Decentralizing corporate governance? A praxeological inquiry

Scott L. Mitchell; Mark D. Packard; Brent B. Clark

doi:10.1057/s41310-022-00151-7

Decentralizing corporate governance? A praxeological inquiry

Mitchell, Scott L.; Packard, Mark D.; Clark, Brent B. 2022-12-01 00:00:00 The theory and practice of corporate governance has been in something of an arms race with corporate malefactors—as corporate governance mechanisms have incrementally advance, so too have the strategies of malefactors who skirt those gov- ernance practices to engage in costly misconduct. Modern centralized governance approaches appear inapt to ll fi ing the gaps caused by agency and knowledge problems. Here, we start afresh using the atypical ‘praxeological’ method to reconstruct governance theory anew from basic foundations. The resultant theory is distinctive from prevailing corporate governance theorizing in several key ways. One of the more important conclusions from our reconstructed theory is that governance may benefit from a more ‘market’ or decentralized approach. In short, the governance holes derived from agency and knowledge problems are, or may be, much smaller when governance is decentralized, where employees police each other. While the implementation of such a radical rethinking of governance practice is left ambiguous in our treatment, the theoretical basis for such an approach is compelling. Keywords Corporate governance · Agency theory · Knowledge asymmetry · Ownership · Management · Praxeological method JEL Classification G30 · G34 · O16 · B53 · D82 · D86 Most directors today recognize the importance of robust Introduction oversight, but it is unclear whether boards, as they are currently constituted and operate, are up to the task. The The theories underlying modern corporate governance prac- increasing size and complexity of companies, the expanding tices have grown stale. Whereas modern corporations have array of risk areas, and the difficulty boards have in getting found ways to successfully expand far beyond the scope of the information needed to exercise effective oversight all traditional theory, our theories of governance have failed bode poorly for a positive answer to this question. to keep pace. In fact, despite explicit recognition of and ever-expanding research on governance problems—issues — Paine and Srinivasan (2019, p. 16) as theft, fraud, and other misconduct (Hersel et al. 2019)— these wrongdoings continue to plague businesses at essen- tially a steady rate. It seems that despite firms’, regulators’, * Scott L. Mitchell and scientists’ efforts, increasingly complex governance smitchell@oceg.org mechanisms are met with increasingly complex ways of hid- Mark D. Packard ing from or skirting these efforts. Thus, as Paine and Srini- packardm@fau.edu vasan note in the introductory quotation, it seems doubtful Brent B. Clark that corporate governance theory, as presently conceived, is bbclark@unomaha.edu up to the task of such oversight. The theoretical impetus for the present-state corporate OCEG (Open Compliance & Ethics Group), 4144 N 44th St, Phoenix, AZ 85018, USA governance structure has been, primarily, Jensen and Meck- ling’s (1976) foundational work on Agency Theory, wherein Management Department, Florida Atlantic University, 777 Glades Rd, Boca Raton, FL 33431, USA agency problems are unpacked, the role of principal moni- toring is developed, and other solutions, such as ‘bonding’ Management Department, University of Nebraska, Omaha, 6001 Dodge St., Omaha, NE 68182, USA Vol.:(0123456789) 414 S. L. Mitchell et al. (i.e., the bondholders’ use of external auditing services) or from empirical observation. It is the so-called Crusoe meth- compensating agents with ‘inside equity’ to align incentives odology, a classical approach to theory building in which and mitigate the desire for misconduct, are proposed. While a theorist begins with the simplest form of economy—the we can certainly agree that the theoretical insights purveyed economy of one—to establish the basic economic mechan- by Agency Theory are important and useful, it is also quite ics and then add complexity thereto (Söllner 2016). While clear by now that the implications drawn therefrom have virtually all classical schools of economics have established been largely unsuccessful in resolving those agency prob- their basic premises with this method, the Austrian school lems. It may be worthwhile at this point to start afresh, to has formalized and expanded upon it. reassess the role of governance and the problems it deals with using a distinct (meta-) theoretical lens. The praxeological method Our goal for this article is to build a new theoretical framework for corporate governance. Motivating this effort The foundations for our methodology, which has been is, in large part, recent developments in the philosophy of termed the ‘praxeological’ (Mises 1962, 1998) or ‘Aus- science, specifically regarding social scientific meta-theory. trian’ (Hoppe 1995) method, are in self-evident axioms. Kant As social science continues to grapple with the reproduc- (1998) observed that there are several necessary synthetic ibility crisis (Bergh et al. 2017; Camerer et al. 2018; Open truths that cannot be refuted without contradiction—basic Science Collaboration 2015), growing work in social ontol- principles, such as principles of causality and spatio-tem- ogy is pushing management theory onto new foundations porality, are necessarily known or deduced a priori or else that suppose social science to be of a distinct nature and no other understanding could be derived therefrom. One character than the natural sciences (McBride 2018; Packard such necessary synthetic truth, Mises (1962, p. 6) asserts, 2017; Packard and Bylund 2021; Tsoukas and Chia 2002). is the ‘cognition of action, that is, the cognition of the fact Fortunately, essentially new foundations are not required of that there is such a thing as consciously aiming at ends.’ us, as various social scientists, especially from sociology This ‘human action axiom’ asserts ‘the immutability and (Dilthey 1989; Ricœur 1981; Weber 1978, 2011) and eco- universality of the categories of thought and action’ (Mises nomics (Menger 2009; Mises 1962, 1981), have long been 1998, p. 35): sounding this alarm and have laid subjectivist foundations This axiom, the proposition that humans act, fulfills for the social sciences that are strong and apposite. the requirements precisely for a true synthetic a priori Thus, we build our new foundations for corporate govern- proposition. It cannot be denied that this proposition ance atop the subjectivism of the Austrian School of eco- is true, since the denial would have to be categorized nomics. To do so, we adopt the ‘praxeological method’ of as an action-and so the truth of the statement literally theory building (Hoppe 1995), a rationalist methodology cannot be undone. And the axiom is also not derived developed within the Austrian school whereby theoreti- from observation—there are only bodily movements to cal conclusions are deduced a priori from essentially true be observed but no such things as actions—but stems first principles. From these foundations, along with vari - instead from reflective understanding. (Hoppe 1995, ous insights already devised by the Austrian school (Hayek p. 22) 1937, 1945; Mises 1998), we elaborate a new theory of agency, organization, and governance that concludes with From this human action axiom and the axiom of causality the important insight that growing organizational complexity (Kant 1998), we can then deductively construct economic requires greater dispersion of governance mechanisms rather propositions, both necessary (if they fully derive from a than more centralized oversight. In the simplest of terms, we priori true propositions) and contingent (if they rely on one turn to a bottom-up approach to governance theory building or more contingent states of affairs). Contingent proposi- to either replace or complement the top-down approaches tions are still logically ascertainable, but only partially so that comprise almost the entire body of modern governance and must be assessed under the explicit assertion that the theorizing. We elaborate this insight into specific implica- contingency is given. For example, there are categories of tions and propositions for corporate governance. Kant (1998) distinguishes ‘analytic’ from ‘synthetic’ propositions ‘Crusoe’ methodology in that an analytic proposition is given by the definitions of things, whereas a synthetic proposition is not. ‘A bachelor is unmarried’ is analytically true because ‘unmarried’ is a necessary condition in the Let us begin our theory-building effort with a brief explana- definition of a ‘bachelor.’ These are, generally, uninteresting tautolo- tion of our methodology, which has become rather atypical. gies. A synthetic proposition—e.g., ‘red and yellow make orange’— Our approach is deductive, building upward from basic axi- is not given by the definitions of things, but may be necessarily true oms and assumptions, rather than inferentially downward nonetheless. Decentralizing corporate governance? A praxeological inquiry 415 human action, such as consumption. Not all actions are con- ownership, which we define as the expenditure of resources sumption, and so to study consumption via this method, we toward an intended gain in subjective well-being (Packard must understand the context in which consumption is the and Bylund 2021). The second and secondary ownership given action and construct a consumption function logic atop function is the entrepreneurship (or producer) subfunction, the givenness of consumption (i.e., given that an action is which is tasked with judgment over the preferred productive consumption, what are its nature and consequences?). use of resources and the construction of specific plans for In following this method, we begin with basic axioms and their use (Foss and Klein 2012). Under this entrepreneurship build them logically upward into contingent propositions, subfunction is the management sub-subfunction, which is building as much as possible from those necessary truths to tasked with the enactment of the entrepreneur’s judgment inform the nature and consequence of any presumed state of and plans. Under the management sub-subfunction is the affairs. Insofar as we maintain strict reliance on necessary labor sub-sub-subfunction, which is tasked with the execu- states of affairs, and provided we maintain logical integrity, tion of specific production activities. the conclusions we deduce are contingently true or, at the The governance function is not an ownership subfunc- very least, logically plausible (depending on the nature of tion (although it is often performed by owners), but ‘entails the contingencies included). both the identification and acceptance (or not) of involuntary boundaries [of action], as well as the determination of what Basic premises and definitions voluntary boundaries to impose on themselves’ (Mitchell et al. 2021: 13) or, in other words, the conscribing of the To begin our theoretical development, we must first put forth ownership function to certain boundaries, whether moral, some basic foundations and essential definitions. Founda- strategic, or political. As part of this function, the oversight tionally, we build from the human action axiom, from which subfunction polices and enforces these boundaries. we must extrapolate basic categories of action. Mises (1998: These den fi itions provide the foundations and clarity nec - 252–257) elaborated various subcategories of the human essary for the following theoretical elaboration. action parent construct, which would include the action functions of consumer, owner, investor (capitalist), entre- preneur, manager, and worker. All intentional (economic) Rebuilding corporate governance theory action, Mises argues, is encapsulated by one (or more) of these economic subfunctions. Having explicated our rationalist methodology and set forth More recently, Mitchell et al. (2021) refine these catego- our foundational definitions, let us now proceed with the ries into two parent action functions: ownership, and