Altering Organizational Interdependence: Organizational Growth

The acquisition of organizations accomplished through merger is only one instance of organizational growth. Another method of growth, of course, is to expand present operations through direct capital investment. In this section we will discuss organizational growth, a more general concept than merger. We argue that growth, whether accom- plished by merger .ox. direct expansion, represents an attempt to cope with problematic dependence. We also examine the competing argument that growth is undertaken to increase organizational profitability. Growth, regardless of how it is achieve, provides organizations with additional control over their environments and enhances their likelihood of survival. Large organizations, because they are interdependent with so many other organizations and with so many people, such as employees and investors, are supported by society long after they are able to satisfy demands efficiently.

Some writers have argued that growth arises from an inevitable internal pressure for expansion of organizational activities. Katona (1951), for instance, maintained that organizations grew for self-realization. Growth is a way of justifying the worth of the organization and its present activities. Growth, in this sense, can be viewed as a form of commitment. An organization, engaging in some activities, becomes committed to these activities. This commitment means that the activities come to be viewed as worthwhile and important, and therefore, the organization seeks to expand to perform even more of these worthwhile activities. Katz and Kahn (1966) expressed a similar idea when they noted that technological progress frequently fosters growth, even when it might not be desirable. New technologies and improved methods are incorporated because they relate to the organization’s work. Frequently, these advances increase production capacity. Katz and Kahn cited the example of the expansion of steel manufacturing capacity as a consequence of the adoption of technological advances at a time when the industry was already suffering from excess capacity.

While it may be true that growth stems from the internal dynamics of the organization, merely attributing growth to these forces neglects the issue of growth in what areas or what activities, as well as the fact that in social systems, as opposed to biological systems, growth is fre-quendy the outcome of decisions. While the size of a plant may be genetically determined, as well as limited by the resources the plant is given, in the instance of organizational growth, there is some choice concerning how large the organization is to become. As Starbuck has said, “Growth is not spontaneous. It is the consequence of decisions” (1965:453). It is reasonable to argue that organizational growth occurs because size fosters the achievement of either organizational goals or the goals of some members nf the organization (McGuire, 1963).

The possibility that growth is not inevitable, but rather the result of choice, has led writers to offer motivations for growth. Starbuck (1965) enumerated ten possible goals served by growth, though he did not empirically distinguish their importance. One often-cited class of reasons for growth deal with the individual motivations of the organization’s executives and include such elements as adventurousness, desire for prestige, power, and increased compensation. Other motives posit objectives such as profitability or the achievement of economies of scale in operation. Unfortunately, evidence will not permit determination of what intentions executives had in mind when decisions were made to expand the organization. Most of the research has been addressed to the consequences of growth, with the expectation that motivation can be inferred from consequences. Such an inferential process, however, can possibly be misleading. Observing no relationship between growth and profitability does not, inevitably, mean that profitability was not the reason for the expansion—only that the result was not achieved. For instance, observing that most small investors lose money in the stock market should not imply that people invest in order to lose money.

Our own view is that expansion represents an intentional response to organizational interdependence, but a response which is neither inevitable nor constant. Rather, when organizations experience problems as a consequence of interdependence, such as uncertainty or external control, an attempt is made to manage the interdependence. Depending on how the environment is enacted and” the organization’s capabilities and resources, different Strategies for managing the interdependence will be adopted. Growth is but one solution and, represents, as seen from the data on merger, an attempt to directly control the interdependence by either the domination or avoidance of exchanges.

1. Mergers, growth, and Profitability

Mueller (1969) has argued that conglomerate mergers are made only for growth, and Reid (1968) found that merger active firms were not more profitable than firms that were less active in acquiring other organizations although they were superior on indices of growth. Reid’s analysis suggests that if mergers, a form of capital investment- are undertaken to increase profits, they are notably unsuccessful in doing so. Dewing (1921) found that the earnings of firms engaging in mergers declined after th,e consolidations, and that the anticipated benefits of the mergers had been overestimated before the merger occurred. Livermore (1935) studied 328 firms which merged during the period 1890 to 1904. Successful surviving mergers accounted for less than 50 percent of the total. Reid (1962) examined 66 firms between 1950 and 1959. The more successful firms in terms of profits were more likely to be those riot active in making acquisitions. Kelley (1967) concluded that merger active films were neither more nor less profitable than other comparable firms in their industry, and Hogarty (1970) observed that the performance of stock prices of merger active firms was not superior to the performance of stock prices of less active firms. The available evidence suggests that mergers increase organizational size, of course, but do not consistently increase profitability.

