pay tax at a higher rate and/or reduce welfare entitlements.  In this regard it assumed that only resident individuals on the electoral rolls qualify for free equity in stakeholder mutual firms.  Any free equity entitlements accruing to corporations as strategic stakeholders would need to pass through to their employees. 

 

Many start up companies dilute investors ownership interests by share issues to employees with or without a tax incentive.  The introduction of stakeholder ownership and control interests can provide benefits to investors to offset gradual dilution of the investor’s equity without tax incentives.  In a number of countries such as the USA, UK and Australia there are already tax incentives to encourage employee ownership and as a result the degree of investor ownership is decreasing in even the largest publicly traded companies.  As a result, the aggregate of employee ownership is increasingly making them one of the largest shareholders.  In some companies employees have collectively become the largest owners.  This illustrates how the process of ownership transfer is already taking place, but only to employees rather than being shared with other stakeholders.

 

Excess employee ownership can introduce counter productive results with a unitary board because of its absolute power to manage its own conflicts of interest as noted earlier.  The experience with privatisation in Russia clearly demonstrates this problem as documented by Black, Kraakman & Taraossova (1999), Fox & Heller (1999) and Megginson & Netter (2000). 

 

The solution is a division of power as suggested by Dallas (1988: 80) and supported by the empirical evidence of Bernstein (1980).  Bernstein surveyed employee ownership around the world and did not report one firm that did not have a compound board.  Bernstein (1980: 116) identified six fundamental conditions for successful employee ownership: (i) participation in decision making; (ii) economic return to the participants based on the surplus they produce; (iii) sharing management-level information with employees; (iv) guaranteed individual rights; (v) an independent appeals system and (vi) a complex participatory/democratic consciousness.  Items (iv) and (v) require a division of power and so a compound board if external agents are not to become involved.  As illustrated by Mondragón firms, a compound board provides a way to meet conditions (i) and (iii).  The above considerations support the view that a compound board is a condition precedent for employee control to be maintained on a sustainable competitive basis (Turnbull 2000b). 

 

The sharing of employee control with customers and suppliers, including the host community providing infrastructure services introduces additional checks and balances on employee appropriation of value.  Conversely, excessive appropriation of value by other stakeholders is countered by employee participation in control.  A stakeholder mutual with at least three independent classes of strategic stakeholders provides a basis for introducing competition for corporate control through the board room rather than the much more expensive and problematical competition for control through the stock market for publicly traded companies. 

 

Persson, Roland, & Tabellini (1996) and Diermeier & Myerson, (1999) have shown how an appropriate division of power can increase the welfare of all stakeholders.  A stakeholder mutual with an appropriate division of power provides a firmer basis for introducing what Pound (1993) described as the “political model of governance” than relying only on investors to create competition for corporate control.  Pound (1992: 83) states,“this new form 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 1980s”.  The success of the political approach to corporate governance is illustrated by all the employee owned firms surveyed by Bernstein, Mondragón firms and VISA International all not being publicly traded.  The founding CEO of VISA explains that it, "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).  None of the firms mentioned above are publicly traded and they all have compound boards.

 

However, this does not mean that a stakeholder mutual cannot be publicly traded.  It just supports the view that firms do not have to be publicly traded to be efficient and internationally competitive.  The conversion of a publicly traded company to a stakeholder mutual would require the firm to be publicly traded during the transition period.  Trading in stakeholder shares could also continue after the transition, which may involve ten or more years.  There are various ways in which stakeholder mutual firms could be formed.  A ten-year period could be practical for publicly traded companies with appropriate tax incentives or for a privatisation process using a BOOT concept.  If no tax incentive were provided, then a ten-year transfer holiday would provide investors with sufficient time to recover their costs and obtain competitive returns before their interest was diluted out over the following ten years.  This longer transfer period is used in Figure 5, ‘Stakeholder mutual information and control architecture’, which illustrate how competition for corporate control can be introduced through a division of power introduced by a compound board.

 

The bottom section of Figure 5 replicates the architecture of a Mondragón firm.  Participation by strategic stakeholders is introduced through customer forums and supplier assemblies.  There may be a number of these reflecting different goods and services and/or geographic locations.  Larger firms like The John Lewis Partnership in the UK, with over 40,000 employees, follow this practice for their employees by establishing branch councils in each location (Gazette 1994). 

 

The customer forums provide a basis for developing and sustaining total quality management (TQM), while the supplier assemblies provide a basis for developing and sustaining just in time (JIT) delivery of goods or services.  This provides another practical way in which stakeholder participation can add value to improve the competitive standing of a firm.  Wruck & Jensen (1994: 248) define TQM "as a science-based, non-hierarchical and non-market-oriented organizing technology that increases efficiency and quality." 

 

 

 

The customer/user forums, supplier assemblies, employees’ council and community committee appoint delegates to a stakeholder council shown on the right hand side of Figure 5.  The stakeholder council is in the position to carry out the role of keiretsu council in providing feedback information to both management and shareholders on the operations of the business and the quality of management.  A stakeholder council creates a systemic process to inform directors on the business SWOT independently of management who may be part of the problem.  The council can also provide an informed and knowledgeable evaluation, to the directors, on the quality of management.  Likewise, stakeholder councils are in the best position to carry out director and board evaluation on behalf of the investors. 