govern- theory-building process. Our starting point is, again, Mises’s ance. Under the ownership category are the entrepreneurship human action axiom—‘the proposition that humans act, that and consumption functions, which have their own subfunc- they display intentional behavior’ (Hoppe 1995, p. 61), with tions. Specifically, the entrepreneurship subcategory has, the categorical functions just defined. Admitting the meth- under it, the management and labor subfunctions. Under odological individualist position that socioeconomic activi- the governance parent function is the oversight subfunction. ties are comprised of intentional individual actions and their Each of these action categories requires definition for our intentional interactions, we can begin our theory construc- theory-building. tion with a standard Robinson Crusoe scenario. Defining the categories of action Autarkic self‑governance Following Mises (1998), Mitchell et al. (2021) define the Let us suppose that an actor (e.g., Crusoe) is found in the distinct categories of human action as ideal types character- ‘state of nature,’ i.e., alone and isolated. Although it is ized by their economic function. The ownership function tempting to leap to a conclusion that such a person is out- entails ultimate right of control over a resource. Owner- side of economic analysis, such a conclusion would be rash. ship is obtained by taking a resource out of the ‘state of Indeed, the ‘autarkic economy’ or economy-of-one is just nature’ (i.e., homesteading; Locke 1689) or by just acqui- as real as the ‘catallactic’ or social economy within which it sition through voluntary exchange. By right, other claims is embedded (Packard 2020). ‘Economy’ is defined as ‘the to the control of an owned resource are superseded by the productive pursuit of needs satisfactions through purposeful owner’s. Control or authority over an owned resource can action’ (Menger 2007; Packard 2020, p. 398). Thus, a single, be delegated to another by its owner, but the owner retains isolated actor acts economically, producing supply to satisfy the ultimate right to revoke such authority at their discretion. demand, despite there being no market exchange. The primary and ultimate end of owning and using Assuming the Robinson Crusoe scenario, then, what resources is the consumption subfunction (Hutt 1990) of can we say about corporate governance? Does a single 416 S. L. Mitchell et al. actor have need of such? Clearly, the qualifier ‘corporate’ strict sense, we can still distinguish the various roles. Autar- becomes moot and can here be discarded. But is there autar- kic management is thus, simply, the temporal allocation of kic governance? Certainly, we are prone to talk about self- one’s own knowledge, skills, and efforts toward enacting governance, e.g., in discussions of human psychology and predetermined entrepreneurial plans. Autarkic labor is, of self-discipline, but let us be precise. Is ‘self-governance’ course, performing those self-planned and self-managed literal or metaphorical? activities. Recall that ‘governance’ is here defined as that function Returning to the question of autarkic governance, then, which conscribes the ownership function. Socioeconomi- self-governance can now be defined as self-imposed con- cally, the principle of ownership in the autarkic context is strains on their own ownership decisions. Said differently, trivial, if not useless. In autarky, there can be no competing Crusoe might judge it imprudent to spend all of his scarce claims for control over resources, and so all resources can time in endless experimentation in search of better solutions be thought to be controlled and, thus, owned by the autark. to his various needs. Were Crusoe to have such a procliv- However, in a stricter Lockean sense, such resources are not ity, he would need self-discipline to allocate his time and ‘owned’ by the autark until taken out of the state of nature resources effectively toward, foremost, ensuring survival to be used. Robinson Crusoe does not own the whole island, and some minimum level of well-being and, then, whatever even though he has it all to himself, but owns only those additional time available toward capital accumulation and things he has taken from it and used. Although this may innovation as investments toward greater future productivity appear a trivial distinction, it will prove a necessary founda- and well-being. It is this conscribe and constrain function tion as we begin to build theoretically upward. that is the essence of governance. Within the ownership function is the entrepreneurial function, which concerns judgment over the optimal use of Two‑person orders owned resources. Intuition may rebuff the idea that Robinson Crusoe could be an entrepreneur. However, Packard (2020) Let us now expand our analysis to the two-person context. argues that autarkic entrepreneurship is in fact a critical The introduction of a second person allows social interac- and vastly overlooked aspect of the modern economy and, tions that can increase learning and productivity, but also of course, of the Robinson Crusoe economy. If entrepre- introduces meaning to the concept of ownership. Because neurship is ‘the intentional pursuit of new economic value’ resources are scarce, and because consumption of resources (Packard 2017, p. 544), then that function can be performed may entail their destruction, the ownership of resources by Robinson Crusoe or any other actor regardless of whether becomes a critical and potentially contentious issue here. or not they make additional economic gains through a divi- Thus, whereas governance in the Robinson Crusoe exam- sion of labor and market exchange. To elaborate somewhat ple was an issue of mere self-governance, the addition of on the idea of autarkic entrepreneurship, we recognize that another requires governance to include both self-governance intentions are rarely well-established, priority-ranked, or and other-governance, or governance of interactions between clear-cut, but are instead often fuzzy, temporally depend- the actors. Such expanded governance can take many forms, ent, nested, and often contradictory. The task of the autarkic each a variant of five basic forms: autarky, collective, coop- entrepreneur, then, is to allocate resources, including time erative, market, and hierarchy (see Table 1). and effort, to the highest-valued ends or, more specifically, to the tasks that will bring about the greatest value over time. Separated autarkies Also, because they are performed by the self-same per- son, the subfunctions of management and labor also appear The first possible social arrangement of two economic actors trivial, subsumed by the entrepreneurial function. In other is economic isolation—that is, they can each have their own words, because Crusoe is the only one to act, he must not properties and pursue their own affairs independently of just make judgments and plans but also enact them. Yet, in a each other. In this case, the economic structure is generally the same as above, but the concept of ownership becomes a much more central issue. Where two autarkies are close in proximity, questions of ownership can become contentious. Locke’s (2003 [1689]: 111–112) theory of property is thus: “[E] Ownership implies the right to exclude or prohibit another very man has a property in his own person. This nobody has any right from its use, whether in production or consumption. Under to but himself. The labour of his body and the work of his hands, we such circumstances, trespassing, theft, robbery, and other may say, are properly his. Whatsoever then he removes out of the state that nature hath provided, and left it in, he hath mixed his labour property disputes and violations become potential issues. with, and joined to it something that is his own, and thereby makes The task of ownership in this case is not constrained it his property. It being by him removed from the common state merely to production and consumption, as in the sole autarky nature placed it in, it hath by this labour something annexed to it that scenario, but must now also include protecting that which excludes the common right of other men.”. Decentralizing corporate governance? A praxeological inquiry 417 Table 1 Types of two person orders Social order Ownership Governance Entrepreneurship Oversight Management Labor Separated Autarkies Autarkic Autarkic Autarkic Individual Individual Individual Collective Conjoint Conjoint Conjoint Collective/divided Conjoint Collective Cooperative Autarkic Conjoint Autarkic/ conjoint Divided Conjoint Collective Market Autarkic Autarkic Autarkic Divided Intersubjective Individual Hierarchy Autarkic Principal Principal/divided Agent/divided Principal Principal is owned due to the possibility of property rights violations. productive efforts, for better or for worse, they are disincen- Thus, the role of both ownership and of governance are tivized to put forth additional effort. In a collective, this is expanded to include potential interactions with the other. naturally the case where productive capacity is not equiva- In this specific case of uncooperative autarkies, other gov - lent between partners or where their individual consump- ernance focuses specifically on property protections. Such tion needs vary. While perfect equidistribution may seem the protections may include legal innovations (e.g., agreements), likely candidate for resource purveyance, such a distribution defense innovations, policing activities, trust-building may not be equitable in terms of its outcome, especially efforts, and so forth. Because of these costs, separated autar - when individual needs and capabilities vary significantly. A kies are comparatively inefficient. collective of both a physically large actor and a small, petite actor may imply an imbalanced distribution of foodstuffs Collective to provide full and proper aliment to each person. But what such a distribution ought to be can be difficult to ascertain. A second possible arrangement is a collective, where indi- For example, there are significant hurdles in understanding vidual ownership is partially surrendered, some or all aliena- (Packard 2019; Witt 2001) and communicating (Packard and ble (i.e., non-personhood) resources instead being conjointly Burnham 2021; Polanyi 1962) idiosyncratic needs. What ‘owned.’ Because ownership is herein understood as the con- one can understand of another’s needs is comparatively little trol of a resource, we do not mean by conjoint ownership and difficult to ascertain. Thus, where the collective is not that one or the other actor cannot control a resource without universally relieved of strongly autarkic motives, the gov- the permission of the other, although such an arrangement ernance function necessarily breaks down and production might be made. Instead, what conjoint ownership means withers. is that the rights to exclusion implied by ownership are removed. Thus, like the single autarky scenario, the notion Cooperative of ownership here is trivial. The abolishment of private ownership entails significant The third possible arrangement is a cooperative, where eco- ownership and governance difficulties in dealing with scar - nomic production is cooperatively conjoined. In a coopera- city and resource consumption. The collaborative actors tive, ownership of property remains autarkic, but the entre- must somehow allocate those scarce resources aptly—deter- preneurship function and the governance of production does mining both what they should and should not be used for— not. Such forms of organization facilitate more complex pro- according to their conjoint objectives and charge, such as to duction activities, as many tasks are too difficult or complex minimize conflict between them. Such collective ownership for a single actor to accomplish alone, and even more simple and governance are difficult, as decisions regarding resource tasks can often be performed more efficiently through a divi- allocation must be done conjointly or, else, one must defer to sion of labor (Durkheim 2014; Smith 2007). Management of the other. This may cause problems of incentives and equity. more complex projects may (but need not) require that one The governance of collective resources is further impeded actor take on the managerial role, while the management of by a key incentive problem, colloquially referred to as the simpler projects will tend to be done conjointly. ‘tragedy of the commons’ (Hardin 1968). This references The principal problem overhanging this form of organ- the incentive problem that arises when productive efforts are izing is the sharing of the entrepreneurship and governance untethered from the consumptive benefits that such efforts functions. That is, who in the partnership determines what is engender. When one does not reap the benefits of their own (and is not) to be produced, as well as when, and how? Thus, 418 S. L. Mitchell et al. this organization runs into similar challenges as the collec- The market order also necessitates the same need to pro- tive, as it is not always clear who merits control over pro- tect one’s property that is observed in separated autarkies duction efforts under what circumstances. In an ideal case, and in cooperatives. But again, there is a natural dampening the decision should be unanimous but, in reality, the idi- of the incentive to violate properties in order to maintain the osyncratic needs of the partners are in tension. Thus, should more efficient market order—violations would result in the entrepreneurship and governance be allocated according to comparatively inefficient separated autarkies. knowledge and ability or to need, and how would such fac- In general, economists have found market orders to be tors be fairly ascertained? Even if an acceptable balance of comparatively efficient in most economic circumstances, and the entrepreneurship and governance functions could be generally more efficient than the three previously outlined struck, the order of productive operations may also induce organizational forms. However, when transaction costs are tension within the cooperative, as the partner who benefits high, they can cause inefficiencies that may be overcome first may benefit more and longer than the partner who gets with a hierarchical form of organization (Williamson 1967, control of production later. Here, Hayekian knowledge prob- 1975). lems (Hayek 1945) begin to arise—each partner’s knowledge is distinct, much of it tacit (Polanyi 1958), which makes Hierarchy efficient governance and management of the cooperative by one or the other necessarily inefficient, the active governor The final possible arrangement of two actors, then, is a hier - unable to efficiently employ the other’s knowledge. archy, such as employment. In the hierarchical relationship, Finally, because property is individual, there may be need ownership is autarkic, but one partner is subjugated beneath for personal property protections, as in separated autarkies. the other such that only one performs the entrepreneurship However, because violations of properties would upset part- and governance functions, while the other performs subser- ners’ willingness to participate in the cooperative and could vient duties. The subjugated actor (agent) acts at the behest thus lead to the less-efficient order of separated autarkies, of the entrepreneur-governor (principal), who grants to the there is some natural dampening of the incentive to violate agent some compensation for their productive efforts. the partner’s property claims. The hierarchical form occurs when one actor voluntar- In short, a cooperative is viable but inefficient, and ily subjugates themself to the governance of the other. One must rely to a great extent on selflessness in order to be might subjugate themself in a hierarchical form, rather than sustainable. some other form of organizing, for at least three reasons: (1) if the agent is less talented or capable than the principal Market and, thus, would do better under the principal’s leadership and tutelage (i.e., apprenticeship), (2) if the two actors’ risk A fourth possible organization is a market order, which preferences vary significantly, or (3) if the principal owns entails autarkic entrepreneurship by both partners, the indi- superior properties such that the agent would benefit more vidual outputs of which can then be cooperatively exchanged from such a relationship than via any other form. First, the in mutually beneficial trade. Thus, both production and gov - apprenticeship organizational format is effective where one ernance remain autarkic, while engaging in limited coop- possesses highly valuable knowledge and skills that the other eration post-production to gain the benefits of a division does not. This organizational form allows the ‘apprentice’ of labor. to learn these skills over time, while giving the ‘master’ The benefits of a market organization are highly similar significant gains from the division of labor in the mean- to a cooperative, while resolving the problems of conjoint time. Second, one may voluntarily subjugate themself in entrepreneurship and governance by leaving the entrepre- an employment relationship in exchange for a guarantee neurship function autarkic, while the governance function is of income, any additional gains (losses) being kept (sur- intersubjective. By ‘intersubjective,’ we mean that the par- rendered) by the principal (entrepreneur) (Mises 1951). ties, while free to self-govern, may voluntarily agree to some Finally, employment may be chosen out of necessity, where institutional rules to govern the exchange relationship, which a cooperative is infeasible due to significant differences in are overseen and enforced individually. Because the entre- owned resource. For example, if actor A owns fertile land preneurial function is autarkic, complex productive tasks and actor B’s properties are infertile, B may voluntarily that require the efforts of both actors may become difficult, enter an employment arrangement to reap benefits from A’s requiring negotiated agreements that can be difficult to reach when the value output is not easily divisible. Intersubjective governance also introduces transaction costs to the order Hierarchy could alternatively take a master–slave form, where only (Coase 1937), which can reduce total economic efficiency one has ownership and the other has none. For obvious reasons, this under certain circumstances. order is morally untenable and not worth elaboration. Decentralizing corporate governance? A praxeological inquiry 419 properties. Subjugation is likely to be preferred in this case prevailing view today generally holds that markets and hier- only if B cannot find some other productive activities that archies are the most economically advantaged and least dis- could engender a sustainable market arrangement. advantaged, and so these tend to attract the bulk of scholarly The hierarchical form introduces the well-known prin- attention (e.g., Anderson and Brown 2010; Bylund 2014; cipal-agent problem and the mechanics of agency theory Halevy et al. 2011; Halevy et al. 2012; Williamson 1973, (Jensen and Meckling 1976). More specifically, hierarchy 1975). Most modern economic production in fact occurs is faced with critical challenges due to the idiosyncratic via some hybrid of these organizational forms (Foss 2003; motives (Menger 2007; Rothbard 1956) and knowledge Makadok and Coff 2009), to be elaborated later. (Hayek 1937, 1945) of the principal and agent. This agency problem—that ‘agency conflicts arising from a divergence Adding a third actor between agents’ and principals’ utility functions, creat- ing potential for mischief’ (Lan and Heracleous 2010, p. Let us continue our deductive analysis by adding one more 294)—has been widely discussed in both the agency theory actor. A third actor brings up several new problems and pos- (e.g., Bosse and Phillips 2016; Eisenhardt 1989; Jensen and sibilities. Moving forward, we will not further elaborate the Meckling 1976; Lan and Heracleous 2010) and transaction less efficient autarky, collective, or cooperative forms of cost (e.g., Argyres and Zenger 2012; Bylund 2021; Klein governance, as we admit that an efficient order would not 2010; Williamson 1994) literatures. It is also the primary take any of those forms. We will merely observe that add- impetus for arguments for decentralization, i.e., the relega- ing additional actors to these forms only further exacerbates tion of decision authority to lower-level employees (Foss their weaknesses (although a third would also augment a et al. 2015; Hempel et al. 2012). collective and cooperative’s benefits of task complexity). In Also and less widely recognized, Hayekian knowledge contrast, adding additional actors can augment the efficiency problems are not constrained merely to interorganizational of market and hierarchy orders, which will thus tend to be interactions, but applies equally to intra-organizational preferred. processes—i.e., there are ‘internal Hayekian knowledge problems’ (Ng 2020, p. 464). These problems arise within Market hierarchy from the fact that the principal cannot fully know and thus exploit the idiosyncratic knowledge of the agent, Adding a third actor to a market form, in contrast to the other and that the agent cannot effectively employ their own forms, significantly magnifies its strengths, while only mod- knowledge and skills most effectively toward the principal’s erately exacerbating its weaknesses. Specifically, the com- ends due to a thick tacit knowledge barrier. All that can be plexity of productive tasks that the market could achieve is communicated is an explicit task and its purpose, which are increased, and the division of labor increases. Hayek (1988) detethered to some necessary extent from the tacit needs argues that it is no coincidence that the most densely popu- and aims underlying the requested task. This knowledge lated societies also enjoy the highest average standard of barrier must inhibit the agent from employing the entirety living, as the efficiencies of a division of labor intensify of their own knowledge toward innovative solutions to the exponentially. principal’s needs. The principal is also vastly limited in their The problems of markets also grow with increased mar- innovative capacity to only that knowledge they themselves ket actors. Primarily, the threat of property infringements possess as well, perhaps, as a limited amount of knowledge increases with more possible malefactors. This may divert about the agent’s knowledge and skillset, curtailing possible greater productive effort toward oversight efforts, such as tasks to a limited and inefficient set. As a result, hierarchi- property protections, which can reduce market efficiency. cal governance generally leaves a vast trove of knowledge Certain transaction costs (e.g., search costs) may also unused. This problem also inhibits the principal’s knowledge increase somewhat with a growth in market participants, of the agent’s needs, which may inhibit satisfactory compen- but such increases are not foregone. sation for work done on the principal’s behalf, which can lead to the breaking of the relationship. Hierarchy Adding a third person into the hierarchical form exacer- Conclusions bates both the agency problems and the Hayekian knowl- edge problems, as it introduces a third idiosyncratic will and Of the five possible economic arrangements of two collo- more idiosyncratic and tacit knowledge. It also introduces cated actors, each has key drawbacks that generally derive new ‘structural’ opportunities. First, the hierarchical struc- from the benefits and complications of sharing versus divid- ture may remain ‘flat,’ i.e., the principal may govern both ing the entrepreneurship and governance functions. The agents as their manager and supervisor. The management 420 S. L. Mitchell et al. task entails judgment over the resources and tasks assigned and complex firms (hierarchies) as islands of specialization. to the agents. The task of supervision is the monitoring of But here, the Hayekian knowledge problems of hierarchy activities to limit shirking (Jones 1984), partially alleviat- previously described become a central issue. ing the agency problem. A second option is for the function and subfunctions