If mergers   represent   a   strategy   of   growth   undertaken   to   control environmental interdependence, it is clear why profitability is not necessarily enhanced. Acquiring firms are not free to select firms based on considerations of profitability alone. Mergers undertaken to absorb interdependence are limited to acquisitions from the group of—firms which affect an organization’s business. Even if business organizations desire to acquire the most profitable ventures, other things being equal, the requirement of coping with resource interdependence imposes a search rule which limits the set of potential acquisitions. Merging to manage symbiotic interdependence limits firms to ac-quiring others in industries with which they transact. If a firm merges to cope with competitive interdependence, it must obviously acquire’ competitors.

Firms merging to control interdependence are limited to selecting – from the set of firms on which they are dependent. On the other hand, firms which merge to diversify into other activities are less restricted. 1 Diversification may permit considering a greater number of firms than those with whom resources are exchanged. A larger set of alternatives should permit firms to select more profitable merger candidates. The difference in size of potential sets of acquisitions, therefore, should: lead to differential profitability of merger targets depending upon whether the firms are merging for reasons of diversification or of horizontal or vertical integration.

To examine this argument, an analysis of the profitability of acquired firms was made. The Federal Trade Commission has published profitability levels of companies acquired in mergers of various types: (Federal Trade Commission, 1969). Their listing includes 401 mergers: in manufacturing and mining during 1950-1968 in which the assets of the acquired company were $25 million or more. In Table 6.5, we have reduced the FTC data to show the rate of return of firms acquired in two types of acquisitions—those acquired in horizontal and vertical mergers and those acquired in mergers made for purposes of diversifi-:. cation. A chi-square test of the difference in the distributions indicates that firms acquired for horizontal expansion or vertical integration are less profitable than firms acquired for diversification (p <.02).

As noted previously, merger is only one form of growth, and we can ask the more general question of whether growth increases profit-ability. Growth might allow economies of scale to be realized, per-mitting profit margins to increase. Growth may also increase die market power of a firm, and this market power may lead to increased profits. Growth, of course, leads to larger size, so the issue can be . recast as the relationship between size and profitability. A number of studies have examined this relationship, where profitability has been considered either before or after taxes and as a percentage of sales or  assets. Regardless of how profits were assessed, these studies (Stekler, 1963; Stekler, 1964; Sherman, 1968; Alexander, 1949) all indicated that u firms’ average profit rates increase until some relatively modest size is achieved and then remain roughly constant or decline slightly. More-over, considering only those corporations that report positive net in-come, average profits actually decline as size increases.

The argument that increasing size is necessary to achieve econo-mies of scale is also suspect. While cost reductions do occur as firms increase in size from being quite small to more moderate size, such economies of scale are achieved at relatively small firm sizes and do , not increase thereafter with further growth. Bain (1954; 1956) has conducted some of the most extensive examinations of economies of scale. He concluded that the economies to be gained can not account for the very large firm sizes observed. In part, this may be due to the fact that economies arise ip production facilities more so than for , the entire firm. It may also be due to the fact that economies are not the reason for growth.

Large size may not necessarily increase profits because economic power may tend to be confronted by countervailing power (Galbraith, ji1952). We have already noted that organizations facing concentrated power in industries with which they transact may move to concentrate power themselves to deal with the situation. Power, especially the power of large economic units, is further limited by government regu-lation and the antitrust laws. When interest groups conflict, one party always will attempt to stimulate government action if the opposition develops too much power. Thus, business and labor each have at- ptempted to have Congress limit or break up the power the other has obtained. In the early 1900s, labor was ruled to be subject to the Sherman Antitrust Act to prevent collective action against employers. By 1914, labor was exempted from this restriction under the Clayton  Act. The subsequent growth of labor unions was somewhat checked by the Taft-Hartley law of 1948; right-to-work provisions were directed at preventing the use of legal coercion to create complete monopolies of unionized labor. Size, and the concomitant visibility, makes an organization a more likely target for groups ranging from consumer rights’ organizations to antitrust enforcement agencies. So, with the economic power that accompanies the attainment of large size comes additional scrutiny and constraints on the utilization of that power.