 

The self-interest and commitment to the business by stakeholders provides the incentive for them to contribute their services without payment.  There are a number of examples cited by Givens (1991) of utility company customers in the USA donating money to improve the operations of their supplier.  It is significant to note that such contributions, which fund the establishment of Citizen Utility Boards (CUBs), may typically involve only 2 or 3% of all customers.  This provides a free ride for the other 97% or so providing an example of altruism but not irrationality as the benefit to all customers can be sufficient to repay those who do make a contribution.  However, as deferred residual claimants, all strategic stakeholders obtain an incentive to contribute to maximising long-term value of the enterprise to a greater extent than most investors who are not unlikely to have firm specific knowledge unless they are also a strategic stakeholder.

 

The establishment of a formal and rich feedback information system with clients also provides competitive advantages in developing new products and processes.  Hippel (1986) reported that over 80% of product innovations originate from users rather than the research and development department of the larger firms.  Innovations developed by users reduce both risks and costs to producers in product development.  Stakeholder councils provide a forum for identifying and collaborating with "lead users" as described by Hippel.

 

Stakeholders do not have the power to elect directors, or members of the watchdog committee, described in Figure 5 as a “Corporate Senate” (Turnbull 1992b, 1993) to protect the interest of all shareholders and mediate board conflicts of interest.  This arrangement prevents stakeholders compromising the duty of directors and senators to act in the best interest of shareholders as whole in way that concerned Pejovich (1990), Sternberg (1997) and Jensen (2000).  Pejovich (1990: 69) was concerned that “co-determination” and “industrial democracy” are “code words for wealth transfers” which undermine the property rights of shareholders.  However, wealth transfer could be an explicit objective of tax and other incentives used to introduce stakeholder mutuals.

 

The compound board created by the arrangements shown in Figure 5 meets the recommendation of Williamson (1985: 308) that if stakeholders are involved at all then they should be “restricted to informational participation”.  The compound board of Figure 5 illustrates the statement of Williamson (1985: 305) that the “possibility is to invent a governance structure that holders of equity recognise as a safeguard against expropriation and egregious mismanagement.”

 

A compound board introduces a new approach to corporate governance.  It provides a constructive way to introduce the recommendation to policy makers by Porter (1992: 16) to “encourage board representation by significant customers, suppliers, financial advisers, employee, and community representatives”.  Porter (1992: 17) also recommended to corporations to “nominate significant owners, customers, suppliers, employees, and community representatives to the board directors”.  However, as noted by Williamson above, that the recommendation of Porter would become counter productive with a unitary board by introducing unacceptable conflicts of interests. 

 

Porter made his recommendation after investigating the competitive advantages of firms in Japan and Germany.  Both countries have institutional arrangements, which provide rich feedback information from customers, suppliers and the host communities to improve the quality of goods, services, working conditions and health of the firm.  In this way directors obtain information independent of management as discussed earlier in section 2.1.1.  However, the analysis made by Porter neglected the compound board structure found in Japan and Germany.  It illustrates Kuhn’s (1970: 24) observation on phenomena that “will not fit the box are often not seen at all”.  However, once this shortcoming is understood, the Porter analysis still explains and supports the competitive advantage of a stakeholder mutual form of firm.

 

In Figure 5, provision is made for community representatives to also participate in the governance of a stakeholder mutual.  Community representatives participate in the Stakeholder Council with those representing suppliers, employees and customers.  The chair of the Stakeholder Council chairs the Board of Directors and the chair of the Community Committee chairs the Corporate Senate.  In each case, to protect the integrity of the property rights of investors, the chair does not have a deliberate vote only a casting vote when there is a tied vote. 

 

The accepted traditional role of a chair of a meeting is to mediate discussion and debate without taking sides or becoming involved in any discussion.  Shackleton (1973: 22) states, “A chairman should never seek to express his own views at a meeting, unless requested by the meeting to do so, except upon a point of procedure”.  Renton (1979: 37) points out that it would unethical to do so and that “justice must not only be done but seen to be done”.  However, the accepted traditional role of chairpersons at shareholder meetings is generally ignored with the chair taking on the role of leader, advocate and defender of board resolutions as well a controlling the conduct of both director and stockholders meetings. 

 

In Anglophile companies it is common for the corporate charter to not only give the chair sole discretion on how meetings are conducted and state that no appeal to her ruling will be considered, but to also provide the chair with the power to determine the process for electing directors.  This gives the chair power to decide which colleagues maintain their position on the board and so can make all directors beholden to the grace and favour of the chair.  This concentration of power allows the chairperson to run general meetings in a manner that in practice shields any or all the directors from becoming accountable to investors. 

