The Uses of Diversity. David Ellerman
But the logic plays out differently when the jobs require more firm-specific skills and where the quality of effort is not only variable but largely hidden. If there was little mutual commitment between the staff and the management, then the staff would have little reason to put forth hidden effort and little incentive to invest time and effort in acquiring firm-specific skills. And management would have little incentive in upgrading staff skills that are not firm specific since the staff might then solicit and accept an offer from another firm that would not need to repeat the training. In firms where firm-specific “human capital” and quality effort are important, the human relations system will tend toward a commitment-based logic (see Blair 1995). A labor union can be a positive contributor to such a human relations strategy (see Freeman and Medoff 1984). High-trust relationships allow more incomplete relational contracts which require investment in building trust and loyalty so that the high-trust environment will be reproduced.
Since low-trust exit-oriented relationships and high-trust commitment-oriented relationships each tend to be self-reinforcing, there are two organizational equilibria. For instance, in Douglas McGregor’s management theory (1960), the two equilibria based on the two logics are “Theory X” and “Theory Y.”
There is also a motivational aspect to these two logics. The exit-oriented logic emphasized in economics goes along with extrinsic pecuniary motivation. But successful organizations sponsor another type of motivation where the individual “identifies” with the product and the organization, and also where the management shows that it “identifies” with the company staff (all of which might be seen as an “implicit contract” between management and the workers). That is motivational side of the internal commitment-oriented logic in the organization.
The Modern Widely Held American Company
If the exit logic fits markets and the commitment logic fits organizations, then what would an organization look like if it was based on the logic of exit? This brings us to the “model” of the widely held American corporation. To apply the exit logic, there is one complication. Who’s in and who’s out? Who are the members of the organization?
There are actually “two companies”: the company as a legal entity and the company as a working group of human beings.13 The legal entity, the legal or de jure firm, has the shareholders as the members. But the members of the actual or de facto firm are the managers and workers who actually carry out the company’s business. In a small closely held company, the de jure firm and the de facto firm are largely the same. But for the large modern publicly traded American company, there is very little overlap between the de jure firm (shareholders) and the de facto firm (employees including managers). Those who are actually inside the company (the staff) are from the legal viewpoint outside the firm and have only a market relationship (employment) with the firm. Those who are legally inside the company (the legal members of the company) are the far-flung shareholders who typically have no business relationship with the company aside from the share ownership and who typically have well-diversified portfolios of shares (figure 2.3).
Figure 2.3 The Two Companies in a Publicly Traded American “Company.”
The commitment-oriented logic of organizational design would be appropriate for a company, but the problem is that there are the two companies. The commitment-oriented design is applied, at best, to the de jure company. The shareholders are seen as the insiders, principals, members, and owners of the (de jure) company. When things are not going well, the shareholders are legally empowered to change “their company.” And since the people who actually work in the company, the de facto company, are seen legally as having only a market relationship to the company (the employment relation), their role is modeled on an exit-based logic.
In the Anglo-American economies, starting from closely held firms (with little divergence between the de jure and de facto firms) the growth of the public market in equity shares has created these rather odd chimeras. And as the de jure firm (“ownership”) has diverged more and more from the actual firm, the legal theory broke down. The transaction costs for dissatisfied far-flung shareholders to organize and actually change things were very high. And the returns from organizing enough shareholders would be shared by all shareholders, so there was also a strong collective action problem. Hence, shareholders used the “Wall Street Rule”; if you don’t like the way things are going, exit by selling your shares.
Hence, the people legally empowered to implement a commitment-based strategy (“change things”) use a de facto exit-based strategy (sell). And the managers and workers who are de facto in a position to implement a commitment-oriented strategy (“change things”) are seen legally as being outsiders (“employees”) on the other end of a market relationship with the company. They are not the principals or owners directly empowered by corporate law to change things—so in the eyes of the law, their only option is to quit (“exit”) if they are dissatisfied (love it or leave it). Any attempt of workers to organize in unions to secure rights in the firm is seen as antithetical to the exit-based logic of competitive markets. The union is seen as the party on the other side of a contract with the company, not as a part of the internal governance structure of a company. Any attempt of the workers, the members of the de facto firm, to formalize powers to directly “change things” is seen as infringing on the “management rights” exercised by the supposed agents of the far-flung shareholders who are the legal members of the company.
Of course, this bizarre structure would not actually work. Some insiders gladly grabbed the levers of actual control dropped by the shareholders. Those insiders are the top managers, so we arrive at what Adolf Berle and Gardner Means called the “separation of ownership and control” (1932, 89) and at what is currently called the “corporate governance problem.” The legal theory or “model” is shareholder capitalism; the underlying actuality is managerial capitalism. Since there is no legal legitimation for the actual system, the public relations machinery in the companies, in the business press, and in academia has broadcast the goal of “maximizing shareholder value” while the managers show their actual goals in their salaries, benefits, perquisites, (manipulated) stock options, and golden parachutes. But recently, the high corporate executive members of the Business Roundtable (2019) have shown that they are no longer willing to pretend being the hirelings of the shareholders. They prefer the role of being seen as the custodians of massive social resources to be managed in the interests of all the stakeholders, not just the shareholders. That is a much more prestigious cover story for the realities of managerial capitalism. And by being accountable to all stakeholders, they are not only in practice but in theory accountable to no group in particular.
And from the motivational viewpoint, the bizarre model structure would not work unless those who are legally outsiders on the other end of the employment contract—getting only the economic reward of salary or wage—were to a significant degree committed to and identified with the company. Although this is almost entirely ignored by conventional exit-oriented economics, Herbert Simon has emphasized the point:
Organizations would be far less effective systems than they actually are if such (economic) rewards were the only means, or even the principal means, of motivation available. In fact, observation of behavior in organizations reveals other powerful motivations that induce employees to accept organizational goals and authority as bases for their actions. . . . (The) most important of these mechanisms (is): organizational identification. (Simon 1991, 34)
Hence, the members of the de facto company do in fact tend to identify with the company even though they are legally outside the company!
The large American firm is actually a rather odd and incoherent organization. Those who are legally inside the firm (shareholders) act as if they were outside, and those who are legally outside the firm (employees) act as if they were inside.
This mismatch between the model and reality leaves the analyst in a quandary. Should one analyze the rather mythical company model as it exists in the lawbooks and in the economics textbooks? That is the “American model” broadcast to the world by