2. Executive Motivation and Organizational Growth

While size has not been correlated with organizational profitability, some writers have attempted to explain organizational decisions favoring growth in terms of the motivations of individual organizational executives. The motivations most commonly used involve individual goal maximization, such as increasing salaries, which are presumed to be negatively related or unrelated to overall organizational performance. One individual motivation for organizational growth is the desire for prestige, power, and job security. Executives in larger companies have more prestige and power than those in smaller firms, as they control more resources. Executives from larger firms are respected and are more often invited to serve on both advisory and policymaking committees and in federal executive positions. Gordon (1945) has argued that the desire for personal power and prestige is one of the more important motives of businesspeople. Williamson ( 1963 ) has provided some evidence that managers do use organizational resources and slack (excess resources) for their own prerogatives, including a automobiles and travel. He also noted, however, that this feathering of one’s nest is constrained by both competitive conditions and shareholder demands. While the effect of size on power and prestige is clear, it is less clear whether size enhances or decreases managerial discretion, as described by Williamson. Large firms may have widely dispersed shareholdings, which may increase the control of managers over the firm. On the other hand, the larger firms are also more visible, and this increased public scrutiny may diminish the autonomy of managers with respect to their own perquisites as well as to decisions made ¡1 for the organization.

The explanation most commonly advanced to account for organi- zational growth is that executive compensation is related to organizational size, and consequently, executives seek organizational growth 1 for the purpose of maximizing their own salaries. Roberts ( 1956; 1959 ) noted that the salary of the highest paid executive in a firm was inde-pendent of the profit earned by the firm but increased with sales j volume. McGuire, Chiu, and Elbing (1962) also showed that execu-tive incomes were more closely related to organizational size, as mea-sured by sales revenues, than they were to profits. Simon (1957) J argued that Roberts’ results were not well explained by economic variables alone. Employing three mechanisms of salary détermina-tion, Simon found that the salaries of executives were partly deter-mined by social comparison with other organizational members. Lowest level salaries were determined by competitive market conditions, while higher executive salaries depended on the steepness of the organizational hierarchy and a stable organizational norm for maintaining executives’ salaries some ratio above the salaries of sub-ordinates (1957:34-35). The correlation of size and salaries may, therefore, be a spurious result of the effect of size on hierarchical structure.

But more recent evidence indicates that these earlier conclusions concerning the relationship between executive compensation and size were naive, in that salary is only one form of executive compensation. Lewellen ( 1968; 1969 ) noted that the compensation of executives had become increasingly weighted toward ownership participation in the form of the corporation’s shares. Compensation data were obtained for the five highest paid positions every year between 1940 and 1963 for 50 of the nation’s largest manufacturing firms. Lewellen concluded, “While in the 1940’s and up to the mid-1950’s, compensation and ownership income were about equally important, thereafter the balance shifted strongly toward the latter. Since 1955, the average annual increments to top executives’ wealth resulting from their holdings of their firms’ stock has been twice as great as the increments generated by their compensation” (1969:316). Thus, “a separation of ownership and management functions clearly exists; it seems that a significant separation of their pecuniary interests does not” (1969:320).

While any given executive may not hold much of the total shares of the firm, his shareholdings of the corporation are likely to be a significant component of Bis own personal wealth. Lewellen argued that since most executives had large shareholdings of the firm that they managed, and since, moreover, many compensation schemes relied on share price (such as stock options, which are worthless if the market price for the shares falls ), the executives -would have interests in share price equivalent to that of the owners of the firm, the shareholders in general.

Lewellen’s findings are, of course, inconsistent with the argument that growth, even when unprofitable, will be pursued to enhance executive compensation. Since neither merger nor size seems to lead to either profitability or increased stock valuation (Hogarty, 1970), Lewellen’s results would tend to be consistent with a profit maximization goal for managers, and would argue against growth for its own sake. As a final note, we should comment that recently there has been increasing attention to the use of monetary compensation again, par- ticularly after the change in tax laws concerning stock options and the poor stock market performance of the early 1970s.