 

When management has control of the proxy votes, this turns general meetings into a charade to allow managers to self-perpetuate their own agendas.  In the words of Williamson (1985: 313), “managers apparently write their own contracts with one hand and sign them with the other”.  It allows directors to set, mark and report on their own exam papers.  It explains how excessive remuneration is paid to executives sometimes in the form of shares which requires shareholder approval (Bertrand & Mullainathan 2000).  It also explains how auditors who are supposed to represent shareholders and protect investors are compromised to give the benefit of any doubt to managers to maintain their appointment and fee income.  Audit reports become part of an officially protected institutional charade (Bazerman, Morgan & Loewenstein 1997).

 

The reason for this unethical state of affairs is because company directors instruct lawyers on how to write corporate constitutions.  It is in the self-interest of directors to maximise their power and discretions.  In a stakeholder mutual, the chair would not be a leader or be accountable for the performance of the company, only her performance in effectively and efficiently conducting meetings with impartiality.  Knowledge of the business would not be required by the chair, only on how to chair meetings fairly and effectively.  The job specifications of the chairperson, directors and the executive board of a stakeholder mutual would be quite different and simpler than those of a firm with a unitary board.

 

The presence of an independent chair also provides a basis for directors to be subject to creditable evaluation by the chair.  Self-evaluation by directors of themselves is just not creditable.  However, unitary boards are increasingly undertaking self-evaluation to head off suggestions that there should be a shareholders committee or some other board to undertake this task on a much more rigorous basis.  It allows boards to use the rhetoric that they are already subject to professional evaluation processes.  Senator Murray (1998) proposed in the Australian Parliament, that all publicly traded companies be required to establish a corporate governance board (CGB) modelled on the Corporate Senate established by the author.

 

A Corporate Senate was established under the Anglophile Corporation’s law of Australia in 1987.  It was created to reduce the cost of raising high-risk funds from investors in the USA and Australia while also protecting the reputations of the directors of a start up business established by the author (Turnbull 1992b, 1993, 2000a).  It achieved its objective by obtaining veto rights over any proposals of the directors in which they had a conflict of interest as listed in Table 3 or any other conflicts as may be brought to the notice of Senators by board members elected by cumulative voting.

 

The Senate had three members elected on the same basis as on a show of hands at an Annual General Meeting of stockholders or a cooperative with each shareholder having one vote.  In this way the Senators could be elected independently of any parent company or control group to provide them with the “will to act” as discussed in section 2.1.2.  Directors were elected by cumulative voting (Bhagat & Brickley. 1984, Gordon 1993) with one vote per share for every board vacancy.  This allowed minority shareholders to appoint a director to provide her with the will to act against a control group.  A director could act privately by reporting to the Senate any arrangements, which favoured the control group over minority interests and so become subject to the veto power of the Senate.  In this way directors obtained the capability to act as discussed in section 2.1.3.

 

Directors could overturn a Senate veto by calling a general meeting of stockholders and obtaining approval with a 50% majority on a one-vote per share basis.  However, the public exposure of conflicts of interest with both sides of the argument exposed to “sunlight” would in itself inhibit the more blatant expropriation by a control group.  The Senate had power to report to shareholders independently of management.  All its resolutions were made public in the annual report to shareholders with that of the auditor who was under the control and direction of the Senate to protect the professional independence of the auditor.

 

Stakeholder councils provide directors with the information to act.  Cumulative voting for directors can provide directors with the will to act.  A corporate senate elected on a one-vote per investor basis provides directors with the power to act.  In this way a stakeholder mutual with the architecture described in Figure 5 can meet the three tests established in section 2.1 to avoid the corruption of people and performance.  It would be unusual for any government, family or publicly traded firms in Anglophile countries to be in a position to meet these tests.  There are also cybernetic reasons why stakeholder mutuals provide competitive advantages and these are next considered.

 

5.0     Cybernetic analysis

This section applies three cybernetic principles to the governance and regulation of firms.  These principle show why a firm governed by a unitary board is at a disadvantage in (i) overcoming bounded rationality in decision making, (ii) obtaining sufficiently accurate information, (iii) exercising control to manage complexity, and (iv) providing a basis for a firm to become self-regulating to reduce the role of government.

 

5.1     Variety in decision making

Mathematician von Neumann (1947) identified the advantages of introducing variety in decision-making 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 von Neumann theorem, which states, "outputs of arbitrarily high reliability can be obtained from computing elements 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 are sufficient number of decision-makers. 

 

The von Neumann theorem explains why authoritarian management that does not accept a plurality of views is more exposed to incorrect decision making.  A compound board, with the diverse views of its stakeholder constituencies and a plurality in its components, as illustrated by the social council in Figure 5, reduces the risk of sub-optimal decision making.  This is independent of any motivation advantages that my be obtained by involving a greater number of people in decision making or decomposing decision making labour by using a compound board to introduce distributive intelligence.