of entrepreneurship and/or governance to Knowledge as an organizing problem be delegated, creating a ‘tall’ or ‘vertical’ hierarchy. This offers different structural configuration possibilities. For Knowledge is always and necessarily individual (Polanyi example, one agent may be tasked with the management 1958), and it is always at least partially subjective (Scheler and/or oversight of the other, the principal maintaining the 1980). There is no ‘social knowledge’ and what is widely roles of entrepreneur and of governor over the former. Alter- known is always known individually through a unique, natively, the tasks of entrepreneurship might be delegated, subjective interpretive lens (Gadamer 2006; Ricœur 1981). the agent effecting ‘derived judgment’ (Foss et al. 2007) over For example, while we all know that ‘the sky is blue,’ the principal’s resources, including the other agent. By del- it can never be ascertained whether the experience that egating the entrepreneurial task to a ‘middle manager’ and another has of ‘seeing the blue sky’ perfectly reflects one’s granting them authority to make entrepreneurial judgments, own self-same experience (e.g., do we all see the same the internal Hayekian knowledge problem is partially alle- ‘blue’?). Because of this, subjective knowledge is neces- viated, but only to an extent. The middle agent still cannot sarily tacit, i.e., it cannot be communicated, at least not in know the lower agent’s full knowledge, nor can they fully its entirety (Polanyi 1962). Beyond the problem of literal know the principal’s mind and intent. incommunicability of tacit knowledge, there are also prac- tical limitations to knowing others’ explicit knowledge. The problem of production While one can communicate their explicit knowledge, certainly not all of it can be communicated, and so one Continuing our analysis, we will build our governance the- must be very selective in deciding what knowledge and ory atop the theory of the firm. Bylund (2016a) advances information is worth sharing. the basic insights of ownership and entrepreneurship, the The idiosyncratic nature of knowledge led Hayek (1937, division of labor, and the separation of knowledge into a 1945) to discuss the problems of economizing such knowl- theory of the firm based in an organizational problem he edge effectively. He concludes: terms the ‘specialization deadlock.’ In short, the speciali- ‘[I]t would seem to follow that the ultimate decisions zation afforded by the division of labor is limited by the must be left to the people who are familiar with these extent of the market. Contract laborers are incentivized to circumstances, who know directly of the relevant be generalists in order to attract many bidders. Specializa- changes and of the resources immediately available tion in complex and specific skills can have extremely high to meet them. We cannot expect that this problem asset specificity. Thus, specialization itself suffers from the will be solved by first communicating all this knowl- ‘holdup’ problem (Williamson 1985). While this is not a edge to a central board which, after integrating all problem in simple markets, advanced societies run into this knowledge, issues its orders. We must solve it by holdup, the specialization deadlock, quite often. some form of decentralization’ (Hayek 1945, p. 524). As entrepreneurs innovate increasingly complex solutions to consumer problems, the production of such complex solu- In a firm, as an island of specialization, entrepreneurs tions becomes extremely costly. Their costs can be severely invest in labor with firm-specific human capital, which curtailed by an advanced division of labor, but this runs into is then managed by the entrepreneur or a hired manager the specialization deadlock problem. Contracted laborers are to enact the entrepreneur’s plans and vision for produc- unwilling to develop such asset-specific skills without some tion. The separation of the entrepreneurial vision from guarantee of long-term employment. Thus, to overcome this the skills and knowledge to achieve it can cause complex specialization deadlock, an entrepreneur may form a firm management problems. These are resolved either through as an ‘island of specialization’ (Bylund 2016a, p. 6), which strict supervisory tactics to ensure a particular vision is is in essence a ‘nexus of contracts’ of employment (Jensen enacted or else by relaxing the vision to be more adap- and Meckling 1976; Kim and Mahoney 2010). As such, tive to the inputs and ideas of the laborers who enact the the entrepreneur promises guaranteed, long-term wages in vision (Burgelman 1983b; Ouchi 1977). These distinct exchange for the laborer’s development and application of approaches (as well as hybrids) offer distinct advantages ‘firm-specific human capital’ (Hashimoto 1981), assuming with respect to the inherent Hayekian knowledge prob- on themselves the risks of entrepreneurial loss (Mises 1951). lems but are weak in others. For example, strong super- In short, in large societies, the typically optimal economic vision ensures that the entrepreneur’s knowledge is suc- organization is a market economy, with increasingly large cessfully applied by the hierarchy but leaves most of the Decentralizing corporate governance? A praxeological inquiry 421 rest of the hierarchy’s knowledge and skills on the table constrains, externally or internally sourced, the firm and as untapped potential. On the other hand, decentralized its operatives must operate within and the policing of those approaches allow much more of that various knowledge constraints. to be used productively but can easily result in diversions Building from these foundations, and from the theoreti- of resources toward too many and too unrelated projects cal scaffolding laid in the prior sections, we can easily see that stretch resources thin and delay production. Thus, that modern corporate governance theory is premised upon appropriate governance of knowledge and resource use a presumption of hierarchical organization. Thus, as we becomes vital. have observed, firms suffer from knowledge and agency problems, which lead to governance breakdowns. Modern governance theory Misconduct in hierarchy Having laid the logical groundwork of organization and Let us adapt Hayek’s (1945) problem of ‘the use of knowl- the role of governance therein, let us now add complexity edge in society’ to the use of specific, governance-related and realism to our basic toward developing a more useful knowledge within a firm. Specifically, we shall assume, and robust theory of corporate governance. From our dis- realistically, that governance-relevant knowledge is hetero- tinctive aprioristic approach, we have derived two general- geneous, at least partially tacit, and that explicit knowledge ized socioeconomic value mechanisms underpinning dif- is (at least somewhat) costly to communicate. By govern- ferent forms of organizing. First, productivity is enhanced ance-related knowledge we mean idiosyncratic knowledge through cooperation and a division of labor to coordinate of external rules, of personal values, and of the various individual (often tacit) knowledge. However, a division resources that the firm controls. This knowledge is gained of labor also implies that there be exchanges, which have idiosyncratically and, so, is necessarily unique to each indi- transaction costs. And second, because ownership means vidual—particularly their highly tacit knowledge of personal control over resources, private ownership is exclusionary, values. Because this knowledge is idiosyncratic and hetero- while shared ownership and control is problematic and geneously dispersed, challenges arise in effectively estab- difficult to govern. Private ownership, in conjunction with lishing and enforcing effective governance policies. colocation that accompanies a division of labor, requires In fact, it is precisely this knowledge heterogeneity, in complex governance practices to protect properties and conjunction with hierarchical production structure that interests. underlies the motivation and opportunities for misconduct. To remind the reader, governance has herein been Misconduct ranges from simple and comparatively incon- defined somewhat more strictly and narrowly than is sequential ‘shirking’ to egregious and consequential mis- common in modern governance theory. Traditionally, conduct such as theft and fraud. Agency theory (Jensen and governance theorists have adopted the Cadbury Report’s Meckling 1976) asserts that these issues are, essentially, (1992) definition of corporate governance as the ‘system Hayekian knowledge problems, or information asymmetries by which companies are directed and controlled,’ or ‘the (Akerlof 1970), between principal and agent. The corporate formal structures, informal structures, and processes that context is almost universally hierarchical to some extent, exist in oversight roles and responsibilities in the corporate the principal delegating the firm’s complex tasks to special- context’ (Hambrick et al. 2008, p. 381). Here, however, we ist agents. The agent, with delegated access to the firm’s have adopted Mitchell et al.’s (2021) definition: ‘govern- resources, are often in a position to exploit their privileged ance establishes norms and values, defines and prioritizes access to and knowledge of resources. purposes and aims, and sets the operative rules within Cressey’s (1953) well-known fraud triangle pinpoints which the ownership functions must operate… [and] also motive or pressure, opportunity, and rationalization as nec- oversees and polices these regulatory boundaries.’ essary to corporate misconduct. Others have added capa- This definition helps us avoid conflating the decision- bility as a fourth factor (Schuchter and Levi 2016; Wolfe making responsibilities of the entrepreneur regarding pro- and Hermanson 2004). However, we might leverage entre- duction activities with the governance activities that con- preneurship theory to distinguish the ‘third-person opportu- strain those activities within certain regulatory boundaries, nity’ for someone from the ‘first-person opportunity’ for me externally dictated or self-imposed. Governance includes (Haynie et al. 2009; McMullen and Shepherd 2006), which political, market (social), industry, and corporate sources implies capability. First-person opportunities for misconduct of regulation of firms’ activities. Although external con - arises from an individual’s unique, idiosyncratic knowledge straints are ‘involuntary,’ internal governance must choose of a firm’s governance of its resources—and particularly to comply or else skirt such regulations. Thus, corporate the flaws in that governance—that enable the exploitation governance entails the determination of which rules and 422 S. L. Mitchell et al. of others’ ‘unknowledge’ (Shackle 1983) of those same viable form of social organizing—market orders are also weaknesses. viable. This insight is the centerpiece of decentralized gov- ernance theory, which we shall now outline. Hierarchical oversight Let us offer some clarification up front, as our intention here is to theoretically explore the possibilities of market This agency problem has been the centerpiece of decades orders within firms’ boundaries. This, of course, seems to fly of research into effective governance practices to mitigate in the face of common understanding, which holds internal misconduct. Standard agency theory highlights the role of firm organization as an explicit alternative to market orders oversight to ensure that agents are not misbehaving (Jensen (e.g., Williamson 1975). But the essence of the market order and Meckling 1976). Oversight can take many forms, with is autarky, as we have outlined above. The artificial bound- managerial oversight and audits being the most common. ary of a firm is not inherently obviating of autarky—many The goal of such oversight is to reduce opportunity for firms are decentralized, ‘flattening’ their hierarchy. Some misconduct (Gomulya and Boeker 2016; Pierce et al. 2015). firms (e.g., Valve, The Morning Star Company) have no When a manager is regularly looking over an agent’s shoul- hierarchy