3. Growth and Stability

If growth and size provide no apparent advantage in terms of econo-mjes of scale, profits, or executive compensation, what can account for growth? One possibility is, as we have argued, that growth increases Smyth (1968) analyzed 186 British companies and found that the variability of profits over time decreased as the organization’s size increased. Caves (1970) concluded that the monopolistic power en-joyed by large business enterprises is taken in the form of risk avoidance or uncertainty reduction rather than in the form of in-creased profits.

Starbuck (1965:463) has noted that the desire for stability may be . one of the most important considerations in choosing the direction for , i growth. Osborn (1951) found that both the rate of profit for corpora-tions that earned income and the rate of loss for corporations that iq suffered losses varied inversely with size. Stability is also evident in the / pricing in oligopolistic markets. “The significance of price rigidity is > that, in oligopolistic markets with partial collusion or imperfectly *> recognized mutual dependence, the immobility reduces the risks of j misunderstanding and subsequent ‘destructive competition’ in the – process of adjusting prices” (Caves, 1970:290).

Stability is also sought in market shares of industrial firms. Gort -J (1963) calculated for each of the 205 four-digit SIC industries two measures of stability of market shares from 1947 to the 1954 Census of Manufacturers. The first measure was the correlation coefficient be-tween the 1947 and 1954 shares, and the second was the geometric mean of the regression coefficient of 1947 shares on 1954 shares and 1954 on 1947. The 1954 level of industry concentration was highly related to either measure of market share stability. Gort tested absolute size as an additional variable, but it accounted for little addi-tional variance, indicating that the critical variable is control and sta- 3 bifity of markets, which is enhanced by large size.                                                                                                                                     ‘

Saying that growth brings stability begs the question of why or-ganizations desire stability and certainty. The reason why stability, or the reduction of uncertainty, is so important to organization has al-ready been implied. First, planning is largely impossible because organizational environments are enacted and can be anticipated only retrospectively. Second, the interdependence in environments that are composed of large organizations is more complex and more threatening to organizational survival, necessitating strategies to stabilize inter-organizational relations. And, to theextent that organizational choice is constrained by the patterns of interdependence and influence emanating from the social context, then changes or disruptions in the patterns of influence and/or interdependence require new organiza-tional adaptations to the social context, and there is always the risk that a new successful adaptation may not be found, leading to the disappearance of the organization.

Organizational size, in addition to providing stability, itself en-hances the organization’s survival value. As Starbuck has noted, “The importance of survival to an organization cannot be overstated” (1965:463). Steindl (1945) found the small firms were more likely to disappear than large ones. Large firms, because of their size, have larger constituencies to look after them, as well as more important and established relations with other segments of the business community.

Organizations that are large have more power and leverage over their environments. They are more able to resist immediate pressures for change and, moreover, have more time in which to recognize external threats and adapt to meet them. Growth enhances the organization’s survival value, then, by providing a cushion, or slack, against organizational failure. Large organizations also develop larger sets of groups and organizations interested in their problems with willingness to assist in survival. For even interest groups making demands on large organizations are better off with the survival of the organization than without it. This is illustrated nicely by the rush of labor unions to petition the government to save Lockheed. The unions’ demands for wages have a better chance of being met by a surviving firm than by one that is bankrupt.

Growth enhances an organization’s survival potential because it provides additional stability and reduces uncertainty and also provides leverage for the organization in managing interorganizational relationships. This is not to say that growth is equally efficacious in providing these benefits to all types of organizations. Organizational growth : potentially raises some problems for organizations. As organizations grow, they may require additional funding and be unable to generate this funding internally. Thus, growth may make the organization more dependent on its environment rather than less. jbut these new interdependencies can be, in turn, addressed, and in general, growth provides the ability for the organization to deal with its interdependence with the environment by absorbing portions of the interdependence .andi developing additional power with respect to those other organizations with which it is interdependent.

Source: Pfeffer Jeffrey, Salancik Gerald (2003), The External Control of Organizations: A Resource Dependence Perspective, Stanford Business Books; 1st edition

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