 

5.2     Variety of information channels

Shannon, another pioneer of cybernetics, made a somewhat similar observation.  Shannon (1949) showed that accurate information 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 compelled to rely on the information it required through "orthodox" channels of communications, it would certainly never have anything like requisite variety for controlling the company – 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 are required.  By having a variety of independent sources of information, the integrity of information can be established to overcome the problems of lost or distorted information as illustrated in Table 4.  The need for collaborating evidence is a common feature in many types of investigations and many CEOs establish informal information networks to supplement formal channels of reporting.  However, idiosyncratic informal channels do not represent a systemic process for assuring the integrity of management information. 

 

Both the CEO and directors of a unitary board are generally at a disadvantage in having access to systemic process for obtaining the “other side of the story” of any strengths, weaknesses, opportunities and threats (SWOT) in either management or the business.  Hence the recommendations of Porter noted above and illustrated in the information and control architecture presented in Figures 1 and 5.

 

5.3     Variety of control channels

Another fundamental law of cybernetics is the related ‘Law of Requisite Variety’ which states "the variety of a regulator must equal that of the disturbances whose effect it is to negate" (Ashby 1968: 202).  Another formulation by Beer (1995a: 41) is "that control can be obtained only if the variety of the controller (and in this case all parts of the controller) is at least as great as the variety of the situation to be controlled."

 

Beer describes this as Ashby's Law, which he observed is poorly understood.  To overcome this problem, Beer (1995c: 84–96) provides several examples to communicate its meaning.  Beer (1995b: 279) uses the football team metaphor to illustrate the law.  The same number of players are required to provide an even chance for players in one team competed with another.  A team without sufficient players, (i.e. requisite variety) becomes uncompetitive, and likewise, firms.

 

In the case of corporations, Ashby's Law means that if the competitive standing of a firm is affected by variables numbered P in its environment then corporate controllers need at least P types of responses to remain competitive to carry out their performance (P) duties.  If the conformance requirements of the board require the number of activities to be regulated is C then directors need at least C types of control mechanisms.  For directors to effectively carry out both their performance and conformance roles they need requisite variety in their control system to manage all P + C variables.  However, many parts of a control system required to manage P variables will also manage many C variables and visa-versa.  With this situation, the control system needed to improve competitiveness and self-regulation can support each other.

 

In the words of Ashby (1968: 207) "Only variety can destroy [i.e. control] variety".  Another formulation of the law of requisite variety is that complexity is required to manage complexity.  Non-trivial firms with a unitary board do not meet the test of possessing requisite variety in their information and control channels and so their competitive capabilities cannot match those with an appropriately designed compound board.  Ashby’s law of requisite variety explains what Hock (1994: 7) refers to as the "second law of the universe: nothing can be made simpler without becoming more complex”.  The compound boards shown in Figures 2 and 5 illustrate this point and how appropriate division of power can increase the welfare of all stakeholders.

 

5.4     Amplification of regulation

Another insight of Asbhy is the impossibility of amplifying regulation.  In discussing the capacity of any controller to regulate/manage variables, Ashby (1968: 268) states:  "The Law of Requisite Variety, like the law of Conservation of Energy, absolutely prohibits any direct and simple amplification 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 from supplementing his energy by using a crane.

 

Likewise, supplementation of regulation depends upon one regulator being used to regulate many others.  One man could not regulate the temperatures in a 100-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 thermostat, 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 law of requisite variety explains why it is impossible for governments to regulate the complexity of society without supplementation.  However, law-makers are not aware of this limitation and so keep on introducing more and more prescriptive laws in an effort to introduce greater regulation.  The result is more red tape to frustrate business, more cost to government with problematical protection for consumers and investors for whom the laws are intended to protect. 

 

Supplementation is essential because in the regulation of firms, one law/size does not fit all.  It is by trying to protect the public for all firms in all situations that the law gets so complex.  Instead of prescribing details/temperature for each firm/room, the law need only prescribe the processes by which each firm/room is regulated.  Prescription is still needed but it is at a more basic level to ensure that supplementation is provided by each firm to introduce elements of self-regulation.  It is by this process of supplementation that the architecture of the human brain with its hundred trillion (1015) connections between its 100 million neurones (108) is created by the DNA code which contains only one hundred thousand (105) genes (Kurzweil 1999: 203, 323).  The DNA molecule contains the design instructions to not only build the human brain but all the rest of the body.

 

The Vice President of the USA suggested that the reason for the lack of knowledge about efficient regulation by the USA in the “information age” is that only nine of the 535 members of Congress have any professional education in technology (Gore 1996).  Another reason could be that social scientists are not sufficiently familiar with the theory and practice of self-regulation to understand why it cannot work with the dominant form of institutions in advanced economies.  This dominant form is based on centralised information and control without checks and balances, self-correcting feedback information and control channels to allow self-governance in either the private or public sector.

 

Gore (1996) proposed that governments should “imprint the DNA” of social institutions to make them much more self-regulating to minimise the role of government.  This could be achieved by the government making it a condition for social institutions to exist that they establish self-governing constitutions.  How this process could be introduced, is illustrated by the Mondragón bank that makes it a condition for financing any new firm that the firm adopts a self-regulating constitution such as illustrated in Figure 2.  By making the primary building blocks of their system self-regulating the MCC provides a basis for the whole system to become self-regulating and self-governing as discussed in the next sub-section.  This approach could be replicated in market economies by using tax and other incentives for corporations to adopt in their constitutions elements of self-regulation to replace government regulation (Turnbull 1997b, 2000a).