whatsoever, operating essentially as an internal der, it is difficult for that agent to find opportunity to mis- market. behave. Regular audits have a similar effect—fear that an A mountain of research extolls the virtues (and costs) auditor will discover the misconduct ensures that such mis- of decentralizing production processes, allowing for more conduct is avoided (Neville et al. 2019; Velte 2021). autonomy (autarky) in determining productive activities. Firms also attempt to reduce the motivation to misbehave. Some of these virtues include greater job satisfaction (Car- Firms will often compensate their top agents (executives), penter 1971; Wheatley 2017; Worthy 1950) and less stress who have the greatest access to the firm’s resources, with (Ivancevich and Donnelly 1975) and turnover (Liu et al. equity, stock options, restricted stock, or long-term incen- 2011), more proactivity (Den Hartog and Belschak 2012) tive payouts (Burns and Kedia 2006). These forms of com- and innovativeness (Damanpour 1991; Klein et al. 2019; pensation reduce managers’ motivation to misbehave, as Pierce and Delbecq 1977), and better teamwork (Griffin misconduct would come at the expense of the firm’s perfor - et al. 2001; Yang and Choi 2009). mance and would, thus, hurt their own financial well-being. Virtually no research yet exists, however, with regard to Beyond this, firms will often attempt to mitigate miscon - the decentralization of governance practices. In large part, duct at the lower hierarchical levels by establishing a posi- this is because no firms, to our knowledge, practice such tive culture and employee buy-in to the firm’s purpose (Liu governance decentralization. But this is something of a 2016). Where there is cultural buy-in, agents are less likely chicken or egg problem—it is not clear whether no such to undermine the firm’s efforts through misbehavior. practices exist because it is inefficient or due to mimetic These top-down approaches tend to be costly and only isomorphism to standard practices of centralized govern- partially effective. Even strict and severe oversight cannot ance. We propose that it may, in fact, be the latter, which is inhibit all possible misconduct. There are cracks in every bolstered by the fact that conformity to standard centralized system that can escape even the most careful manager or governance practices is, in many countries, required by law auditor. Indeed, evidence suggests that, over time, improving for public corporations. oversight methods and technologies are being met by equally But let us pull on the thread a little more to theoretically improving deception and obfuscation techniques (Paine and unravel the processes of governance were these systems to Srinivasan 2019). Efforts to mitigate misbehavior motivation be decentralized. are also only partially successful—it is impossible to ensure sufficient buy-in from all to avoid misconduct. Decentralized governance: an introduction Thus, top-down governance solutions have been remark- ably unsatisfactory in mitigating corporate misbehavior. Yet, Let us begin our conclusionary analysis with an introduction despite these flaws, they remain the standard for corporate to what decentralized governance means and what such gov- governance. ernance might look like in practice. At a glance, it may seem strange to conceive of governance as potentially decentral- ized, which is essentially the practice of allowing employ- Decentralized governance theory ees to ‘govern themselves.’ Yet, self-governance, far from We now arrive at the crux of our theoretical argument. The challenges of modern governance just reviewed are, again, inherent to hierarchical forms of organizing. However, as 4 These virtues are not ubiquitous or universal, and there is scope for our theoretical analysis has shown, hierarchy is not the only centralization also (Cummings, 1995; Foss & Klein, 2022). Decentralizing corporate governance? A praxeological inquiry 423 an absurdity, is in fact thought to be economically efficient a hefty annual subscription fee. Subscription also meant (Barzel 1987). agreement to abide by common rules of order, with fines In decentralized governance systems, the rules of gov- levied on rule-breakers. Because some were uncoopera- ernance are emergent rather than imposed. Members of the tive with the new rules, the group was disintegrated and organization voluntarily agree to the rules and are able to a new exclusive exchange, the LSE, was formed. Because propose revisions. Such rules are ‘softer’ than top-down gov- its rules were self-enacted and self-enforced, various rules ernance, as the body of members attend to the ‘spirit of the were tried and scrapped until it codified its rulebook in law’ rather than to the minutiae of codified rules. This allows 1812. In 1877, the government recognized that the LSE’s for some variance in rule abiding. Questions and concerns decentralized self-governance was ‘capable of affording about rules and rule breaking are brought before the entire relief and exercising restraint far more prompt and often organization or else a designated committee to determine an satisfactory than any within the read of the courts of law’ appropriate ruling. (quoted in Stringham 2002: 13). Policing of the rules is done by the group members themselves. In some cases, the self-reporting of viola- The Maghribi traders tions may be encouraged through leniency mechanisms. For example, some regulatory agencies offer reduced pen- Another interesting example is the 11th Century Maghribi alties for voluntary disclosure of regulatory violations, Traders’ Coalition (Greif 1989, 1993). During the Middle which lower policing costs (Short and Toffel 2007; Tof- Ages, trade across the Mediterranean regions was fraught fel and Short 2011) and tend to result in more effective with peril. Land shipping was slow, and sea shipping was remediation (Innes 1999). Rather than risk discovery and risky. Storms were a severe threat, as was piracy. Further- the more severe consequence it entails, some may instead more, it was easy for a hired shipping agent to simply steal voluntarily disclose their misbehavior. However, much of the goods—they could easily claim the goods were lost or the policing and enforcement of rules would be done by stolen. There was at best a crude legal system that was inca- constituent members of the organization. Impetus for such pable of policing and prosecuting such malefactors. Thus, policing efforts is not just preservation of the organiza- traders would personally accompany their goods on such tion’s resources but also the maintenance of the organiza- journeys, costing them dearly in productive time. It was this tion’s integrity and reputation. Penalties for rule breaking inefficiency that the Maghribi coalition addressed: would vary according to the severity of the infringement, The Maghribi traders overcame the contractual prob- ranging from internal discipline, to expulsion and profes- lems associated with agency relationships by organ- sional ostracism, to legal prosecution. izing such relationships through a nonanonymous organizational framework, the coalition. Within the coalition an internal information-transmission system The London stock exchange served to balance asymmetric information and a repu- tation mechanism was used to ensure proper conduct. As a compelling exemplar of self-governance, Stringham This reputation mechanism explains the observed (2002) offers the history of the London Stock Exchange ‘trust’ relations among the traders. The ‘trust’ did not (LSE). After an act was passed in 1696 ‘To Restrain the reflect a social control system or the internalization of Number and the Practice of Brokers and Stockjobbers’ norms of behavior (although these factors play a role (ibid: 5), a number of London’s quickly growing stockbro- in any economic system). Rather, the Maghribi traders kerage profession began to skirt the new law by leaving the established a relationship between past conduct and Royal Exchange and participating in informal exchanges, future economic reward. As a result, agents resisted often in coffeehouses. Outside of the formal regulations of the short-term gains attainable though deception, since the State, informal market governance practices began to the reduction in future utility resulting from dishon- emerge to deal with the presence of fraudsters and default- est behavior outweighed the associated increase in the ers. The first self-governance mechanisms entailed shun- present utility. Since this fact was known beforehand to ning and banning of defaulters, but its enforcement over all traders, agents could acquire a reputation as honest time was difficult. In an attempt to better exclude default- agents. (Greif 1989: 881) ers and fraudsters from the profession, the more reputable brokers formed an exclusive club in 1762. After an ousted The trade coalition did not operate with a top-down hier- member brought suit against the club, the group was forced archical governance structure, but self-policed with repu- to open admission to any who paid a daily fee. But it was tation and trust penalties or even, when necessary, expul- soon realized that the daily fee was not enough to keep out sion and ostracism. As a result, it enjoyed a high degree of disreputable brokers, so the group began to instead require reliability and strong reputation, putting them at significant 424 S. L. Mitchell et al. advantage in the shipping industry, for an enduring period systems and mechanisms that agents actually use, leaving of time. governance gaps that are opportunities for misbehavior. If governance is decentralized, agents far more familiar with Decentralized governance and agency and knowledgeable of those systems can place that indi- and knowledge problems vidual knowledge toward better oversight, reducing or elimi- nating those gaps that centralized governance audits so often To theoretically validate the promise of decentralized gov- overlook. ernance, let us reconsider the principal-agent problem and other Hayekian knowledge problems through market organi- Decentralization and governance innovations zational mechanics. In any multi-person collaborative sys- tem (collective, cooperative, market, hierarchy), there are One of the more interesting features of decentralized gov- knowledge asymmetry problems. In collectives and coop- ernance is that the ‘softness’ of established rules allows for erative, as previously reviewed, these asymmetries tend to governance innovations. Hayek (1978, pp. 62–63) explains: result in a tragedy of the commons. In hierarchies, these There is an advantage in obedience to such rules not can manifest as principal-agent problems as well as other being coerced, not only because coercion as such is systemic flaws that result in opportunities for corporate bad, but because it is, in fact, often desirable that misdeeds. rules should be observed only in most instances and For markets, however, knowledge asymmetry problems that the individual should be able to transgress them are largely mitigated due to the maintaining of autarkic when it seems to him worthwhile to incur the odium rights to property, production, and self-governance, with which this will cause. It is also important that the intersubjective governance by mutual agreement or govern- strength of the social pressure and of the force of ment. As a result, each individual’s distinct knowledge is habit which insures their observance is variable. placed at that individual’s own behest, their utility maxi- It is this flexibility of voluntary rules which in the mization efforts further bolstered by mutually beneficial field of morals makes gradual evolution and sponta- exchange. Not all such asymmetries are thus mitigated, how- neous growth possible, which allows further expe- ever—intellectual property protections and lemons problems rience to lead to modifications and improvements. (Akerlof 1970) can leave persistent inefficiencies. Yet, in Such an evolution is only possible with rules which Akerlof’s used car example, even these asymmetry prob- are neither coercive or deliberately imposed—rules lems have been largely mitigated over