McKinsey, the legendary management consultancy whose alumni include global chief executives and prominent public figures, celebrated the 50th anniversary of the creation of the McKinsey Quarterly with articles in the journal’s September edition about the future of the corporation and strategy.
It included an interview with former McKinsey employee Tom Peters and reports on the insights of business school academics, corporate strategists and former chief executives including, one-time head of IBM Lou Gerstner.
It wasn’t a celebration of the corporation, but the journal expressed confidence that the large company was a permanent and even essential part of advanced economies. There were no views critical of corporations and their pervasiveness. They do a good job, and if they don’t they’ll go out of business. And wouldn’t everyone like to run one?
In contrast, environmentalist George Monbiot in an article published on the Guardian comment-is-free (Cif) online service on 8 October slammed modern corporations and charged them with many crimes against humanity and nature.
“If there is a “generational struggle to defend the principles of the free market”, it’s a struggle against the corporations, which have replaced the market with a state-endorsed oligarchy,” Monbiot stormed. More than 1,000 CiF readers commented on his article and most agreed.
The role of the corporation is getting more scrutiny than it has in decades following the banking crisis of 2007-08. The authorities are introducing regulations to control the behavior of banks. Action to reduce corporations’ tax-evasion activities is promised.
And yet, there is no evidence that large corporations won’t grow further in the years to come. In fact, there’s every sign that the share of economic activity in advanced economies controlled by large firms will continue to increase.
Why corporations exist has tested economists for decades. Conventional theory in its original form provided no reason why a firm would be set up, let alone survive. All you needed to get socially and technically-optimal results is many buyers and many sellers. From this perspective, large companies had to be monopolies or oligopolists.
In a ground-breaking paper published in 1937, British economist Ronald Coase filled the theoretical gap by arguing that firms exist to avoid transaction costs associated with dealing with the market: uncertainty, price discovery, and price negotiations, particularly involving employees. Without a firm, all its internal relationships would have to be individually negotiated and renegotiated. Logically, a firm exists because it’s cheaper and easier for everyone to accept an overarching institutional arrangement.
This can look like Coase was arguing that managers are almost inhumanly rational and behave like machines. This approach failed to take into account the extent to human failings affect the way companies operate. Managerial, behavioural and organic theories have been developed, drawing inspiration from psychology and the natural world.
The calls for tighter regulation of corporations is largely inspired by the idea that managers are not rational optimisers, as Coase would seem to suggest, but flawed human beings like the rest of us whose judgment becomes increasingly dangerous as his or her power grows.
The divide reflects the intense dichotomy in views about corporations expressed by the experts interviewed by the McKinsey Quarterly, who believe elite managers with the right training and tools can keep corporations both profitable and ethical, and Monbiot and his partisans who believe corporations are bad for everyone and fundamentally unreformable.
Economics2030 argues that both sides have legitimate perspectives and sufficient facts to make their case sound reasonable.
But both are missing the critical factor in modern corporations: the vital importance of intangible capital.
The overwhelming majority of the assets of large companies in advanced economies are intangible. They include goodwill, brands, patents, intellectual property and financial instruments.
The reality is that the managers of large corporations are not managing people or even administering things.
They are fostering dreams.
Intangible capital is by definition non-physical. And even a financial instrument only has value if people believe it can be translated risklessly into something tangible.
For both champions and critics of corporations, the discussion is often, therefore, not about facts, but about ideas and prejudices in the heads of customers, managers, owners, regulators and employees.
What matters is not what a corporation does, but the extent to which it can convince others that whatever it is it actually does has value.
And there’s a larger issue at stake.
Accounting codes and legislation have granted corporations the capacity to value the dreams they nurture and turn them into balance sheet items. And only they have it.
But, how can you value an idea?
First, you need to be able to assert ownership credibly, which is not always straightforward even in an environment where intellectual property is recognised and rigorously supported by law and courts.
Then you have to project an income stream from the idea over time; conventionally in perpetuity. Given that the idea has no physical form, it would seem almost impossible to do so.
And yet practically every major company in advanced economies does that and, if you are Google or Facebook, richly rewarded for doing so.
This fact should be offensive to economists. Perversely, it is not. But that’s not important.
What matters is that students of corporations, whether they are for or against, form a proper view of why they exist and are set to grow yet further.
It’s not because their CEOs are dispassionate geniuses, as the McKinsey Quarterly suggests they will need to be.
And it’s not because a company manager sells his or her soul the moment the promotion and bigger pay cheque is accepted, as Monbiot holds.
It is because they are allowed the freedom which individuals don’t have to turn the intangible into financial assets and to expand in a way that would have been impossible when the only things companies did that counted could be touched.