 

5.5     Criteria for self-regulation

Table 7, ‘Evaluation of hierarchies to control, regulate or self-govern’ details the conditions precedent for the establishment of control, regulation and self-governance in firms.  Unless a firm has a workable control system it cannot be regulated.  Likewise, if a firm cannot be regulated it cannot be governed, let alone achieve self-governance. 

 

There are four basic requirements for a workable system of control shown in Table 7.  These are: (i) obedience to commands; (ii) accurate communications down the hierarchy; (iii) meaningful operational implementation; with (iv) timely application.  The four basic requirements to obtain a workable system of regulation then become respectively; (i) meaningful monitoring of outcomes, (ii) accurate reporting of outcomes up the hierarchy, (iii) meaningful condensation of reports to superiors with (iv) appropriate and timely responses to variations.  The four basic requirements to obtain a workable system of self-governance 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 penalise the controllers; (iii) independent processes to appoint and retire controllers; with (iv) timely evaluations for rewards/penalties and review of appointment of the controllers.

 

The four basic requirements for a workable system of control, regulation and self-governance of hierarchies are summarised in the top section of Table 7.  Problems that can arise in each of the four basic requirements are listed in the bottom section of Table 7.  Each problem represents a contrary condition to the requirements discussed in the previous paragraph.  Each problem is likely to be present in firms organised as centrally controlled hierarchies as is inherent in unitary boards or a government.  Table 4 indicates the problems of a board or CEO to obtain accurate and timely information are jeopardised by loss of accuracy and biases in the communications up the hierarchy and likewise the meaningful implementation of instructions down the hierarchy.  These problems in the control and regulation of centrally controlled hierarchical firms are set out in bottom section of Table 7.

 

Table 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:

 

                    1

Obedience to commands

Meaningful monitoring of outcomes

Adequate information for the governed to evaluate controllers or new nominees for election

 

                    2

REQUIRE-

Accurate communications down hierarchy

Accurate reporting of outcomes up hierarchy

Independent processes for the governed (stakeholders) to reward or penalise controllers

MENTS    

                    3

Meaningful operational implementation

Meaningful condensation of reports

Independent processes for the governed to appoint and retire controllers

 

                    4

Timely implementation

Appropriate  and timely responses to variations

Timely evaluations for rewards/penalties and review of appointment of controllers

                    1

Disobedience

Incomplete monitoring

Incomplete information or subject to bias from controllers

 

                    2

 

PROBLEMS

Biases, distortion in relaying commands

Reporting slow, biased, missing or incomplete

Controllers influencing or determining their own standards of performance and their own rewards and penalties

 

                    3

Ineffectual operational implementation

Incomplete, inadequate analysis of variations

Controllers influencing or determining their own appointment and retirement

 

                     4

Timeliness of implementation

Inappropriate responses to correct variations

Controllers influencing or determining the time of their own evaluation or retirement

 

From Table 7 it is evident that a unitary board, with its concentration of power, does not provide a basis for 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 7.  This supports the findings of Bernstein (1970: 116) for the need to have “guaranteed individual rights” and “an independent appeals system”.

 

Beside the corrupting influence of absolute power to manage their own conflicts of self-interest, unitary boards introduce other problems discussed earlier such as: (i) centralised management hierarchy, which creates communication problems; and (ii) centralised decision making and control which creates information overload and exacerbates bounded rationality.  In addition, the power differentials produced by unitary control can lead to trust being replaced by suspicion, altruism with self-interest and cooperation with competition. 

 

However, self-governing competitive advantages may not be efficiently obtained by suppressing any of these contrary human characteristics.  Indeed, it would seem that organisations, which have an information and control architecture that accepts and uses such contrary, inconsistent or irrational characteristics of individuals, could provide advantages.  The contrary, inconsistent and transitionary operating characteristics of people would not have evolved unless they provided competitive advantages.  The utilisation of contrary behaviour traits in social organisations will be referred to as “social tensegrity” for the reasons explained in the next section.

 

5.6     Social tensegrity

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 can be illustrated by considering the construction of the human body.

 

Neither the human skeleton, which is designed to withstand compression forces, or 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 many configurations.  This suggests those individuals who have the ability to act in contrary ways such as: self-serving agents/selfless stewards, trusting/suspicious, dominant/submissive and cooperative/competitive can provide an informational efficient architecture for sustaining self-regulating social structures.

 

Wearing (1973), a professor of psychology, points out that people can be both competitive and cooperative, selfless and selfish, consistent and inconsistent at different times or at the same time.  Because these contrary characteristics have evolved in human nature, they must have value as efficient survival traits for humans to relate to each other.  Many theories of the firm and organisations make assumptions that one trait or another predominates.  For example, agency theory is based on the assumption that managers are self-interested agents, while stewardship theory assumes that they are self-less agents.  What I refer to as Transaction Byte Analysis (TBA) accepts that people can be either or both and that these properties are useful in establishing efficient self-sustaining organisations.