time with innovative which, though observing them is regarded as merit market solutions. and though they will be observed by the majority, Internally to organizations, decentralization of govern- can be broken by individuals who feel that they have ance produces many of the same benefits, but only to the strong enough reasons to brave the censure of their extent that organizational agents are motivated to optimize fellows. Unlike any deliberately imposed coercive the organization’s governance. As with the LSE and the rules, which can be changed only discontinuously Maghribi traders, market competition typically provides and for all at the same time, rules of this kind allow this impetus. Stakeholders are incentivized to mitigate mis- for gradual and experimental change. The existence conduct within the organization so that it can effectively of individuals and groups simultaneously observing compete in the market and preserve its long-term financial partially different rules provide the opportunity for prospects, and thus their own financial stake. Misconduct selection of the more effective ones. undermines competitiveness and can sully the organiza- tion’s reputation. While such behaviors may be appealing to As a result of such flexibility and the innovations it individual agents with little personal stake in the organiza- affords, decentralized governance is expected to improve tion’s long-term success, those in the organization that have its governance practices over time, as the history of the a greater stake are incentivized to protect their organization LSE exhibits. from such malefactors. The success of decentralized govern- Certainly, it is possible for centralized governance to ance, then, hinges on the benefit and interest of agents in the innovate also. But, like centralized production decisions long-term viability of the organization. (Burgelman 1983a, 1991; Ouchi 1977, 1980), innovative- The primary advantage of governance decentralization is ness in governance is severely hampered by the bureau- that greater and more specific knowledge of the resources cracy of centralization, where new ideas are liable to be and access points can be employed in governance practices. shot down by upper-level managers wary of and resistant In typical centralized governance practices, managers and to change. Moreover, in centralized governance systems, auditors watch for standard signals of wrongdoing, these sig- new rules are imposed from the top, leaving the rule-mak- nals are often untethered from the specific resource access ing to regulators that often know very little of the systems Decentralizing corporate governance? A praxeological inquiry 425 that they regulate. Thus, changes to rules—such as the treatment in particular discusses the impetus for integrat- Public Company Accounting Reform and Investor Protec- ing activities within an organization’s hierarchy versus tion (Sarbanes–Oxley) Act of 2002 (Romano 2005; Zhang leaving or disintegrating such activities to the market—the 2007) and the Wall Street Reform and Consumer Protec- classic make-or-buy decision. Certainly, hybrid forms have tion (Dodd-Frank) Act (Bainbridge 2010; Dimitrov et al. been put forth that integrate components of both market 2015)—tend to be inefficient and ineffective. While such and hierarchical features within the firm (e.g., Foss 2003; inefficiencies in centralized governance systems tend to Makadok and Coff 2009). Also, there is growing interest in persist and, if anything, are prone to ‘correction’ through and practice of the decentralization of production activities increased complication, which tends toward exacerbation, in ‘flat’ hierarchies (Foss et al. 2015; Hempel et al. 2012; decentralized governance is more capable of correcting Klein et al. 2019). inefficiencies by abandoning bad rules and innovating bet- Yet, despite this growing interest and advocacy of ter solutions. employing a market order form within the firm for more optimal productive output, there has been no discussion of the possibility of such market orderings for the perfor- Discussion mance of the governance function. We have herein defined the function of ‘governance’ to be ‘to constrain, conscribe, Our aim herein has been to address the arms race between and regulate’ production to within ethical and strategic improving corporate governance and corporate miscon- boundaries, and to police and enforce those boundaries duct, both of which are growing in complexity and effec- (Mitchell et al. 2021, p. 14). As our analysis reveals, there tiveness. It appears that corporate governance is losing is nothing innately distinctive between the production and this race. governance functions that would make one more effec- tive via market order and the other via hierarchical order. ‘The recent spate of behavioral complaints against Instead, the advantages and disadvantages of these dis- senior corporate leaders has raised questions about tinct organizational forms are highly similar for both eco- board oversight of executive conduct and caught nomic functions. Thus, it is possible and even advisable numerous boards off guard. On a different front, in some (perhaps many) circumstances for governance to various companies have suffered serious breaches of be decentralized. cybersecurity that have exposed a lack of prepared- The decentralization of governance may seem somewhat ness and resulted in significant reputational damage; counterintuitive given the long-standing tradition of cen- others have been tripped up by data privacy concerns tralized governance. Are we really to expect employees to and are facing political and user backlash. Environ- govern themselves? Of course, at an organization level, a mental disasters, labor abuses in the supply chain, market economy is essentially defined in terms of allowing mistreatment of customers—these are other exam- firms to govern themselves—central (political) governance ples of the new breed of risk management issues that of economic production is the hallmark of a socialist politi- are consuming the attention of boards. The broaden- cal structure. It is also widely accepted that sole-proprietor ing menu of risks has created a challenge for tra- entrepreneur self-governance is possible. But we rarely see ditional practices of internal controls and is testing such decentralized governance as viable or even possible at the ability of boards to provide adequate oversight.’ an individual level within firms. This is likely due to prin- (Paine and Srinivasan 2019, p. 15). cipal-agent problems that are inherent to employment and To turn the tables and get corporate governance prac- which can undermine the incentive to self-govern in accord- tices in front of its malcontents, we will need a more radi- ance with the principal’s governance requirements. cal rethinking of standard governance practices. Certainly, the challenges of the principal-agent problem Toward this end, we have developed, through ration- are real and consequential, which may justify the use of hier- alist analysis, a theoretical framework that encompasses archy to monitor agent behavior. However, hierarchy as a the general array of socioeconomic ordering alternatives solution to the principal-agent problem brings with it other by which agents can structure and govern their produc- challenges, such as information asymmetry problems (Keil tive interactions. Perhaps unsurprisingly, the two domi- et al. 2004) and disempowerment problems (Hempel et al. nant socioeconomic ordering forms for economies of 2012). It is not altogether clear, then, that hierarchy is always many agents are markets and hierarchies (Williamson the best governance structure for even large organizations. 1973, 1975). What is interesting to us, however, is that As with incomplete contract theory (Grossman and Hart the virtues and challenges of these distinct socioeconomic 1986; Hart and Moore 1990), which argues that contracts ordering forms are almost always delimited at the bound- can never account for all contingencies, top-down govern- ary of the firm itself. Williamson’s (1973, 1975) classical ance is also always incomplete. There are endless possible 426 S. L. Mitchell et al. ways to skirt established rules and their enforcement. As a examples of decentralized governance warrant deeper sci- result, governance mechanisms have to adapt to ever-chang- entific examination. ing rule-breaking and are necessarily always lagging. Also, we expect that this research may cause a stir among As corporate governance practices continue to lag behind corporate governance scholars as we proffer new theo- innovative malefactors, what becomes revealed is that mis- retical foundations for the field. In some ways, our theory behavior is always an issue, first and foremost, of self-gov - rebuilding efforts through the praxeological method have ernance. Assuming that agents know and understand the confirmed (and better explained) long-standing theory on principal’s governance goals and standards, and those of the challenges of governance within the context of hierar- society (e.g., government regulations), misbehavior is always chical organization. Agency theory (Jensen and Meckling a case of some agent willfully contravening those standards 1976) in particular stands the test of deductive rigor, but for personal gain, broadly defined. Modern corporate gov - only for the hierarchical context. Our analysis reveals that ernance, then, is intended to catch or prevent such malefac- hierarchy is only one organizational option, and that internal tors after they have had a self-governance breakdown. market forms are viable, not only for organizing productive Recognizing this, decentralized governance theory seeks activities, but for performing the governance function also. to address (1) how to best improve employee self-govern- Thus, our efforts better theoretically contextualize prevailing ance and (2) how to most effectively catch self-governance governance research and open new avenues for additional breakdowns before they result in substantial resource mis- research. For example, we note with others (e.g., Foss 2003; allocations or losses. Regarding the former, we posit that Makadok and Coff 2009) that hierarchy and markets are ends governance decentralization proffers alternative ways to of a spectrum, with gradients between them. Hybrid govern- think of and motivate self-governance. In fact, we suggest ance forms, then, should be the subject of future research. that centralized governance may do much to undermine self- governance, much in the same way that overbearing political governments can undermine socioeconomic self-determina- Conclusion tion (Bylund 2016b; Easterly 2013; Holcombe 2018). Regarding the latter, decentralized governance theory Corporate governance theory is in a deep rut. Despite dec- suggests that centralized governance suffers from knowl- ades of significant and rigorous academic work, severe polit- edge asymmetries that may, if organized effectively, be par - ical and regulatory interventions in the wake of some of the tially mitigated by decentralizing governance oversight, to largest corporate scandals in world history, and widespread the lower levels of an organization’s hierarchy. As a result, corporate interest in misbehavior prevention, corporate mis- those closest to and most familiar with resource allocation behavior has remained surprisingly constant. Efforts to miti- processes can monitor the gaps in such processes and ensure gate such misdeeds have either been altogether ineffective the protection of those resources. Said differently, those clos- or else malefactors have been as innovative in misbehaving est to the resource allocation processes can best monitor as the overseers have been at detecting such misconduct. It those resources allocations to ensure no loss or leakage. might be time to fundamentally rethink standard corporate Centralized governance is, simply, too removed from those governance practices. specific processes to allow sufficient knowledge of whatever We have herein developed, through rationalist-deductive gaps there may be in the resource allocation process, which methodology, a refined and elaborated framework for under - present opportunities for misbehavior. standing governance practices. This framework implies that Space and scope constraints preclude us from pursuing market-type decentralization of governance is not only possi- an elaboration of what decentralized governance might look ble but may in fact be advantageous to traditional centralized like in practice—what are its primary governance mecha- governance practices, if effectively implemented. This is not nisms, what are the incentives that compel self-governance to say that all organizational contexts call for decentralized and peer monitoring, and how it might be most effectively governance—the most effective form and type of governance implemented. We leave such elaborations to future research. will expectedly depend on the type of organization. But it Fortunately, decentralized governance is not the eccentric is time we move on from a ‘gold standard’ view of central- meanderings of theoretical unrealism—there are various ized governance and to a recognition of a broader array of real-world examples of such decentralized governance in governance approaches that reflect the distinct advantages practice that may offer opportunities for inductive theoriz- and disadvantages of centralization versus decentralization. ing on and empirical testing of such practices and theories. 