1. Structural Attributes
As Chandler indicates (1966, Chap. 1), the late 1800’s witnessed the emergence of the large, single-product, multifunctioned enterprise — in steel, meatpacking, tobacco, oil, and so forth. These firms were organized along functional lines and will be referred to as unitary form (or U-form) enterprises. The principal operating units in the U-form firm are the functional divisions —sales, finance, manufacturing —as shown in the orga- nization chart in Figure 5. Specialization by function not only was then, but, in organizations of only moderate size at least, is now the “natural” way by which to organize multifunctional activities. In many respects, this is the vertical integration issue. Specialization by function permits both economies of scale and an efficient division of labor to be realized — provided that control over the various parts can also be realized (Ansoff and Brandenburg, 1971, pp. 718-720).
2. Consequences of Radial Expansion
The question to be addressed is what problems does the U-form enter- prise experience when it expands, if the U-form (functional) basis for decomposing the enterprise remains in effect throughout? An answer that is both compelling and compact is not easy to provide. Mainly, what is involved is that radial expansion of the U-form enterprise (1) experiences cumulative “control loss” effects, which have internal efficiency consequences, and (2 ) eventually alters the character of the strategic decisionmaking process in ways that favor attending to other-than-profit objectives 81 Chandler summarizes the defects of the large U-form enterprise in the following way (1966, pp. 382-383):
The inherent weakness in the centralized, functionally departmentalized operating company .. . became critical only when the administrative load on the senior executives increased to such an extent that they were unable to handle their entrepreneurial responsibilities efficiently. This situation arose when the operations of the enterprise became too complex and the problems of coordi- nation, appraisal, and policy formulation too intricate for a small number of top officers to handle both long-run, entrepreneurial, and short-run, operational administrative activities.
Figure 5. Unitary Form
The ability of the management to handle the volume and complexity of the demands placed upon it became strained and even collapsed. Unable meaningfully to identify with or contribute to the realization of global goals, managers in each of the functional parts attended to what they perceived to be operational subgoals instead (Chandler, 1966, p. 156).
These are consequences of bounded rationality, although opportunism, coupled with information impactedness, may also be involved. Bounds on rationality give rise to finite spans of control, which in turn require that additional hierarchical levels be introduced as the U-form enterprise expands— whether the expansion is of the radial or vertical integration variety. Adding hierarchical levels can, if only for serial reproduction reasons, lead to an effective loss of control through incomplete or inaccurate transmittal of data moving up and instructions moving down the organizational hierarchy. Although various decoupling devices may be devised to reduce these transmission needs, these are costly and subject to diminishing returns. Decoupling merely alleviates, but does not overcome, the need for intrafunctional and peak coordination.
Information flows rarely take the form of simple serial reproduction, however. Rather, data are summarized and interpreted as they move forward, and instructions are operationalized as they move down (Arrow, 1974, pp. 53- 54; Emery, 1969, p. 114; Beer, 1969, p. 407). Both processes provide additional opportunities for control losses to develop. These can occur in quite unintentional ways.
Continued expansion also eventually overcomes the capacity of the office of the chief executive to provide strategic planning and maintain effective control, which is another manifestation of bounded rationality. The usual means for augmenting this capacity has been to bring the heads of the functional divisions into the peak coordination process. The natural posture for these functional executives to take is one of advocacy in representing the interests of their respective operating units.
This change in the composition of the strategic decision-making unit produces a shift away from preferences characteristic of the office of the chief executive, which tend to be enterprise-wide in scope, in favor of partisan interests more closely associated with the functional divisions. A persistent and collective pressure to provide more and better services is apt to develop; an expansionary bias in favor of staff expenditures easily obtains.
These bounded rationality consequences predictably result from the radial expansion of the U-form enterprise — even one in which the manage- ment is fully committed to conducting the affairs of the firm in a stewardship manner. If, however, managers perceive these stresses on the U-form structure as affording them with opportunities for discretion, because information is impacted to their advantage, and if, in addition, managers are given to behave opportunistically, further consequences obtain. Deliberate distortions will be introduced into the hierarchical information exchange process in support of subgoals. Permissive attitudes toward slack may also develop.
3. The Corporate Control Dilemma
In principle, competition in the product market and competition in the capital market will check discretionary outcomes. The resulting distortions and inefficiencies will not be viable where product market competition is extensive. Moreover, competition in the capital market fills the breach where product market competition breaks down: managers who fail to behave as neoclassical profit maximizers will be replaced at stockholder insistence. Two lines of defense thereby exist. If, however, the firms in question enjoy some degree of monopoly in their respective markets, and if, realistically, stockholders have insufficient knowledge or are otherwise indisposed to effect management displacement except where egregious distortions appear, a managerial discretion problem plainly exists.
Although they scarcely expressed the problem in this fashion, the corporate control dilemma perceived by Berle and Means can be interpreted in these terms. They noted that a separation in ownership from control existed and inquired: “. . . have we any justification for assuming that those in control of a modern corporation will also choose to operate it in the interests of the stockholders?” (Berle and Means, 1932, p. 121). The universe of firms with which they were concerned in the early 1930’s was mainly large U-form enterprises, and many of these firms enjoyed monopoly power in their respective product markets. In consideration of the above-indicated effects on strategic decision-making and corporate goal pursuit that expansion of the U- form firm predictably has, Berle and Means’ concern that stockholder objectives were possibly being sacrificed to favor managerial objectives was altogether appropriate.
Students of the large corporation who have succeeded Berle and Means have generally reached the same conclusion; to wit, the separation of ownership from control is extensive, and it is merely a matter of good fortune that the corporate sector performs as well as it does. In the background lurks the suspicion that one day these enclaves of private power will run amok (Mason, 1960, pp. 7-9). A search for substitute external controls has been set in motion on this account; solemn supplications on behalf of corporate responsibility have also been advanced. But the possibility that discretionary outcomes might be checked by reorganizational changes within the firm has been generally neglected. I submit, however, that organizational innovations, which in the 1930’s were just getting underway, have mitigated capital market failures by transferring functions traditionally imputed to the capital market to the firm instead. Not only were the direct effects of substituting internal organization for the capital market beneficial, but the indirect effects served to renew the efficacy of capital market controls as well.
Source: Williamson Oliver E. (1975), Markets and hierarchies: Analysis and antitrust implications, A Study in the Economics of Internal Organization, The Free Press.