 

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 to achieve sustainable stability in social organisations they need to provide opportunities for contrary human attributes to emerge.  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 from organisations, which maintain their stability or viability, from special attributes of key personalities who happen to be influential in their operations at a particular time. 

 

The distribution of power in Mondragón cooperatives creates a situation where competitive and cooperative “forces are distributed and balanced within the structure” as described by Ingber (1998: 31) for physical structures.  To paraphrase the words of Ingber quoted above, social tensegrity provides a maximum amount of control (strength) for a minimum number of bytes/data/information/knowledge (building material)”. 

 

For social tensegrity to exist in organisations a division of control is required to establish a basis for competition and cooperation between control centres and competition and cooperation for obtaining tenure as a member of a control centre.  Likewise, a compound board is required to provide a basis for a watchdog board to be suspicious about the self-interest of managers and to confirm their trust in them to be selfless stewards.  A compound board provides a forum for customers to check up on any suspicions on the integrity of the goods and services of suppliers and provides a basis for establishing trust to overcome the problems which concerned Akerlof (1970).

 

 

6.0     Competitive advantages of stakeholder mutuals

The distinctive feature of a stakeholder mutual is its diversified ownership with distributed but not diverse control involving its strategic stakeholders. Diversified ownership among strategic stakeholders represents a “re-invention” of the concept of a mutual firm.  Distributed ownership is common characteristic with publicly traded companies but it is not generally diversified through the involvement of stakeholders.  When a firm matures and becomes self-financing, it no longer needs investors so shareholders no longer represent strategic stakeholders.  This situation is illustrated with management buy-outs, which can eliminate investors who are not operational stakeholders.

 

There are many ways of designing the information and control architecture of a firm with diversified ownership to provide distributed control.  Various ways of distributing control in employee firms are presented and analysed by Bernstein (1980).  This paper has only considered the arrangements illustrated in Figure 5.  These are best suited for a firm located at a single location.  When many locations are involved, matching branch stakeholder information and control architecture would become desirable as used by The John Lewis Partnership (Gazette 1994).

 

The architecture of Figure 5 would allow distributed control to be introduced to government, family and publicly traded firms without jeopardising the property rights that provide a basis for concerns about stakeholder involvement in corporate governance.  Nor would the architecture complicate the fiduciary duties of company directors.  Instead it would simplify the roles and duties of directors and so reduce their exposure to personal liability while providing processes to protect their reputations by managing their conflicts of interests.  Besides protecting the interest of shareholders the arrangement could reduce risk and enhance shareholder value from the participation and commitment of strategic stakeholders and the feedback of competitive intelligence that might not otherwise be available to a unitary board.

 

A fundamental problem of a unitary board is to obtain access to information, which identifies problems.  External directors who have been selected for their independence with the firm are likely to have little knowledge, authority or experience with its detailed operations.  As shown in Figure 1, for Anglo firms, shareholders may be short-term and without industry knowledge, resources or ability to improve performance.  Institutional investors have little incentive to incur costs in becoming involved in corporate control as it is their beneficiaries who obtain the most benefit from increases in performance.  In a Japanese keiretsu the board is accountable to long term patient shareholders with the information, will and capability to improve performance.  These are the three tests identified in section 2.1.

 

To summarise, the competitive advantages of a stakeholder mutual are:

(a)    Decomposition in decision making labour to reduce bounded rationality

(b)   Distributed power to

(i)                  facilitate competitive viewpoints

(ii)                mediate conflicts of interest of decision makers

(iii)               control expropriation of shareholder value

(iv)              control stakeholder exploitation

(v)                facilitate interdependency, trust and cooperation

(vi)              facilitate social tensegrity to further self-regulation

(vii)             increase numbers of decision makers

(viii)           increase sharing of information

(c)    Distributed intelligence to:

(i)                  reduce errors in decision making (Neumann 1947)

(ii)                increase communication channels and reduce errors (Shannon 1949)

(iii)               increase the variety of control to improve management of complexity (Ashby 1968)

(iv)              facilitate different levels of organisational learning (Mathews 1996)

(d)   Introduce elements of self-regulation to reduce the complexity of government regulation

(e)    Enrich democracy by allowing more citizens, acting as stakeholders, to participate in the ownership and control of organisations which affect them.

 

Many of the advantages of distributed control identified in this paper could also be made available to government, family and publicly traded companies.  The higher level of investor protection of having a watchdog board and the higher level of continuous improvement information from strategic stakeholders provides a compelling basis for enhancing the share price of an initial public offering (IPO).  The introduction of distributed control with its competitive advantages would maximise the revenues obtained by governments from privatisation even without immediate diversified ownership.  This is why distributed control is recommended as a condition precedent for privatisation. 

 

Even if governments privatised firms through a trade sale, distributed control provides a way to also privatise significant costs of regulation.  By empowering stakeholders to look after their own interests the need for prescriptive detailed regulations can be minimised.  Even natural monopolies would not require a regulator provided customers obtained effective power to control management.  Without formal powers imprinted into the constitutions of US utilities, their CUBs have been effective in moderating price increases (Givens 1991).

 

The contrary characteristics of people require rich interpersonal communications.  Market prices cannot provide the richness of information required.  Price is what Ashby (1968) describes as “second order information” because it is only a number containing a few bytes.  Numbers have no meaning unless there is qualitative information describing the goods or services and the process of exchange including the trustworthiness of the parties involved as analysed by Akerlof (1970).  The use of a hierarchy to govern activities creates problems from excessive power, poor trust and communications.  It also inhibits the ability of organisations to either manage complexity or become self-regulating.  Management practices like JIT and TQM require associative relationships between suppliers, employees and customers to establish trust with rich and frequent exchange of information. 

 

6.1     Implication for ‘the theory a firm’

Coase (1937) pioneered ‘the theory of a firm’ organised as an “authority” system with a “master and servant” relationship.  Such a relationship has little or no relevance to labour controlled firms or those with divided authority from a compound board and network firms (Craven, Piercy, & Shipp, 1996; Nohira, & Eccles 1992).  Another shortcoming of the theory developed by Coase (1937) and Williamson (1975) is assuming that markets and hierarchy are the only ways to govern transactions. Hollingsworth & Lindberg, (1985: 221–2) point out that transactions can also be governed by associations or through strong bonding through family, community and clan like relationships.

 

Stakeholder mutuals introduce two much richer and sociable modes of governing transactions by institutionalising solidarity among strategic stakeholders.  The introduction of an internal compound board allows the three elements of social capital identified by Evans (1996) and Woolcock (1988) to be introduced.  Through the lens of social capital, the clan like relationships between the same class of stakeholders develops “bonding social capital”.  The association between different classes of stakeholders develops “bridging social capital” and the bottom up participation develops “linking social capital” (Evans 1996, Woolcock 1998).  In the Coasian/Williamson theory of the firm the motivations for governing transactions are based on economic values and power as found in markets and hierarchies respectively.  In stakeholder mutuals, these motivations are also present but are complemented by loyalties and common interests found in clans/communities and associations respectively.

 

Coase (1937) and Williams (1975) argued that firms exist because markets fail to govern transactions efficiently as the authority system organised as a hierarchy.  A corollary of this reasoning is that, as organisations become more efficient in governing transactions then the role of markets will decline.  If the development of social capital in firms allows transactions to be governed more efficiently then this corollary leads to the conclusion that the role of markets will decline in allocating resources as firms utilise compound boards.  Evidence for this is provided by the performance of firms in Japan, Germany and Mondragón.  However, the hegemony of market ideology leads commentators to question the desirability of non-market processes in these examples.  Institutional investors and some corporate governance scholars committed to the efficiency of markets argue that there should be global convergence to the Anglophile system of corporate governance.  An analysis of this ethnocentric view is presented in Turnbull (1997a, 2000c).  The analysis of this paper makes it clear that it is the Anglophile system of corporate governance based on a unitary board, which requires reform rather than adoption.

 

Transaction Byte Analysis (TBA) illustrated by Table 4 indicates additional reasons to the one proposed by Coase as to why firms exist.  Beside the problem of markets providing inadequate information to govern transactions as identified by Coase (1937), firms of two or more people exist because this can reduce ‘bounded rationality’ and allow specialisation in skills and/or knowledge.  Complex activities can be decomposed into simpler elements in a manner similar to that, which can be achieved with a compound board.  The use of bytes as the unit of analysis instead of costs as used by Coase and Williamson, explains why teamwork and networking can be a more efficient way to govern activities than using market signals to govern transactions.

 

TBA explains why, how and when the operating efficiency of firms is determined by their information and control architecture.  Architecture, rather than ownership can be the dominant determinant of efficiency.  But a major reason for promoting privatisation is a belief that this alone provides the best way to promote efficiency.  Ownership also matters as illustrated by the discussion comparing homogeneous Anglo ownership by investors with the heterogeneous Japanese ownership illustrated in Figure 1.  This provide a basis for concluding that a change from homogeneous public ownership to homogeneous private ownership does not provide the efficiency advantages of a change from government or homogeneous private ownership to diverse stakeholder ownership. 

 

Distributed control with diverse stakeholder involvement, as shown in Figure 5, with homogeneous investor ownership would represent an intermediate position.  It is this situation which is recommended for all government firms (Turnbull 1994b, 1997c) and as the starting point for privatisation.

 

Bytes/data/information/knowledge were used as the unit of analysis to evaluate different ownership or control structures without needing to consider transaction costs.  The purpose of transacting bytes within and between people is to determine if costs should be incurred in transactions, which result in the production and exchange of goods and services.  TBA not only subsumes Transaction Cost Economics (TCE) as explicated by Williamson (1975, 1985) but extends the analysis into activities where economic transactions are not involved and/or where costs may have little relevance.  This includes the processes of decision-making and control in a firm.

 

TBA accepts both the assumptions of agency theory (Jensen & Meckling 1976) based on self-interest and the contrary ones of stewardship theory (Donaldson & Davis 1994) based on selflessness.  By recognising the phenomena of social tensegrity, TBA does not depend upon assuming any single type of human behaviour.  It also accepts contrary relationships existing at the same time.  Through the lens of TBA, social capital can be defined by the architecture of transacting bytes between individuals while human capital can be defined by the architecture of transacting bytes in the brain. 

 

6.2     Concluding remarks

This paper has presented arguments that the conversion of family, government or publicly traded firms in Anglophile countries into stakeholder mutuals would improve their efficiency and competitiveness.  It was also noted that a stakeholder mutual introduces more sociable relationships and develops various constructive forms of social capital. 

 

The discussion identified the lack of information feedback and so competitive advantages in family and government owned firms and those publicly traded in Anglophile countries.  A number of the inherent conflicts of interest in unitary governed firms, which can corrupt both people and performance, were identified.  This provided the basis for recommending that convergence of corporate governance practices not be based on unitary boards and that all government owned firms adopt stakeholder governance whether or not they are being privatised.  When government firms are being privatised it is recommended that they also introduce ‘boomerang’ ownership which transfers ownership back from investors to stakeholders in a manner similar to BOOT projects.

 

Boomerang ownership prevents excessive profits being paid to investors, which causes the growing inequality in wealth.  This situation is largely created by property rights, which allow investors to capture profits in excess of the incentive required to invest which I described as “surplus profits” (Turnbull 1992a).  Stakeholder mutuals provide a way to distribute surplus profits to those people who create them.  These are the employees, customers and suppliers whom all firms need to sustain their existence.  Conventional corporations with government sanctioned rights of perpetual succession provide investors with unlimited, unknown and uncontrollable surplus profits.  This is inequitable, inefficient and unsustainable without increasing government transfers.  It is also inconsistent with the assumption of a market economy that competition will allocate resources efficiently.  It allows firms owned outside a country, region or community to extract economic values which according to Penrose (1956) are "unlimited, unknown and uncontrollable."

 

A stakeholder mutual creates a democratic basis for distributing surplus profits because by definition, all strategic stakeholders participate in its ownership and governance.  Additional stakeholders can be included.  Participation is an integrated political, social and economic activity.  It provides a way to enrich democracy by allowing those effected by a firm to have some influence over its operations and share in its risks and returns.  Tax incentives are recommended to encourage all firms to convert to being stakeholder mutuals (Turnbull 1975, 1992a, 1997d).

 

The inclusive nature of the governance of a stakeholder mutual allows many elements of government regulation to be taken over to reduce the frustration and costs of bureaucratic and legal interventions.  The ability of a stakeholder mutual to displace the role of government arises from it providing micro political power to stakeholders to govern themselves.  This is currently denied in family, government and publicly traded firms.  As a result many citizens: “are demoralised by unemployment, alienated by insensitive bureaucracies, exploited by business, depressed by environmental degeneration, powerless to take control of their lives and cynical about the interest or the ability of politicians to make thinks better” (Turnbull 1994a: 85).  Stakeholder mutuals provide a building block for citizens and their politicians to make things better.  They provide a way for creating a much more equitable, efficient, democratic and sustainable stakeholder society.

 

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[1] Aoki (1998) describes three “generic modes of organizational coordination” which he calls “hierarchical decomposition”, “information assimilation” and “information encapsulation”.  These three modes are operationally similar to the three modes described by Hollingsworth & Lindberg (1985: 221–2) as “hierarchies, the clan or community and associations” respectively.

[2] Stafford Beer is a past president of the World Organization of General Systems and Cybernetics and a pioneering practitioner of management cybernetics.  In Toronto, August 3rd, 1996 he reviewed Turnbull (1997e) and advised the author that he was not aware of cybernetics being applied to corporate governance.  Beer’s work involved communications and control within firms or bureaucracies, and was also based on information rather than bytes.  President Allende retained Beer in 1971 to assist him in managing the Chilean economy. http://member.newsguy.com/~mayday/crypto/crypto6d.html  http://pespmc1.vub.ac.be/:/CSTHINK.html cybernetic scholars interested in applying cybernetics to the governance of organisations were invited by the author on February 13th, 2000 to publish their interest at http://pespmc1.vub.ac.be/Annotations/SOCINT.0.html

[3] Evolutionary biologist, Robin Dunbar has identified important limitations of the human brain.  Dunbar (1993: 685) reports that the capacity of the human neocortex limits the maximum number of people an individual can establish social bonds and trust with to around 150.  He 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” (Dunbar, 1993: 687).  These findings provide another reason why firms have diminishing return to scale in addition to the three identified by Coase (1937: 87).  These were the diminishing returns to management from (i) additional costs of “organising” within the firm, (ii) the inability “to make best use of factors of production” and “because the ‘other advantages’ of small firms are greater than those of a large firm”.  The limited ability of individuals to process bytes indicated in Table 5 and the loss of information in hierarchies shown in Table 4 provide an explanation to “diminishing returns to management”.