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University with degrees in Statistics and Finance. He also worked as an Weber, M. 1978. Economy and society: An outline of interpretive actuary for Lincoln Financial, a financial analyst for Zions Bancorpora- sociology (G. Roth & C. Wittich Eds.). Berkeley: University of tion, and as a program analyst for Alliant Techsystems. His current California Press. research interests include emerging technology’s effects on organiza- Weber, M. 2011. Methodology of social sciences (E. A. Shils & H. A. tions, entrepreneurial ecosystems, and judgment in uncertainty. Finch, Trans.). New York: Routledge. Wheatley, D. 2017. Autonomy in paid work and employee subjective well-being. Work and Occupations 44 (3): 296–328. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png International Journal of Disclosure and Governance Springer Journals http://www.deepdyve.com/lp/springer-journals/decentralizing-corporate-governance-a-praxeological-inquiry-nxpnj2cw1g

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Publisher: Springer Journals
Copyright: Copyright © The Author(s) 2022
ISSN: 1741-3591
eISSN: 1746-6539
DOI: 10.1057/s41310-022-00151-7
Publisher site: See Article on Publisher Site

Abstract

The theory and practice of corporate governance has been in something of an arms race with corporate malefactors—as corporate governance mechanisms have incrementally advance, so too have the strategies of malefactors who skirt those gov- ernance practices to engage in costly misconduct. Modern centralized governance approaches appear inapt to ll fi ing the gaps caused by agency and knowledge problems. Here, we start afresh using the atypical ‘praxeological’ method to reconstruct governance theory anew from basic foundations. The resultant theory is distinctive from prevailing corporate governance theorizing in several key ways. One of the more important conclusions from our reconstructed theory is that governance may benefit from a more ‘market’ or decentralized approach. In short, the governance holes derived from agency and knowledge problems are, or may be, much smaller when governance is decentralized, where employees police each other. While the implementation of such a radical rethinking of governance practice is left ambiguous in our treatment, the theoretical basis for such an approach is compelling. Keywords Corporate governance · Agency theory · Knowledge asymmetry · Ownership · Management · Praxeological method JEL Classification G30 · G34 · O16 · B53 · D82 · D86 Most directors today recognize the importance of robust Introduction oversight, but it is unclear whether boards, as they are currently constituted and operate, are up to the task. The The theories underlying modern corporate governance prac- increasing size and complexity of companies, the expanding tices have grown stale. Whereas modern corporations have array of risk areas, and the difficulty boards have in getting found ways to successfully expand far beyond the scope of the information needed to exercise effective oversight all traditional theory, our theories of governance have failed bode poorly for a positive answer to this question. to keep pace. In fact, despite explicit recognition of and ever-expanding research on governance problems—issues — Paine and Srinivasan (2019, p. 16) as theft, fraud, and other misconduct (Hersel et al. 2019)— these wrongdoings continue to plague businesses at essen- tially a steady rate. It seems that despite firms’, regulators’, * Scott L. Mitchell and scientists’ efforts, increasingly complex governance smitchell@oceg.org mechanisms are met with increasingly complex ways of hid- Mark D. Packard ing from or skirting these efforts. Thus, as Paine and Srini- packardm@fau.edu vasan note in the introductory quotation, it seems doubtful Brent B. Clark that corporate governance theory, as presently conceived, is bbclark@unomaha.edu up to the task of such oversight. The theoretical impetus for the present-state corporate OCEG (Open Compliance & Ethics Group), 4144 N 44th St, Phoenix, AZ 85018, USA governance structure has been, primarily, Jensen and Meck- ling’s (1976) foundational work on Agency Theory, wherein Management Department, Florida Atlantic University, 777 Glades Rd, Boca Raton, FL 33431, USA agency problems are unpacked, the role of principal moni- toring is developed, and other solutions, such as ‘bonding’ Management Department, University of Nebraska, Omaha, 6001 Dodge St., Omaha, NE 68182, USA Vol.:(0123456789) 414 S. L. Mitchell et al. (i.e., the bondholders’ use of external auditing services) or from empirical observation. It is the so-called Crusoe meth- compensating agents with ‘inside equity’ to align incentives odology, a classical approach to theory building in which and mitigate the desire for misconduct, are proposed. While a theorist begins with the simplest form of economy—the we can certainly agree that the theoretical insights purveyed economy of one—to establish the basic economic mechan- by Agency Theory are important and useful, it is also quite ics and then add complexity thereto (Söllner 2016). While clear by now that the implications drawn therefrom have virtually all classical schools of economics have established been largely unsuccessful in resolving those agency prob- their basic premises with this method, the Austrian school lems. It may be worthwhile at this point to start afresh, to has formalized and expanded upon it. reassess the role of governance and the problems it deals with using a distinct (meta-) theoretical lens. The praxeological method Our goal for this article is to build a new theoretical framework for corporate governance. Motivating this effort The foundations for our methodology, which has been is, in large part, recent developments in the philosophy of termed the ‘praxeological’ (Mises 1962, 1998) or ‘Aus- science, specifically regarding social scientific meta-theory. trian’ (Hoppe 1995) method, are in self-evident axioms. Kant As social science continues to grapple with the reproduc- (1998) observed that there are several necessary synthetic ibility crisis (Bergh et al. 2017; Camerer et al. 2018; Open truths that cannot be refuted without contradiction—basic Science Collaboration 2015), growing work in social ontol- principles, such as principles of causality and spatio-tem- ogy is pushing management theory onto new foundations porality, are necessarily known or deduced a priori or else that suppose social science to be of a distinct nature and no other understanding could be derived therefrom. One character than the natural sciences (McBride 2018; Packard such necessary synthetic truth, Mises (1962, p. 6) asserts, 2017; Packard and Bylund 2021; Tsoukas and Chia 2002). is the ‘cognition of action, that is, the cognition of the fact Fortunately, essentially new foundations are not required of that there is such a thing as consciously aiming at ends.’ us, as various social scientists, especially from sociology This ‘human action axiom’ asserts ‘the immutability and (Dilthey 1989; Ricœur 1981; Weber 1978, 2011) and eco- universality of the categories of thought and action’ (Mises nomics (Menger 2009; Mises 1962, 1981), have long been 1998, p. 35): sounding this alarm and have laid subjectivist foundations This axiom, the proposition that humans act, fulfills for the social sciences that are strong and apposite. the requirements precisely for a true synthetic a priori Thus, we build our new foundations for corporate govern- proposition. It cannot be denied that this proposition ance atop the subjectivism of the Austrian School of eco- is true, since the denial would have to be categorized nomics. To do so, we adopt the ‘praxeological method’ of as an action-and so the truth of the statement literally theory building (Hoppe 1995), a rationalist methodology cannot be undone. And the axiom is also not derived developed within the Austrian school whereby theoreti- from observation—there are only bodily movements to cal conclusions are deduced a priori from essentially true be observed but no such things as actions—but stems first principles. From these foundations, along with vari - instead from reflective understanding. (Hoppe 1995, ous insights already devised by the Austrian school (Hayek p. 22) 1937, 1945; Mises 1998), we elaborate a new theory of agency, organization, and governance that concludes with From this human action axiom and the axiom of causality the important insight that growing organizational complexity (Kant 1998), we can then deductively construct economic requires greater dispersion of governance mechanisms rather propositions, both necessary (if they fully derive from a than more centralized oversight. In the simplest of terms, we priori true propositions) and contingent (if they rely on one turn to a bottom-up approach to governance theory building or more contingent states of affairs). Contingent proposi- to either replace or complement the top-down approaches tions are still logically ascertainable, but only partially so that comprise almost the entire body of modern governance and must be assessed under the explicit assertion that the theorizing. We elaborate this insight into specific implica- contingency is given. For example, there are categories of tions and propositions for corporate governance. Kant (1998) distinguishes ‘analytic’ from ‘synthetic’ propositions ‘Crusoe’ methodology in that an analytic proposition is given by the definitions of things, whereas a synthetic proposition is not. ‘A bachelor is unmarried’ is analytically true because ‘unmarried’ is a necessary condition in the Let us begin our theory-building effort with a brief explana- definition of a ‘bachelor.’ These are, generally, uninteresting tautolo- tion of our methodology, which has become rather atypical. gies. A synthetic proposition—e.g., ‘red and yellow make orange’— Our approach is deductive, building upward from basic axi- is not given by the definitions of things, but may be necessarily true oms and assumptions, rather than inferentially downward nonetheless. Decentralizing corporate governance? A praxeological inquiry 415 human action, such as consumption. Not all actions are con- ownership, which we define as the expenditure of resources sumption, and so to study consumption via this method, we toward an intended gain in subjective well-being (Packard must understand the context in which consumption is the and Bylund 2021). The second and secondary ownership given action and construct a consumption function logic atop function is the entrepreneurship (or producer) subfunction, the givenness of consumption (i.e., given that an action is which is tasked with judgment over the preferred productive consumption, what are its nature and consequences?). use of resources and the construction of specific plans for In following this method, we begin with basic axioms and their use (Foss and Klein 2012). Under this entrepreneurship build them logically upward into contingent propositions, subfunction is the management sub-subfunction, which is building as much as possible from those necessary truths to tasked with the enactment of the entrepreneur’s judgment inform the nature and consequence of any presumed state of and plans. Under the management sub-subfunction is the affairs. Insofar as we maintain strict reliance on necessary labor sub-sub-subfunction, which is tasked with the execu- states of affairs, and provided we maintain logical integrity, tion of specific production activities. the conclusions we deduce are contingently true or, at the The governance function is not an ownership subfunc- very least, logically plausible (depending on the nature of tion (although it is often performed by owners), but ‘entails the contingencies included). both the identification and acceptance (or not) of involuntary boundaries [of action], as well as the determination of what Basic premises and definitions voluntary boundaries to impose on themselves’ (Mitchell et al. 2021: 13) or, in other words, the conscribing of the To begin our theoretical development, we must first put forth ownership function to certain boundaries, whether moral, some basic foundations and essential definitions. Founda- strategic, or political. As part of this function, the oversight tionally, we build from the human action axiom, from which subfunction polices and enforces these boundaries. we must extrapolate basic categories of action. Mises (1998: These den fi itions provide the foundations and clarity nec - 252–257) elaborated various subcategories of the human essary for the following theoretical elaboration. action parent construct, which would include the action functions of consumer, owner, investor (capitalist), entre- preneur, manager, and worker. All intentional (economic) Rebuilding corporate governance theory action, Mises argues, is encapsulated by one (or more) of these economic subfunctions. Having explicated our rationalist methodology and set forth More recently, Mitchell et al. (2021) refine these catego- our foundational definitions, let us now proceed with the ries into two parent action functions: ownership, and govern- theory-building process. Our starting point is, again, Mises’s ance. Under the ownership category are the entrepreneurship human action axiom—‘the proposition that humans act, that and consumption functions, which have their own subfunc- they display intentional behavior’ (Hoppe 1995, p. 61), with tions. Specifically, the entrepreneurship subcategory has, the categorical functions just defined. Admitting the meth- under it, the management and labor subfunctions. Under odological individualist position that socioeconomic activi- the governance parent function is the oversight subfunction. ties are comprised of intentional individual actions and their Each of these action categories requires definition for our intentional interactions, we can begin our theory construc- theory-building. tion with a standard Robinson Crusoe scenario. Defining the categories of action Autarkic self‑governance Following Mises (1998), Mitchell et al. (2021) define the Let us suppose that an actor (e.g., Crusoe) is found in the distinct categories of human action as ideal types character- ‘state of nature,’ i.e., alone and isolated. Although it is ized by their economic function. The ownership function tempting to leap to a conclusion that such a person is out- entails ultimate right of control over a resource. Owner- side of economic analysis, such a conclusion would be rash. ship is obtained by taking a resource out of the ‘state of Indeed, the ‘autarkic economy’ or economy-of-one is just nature’ (i.e., homesteading; Locke 1689) or by just acqui- as real as the ‘catallactic’ or social economy within which it sition through voluntary exchange. By right, other claims is embedded (Packard 2020). ‘Economy’ is defined as ‘the to the control of an owned resource are superseded by the productive pursuit of needs satisfactions through purposeful owner’s. Control or authority over an owned resource can action’ (Menger 2007; Packard 2020, p. 398). Thus, a single, be delegated to another by its owner, but the owner retains isolated actor acts economically, producing supply to satisfy the ultimate right to revoke such authority at their discretion. demand, despite there being no market exchange. The primary and ultimate end of owning and using Assuming the Robinson Crusoe scenario, then, what resources is the consumption subfunction (Hutt 1990) of can we say about corporate governance? Does a single 416 S. L. Mitchell et al. actor have need of such? Clearly, the qualifier ‘corporate’ strict sense, we can still distinguish the various roles. Autar- becomes moot and can here be discarded. But is there autar- kic management is thus, simply, the temporal allocation of kic governance? Certainly, we are prone to talk about self- one’s own knowledge, skills, and efforts toward enacting governance, e.g., in discussions of human psychology and predetermined entrepreneurial plans. Autarkic labor is, of self-discipline, but let us be precise. Is ‘self-governance’ course, performing those self-planned and self-managed literal or metaphorical? activities. Recall that ‘governance’ is here defined as that function Returning to the question of autarkic governance, then, which conscribes the ownership function. Socioeconomi- self-governance can now be defined as self-imposed con- cally, the principle of ownership in the autarkic context is strains on their own ownership decisions. Said differently, trivial, if not useless. In autarky, there can be no competing Crusoe might judge it imprudent to spend all of his scarce claims for control over resources, and so all resources can time in endless experimentation in search of better solutions be thought to be controlled and, thus, owned by the autark. to his various needs. Were Crusoe to have such a procliv- However, in a stricter Lockean sense, such resources are not ity, he would need self-discipline to allocate his time and ‘owned’ by the autark until taken out of the state of nature resources effectively toward, foremost, ensuring survival to be used. Robinson Crusoe does not own the whole island, and some minimum level of well-being and, then, whatever even though he has it all to himself, but owns only those additional time available toward capital accumulation and things he has taken from it and used. Although this may innovation as investments toward greater future productivity appear a trivial distinction, it will prove a necessary founda- and well-being. It is this conscribe and constrain function tion as we begin to build theoretically upward. that is the essence of governance. Within the ownership function is the entrepreneurial function, which concerns judgment over the optimal use of Two‑person orders owned resources. Intuition may rebuff the idea that Robinson Crusoe could be an entrepreneur. However, Packard (2020) Let us now expand our analysis to the two-person context. argues that autarkic entrepreneurship is in fact a critical The introduction of a second person allows social interac- and vastly overlooked aspect of the modern economy and, tions that can increase learning and productivity, but also of course, of the Robinson Crusoe economy. If entrepre- introduces meaning to the concept of ownership. Because neurship is ‘the intentional pursuit of new economic value’ resources are scarce, and because consumption of resources (Packard 2017, p. 544), then that function can be performed may entail their destruction, the ownership of resources by Robinson Crusoe or any other actor regardless of whether becomes a critical and potentially contentious issue here. or not they make additional economic gains through a divi- Thus, whereas governance in the Robinson Crusoe exam- sion of labor and market exchange. To elaborate somewhat ple was an issue of mere self-governance, the addition of on the idea of autarkic entrepreneurship, we recognize that another requires governance to include both self-governance intentions are rarely well-established, priority-ranked, or and other-governance, or governance of interactions between clear-cut, but are instead often fuzzy, temporally depend- the actors. Such expanded governance can take many forms, ent, nested, and often contradictory. The task of the autarkic each a variant of five basic forms: autarky, collective, coop- entrepreneur, then, is to allocate resources, including time erative, market, and hierarchy (see Table 1). and effort, to the highest-valued ends or, more specifically, to the tasks that will bring about the greatest value over time. Separated autarkies Also, because they are performed by the self-same per- son, the subfunctions of management and labor also appear The first possible social arrangement of two economic actors trivial, subsumed by the entrepreneurial function. In other is economic isolation—that is, they can each have their own words, because Crusoe is the only one to act, he must not properties and pursue their own affairs independently of just make judgments and plans but also enact them. Yet, in a each other. In this case, the economic structure is generally the same as above, but the concept of ownership becomes a much more central issue. Where two autarkies are close in proximity, questions of ownership can become contentious. Locke’s (2003 [1689]: 111–112) theory of property is thus: “[E] Ownership implies the right to exclude or prohibit another very man has a property in his own person. This nobody has any right from its use, whether in production or consumption. Under to but himself. The labour of his body and the work of his hands, we such circumstances, trespassing, theft, robbery, and other may say, are properly his. Whatsoever then he removes out of the state that nature hath provided, and left it in, he hath mixed his labour property disputes and violations become potential issues. with, and joined to it something that is his own, and thereby makes The task of ownership in this case is not constrained it his property. It being by him removed from the common state merely to production and consumption, as in the sole autarky nature placed it in, it hath by this labour something annexed to it that scenario, but must now also include protecting that which excludes the common right of other men.”. Decentralizing corporate governance? A praxeological inquiry 417 Table 1 Types of two person orders Social order Ownership Governance Entrepreneurship Oversight Management Labor Separated Autarkies Autarkic Autarkic Autarkic Individual Individual Individual Collective Conjoint Conjoint Conjoint Collective/divided Conjoint Collective Cooperative Autarkic Conjoint Autarkic/ conjoint Divided Conjoint Collective Market Autarkic Autarkic Autarkic Divided Intersubjective Individual Hierarchy Autarkic Principal Principal/divided Agent/divided Principal Principal is owned due to the possibility of property rights violations. productive efforts, for better or for worse, they are disincen- Thus, the role of both ownership and of governance are tivized to put forth additional effort. In a collective, this is expanded to include potential interactions with the other. naturally the case where productive capacity is not equiva- In this specific case of uncooperative autarkies, other gov - lent between partners or where their individual consump- ernance focuses specifically on property protections. Such tion needs vary. While perfect equidistribution may seem the protections may include legal innovations (e.g., agreements), likely candidate for resource purveyance, such a distribution defense innovations, policing activities, trust-building may not be equitable in terms of its outcome, especially efforts, and so forth. Because of these costs, separated autar - when individual needs and capabilities vary significantly. A kies are comparatively inefficient. collective of both a physically large actor and a small, petite actor may imply an imbalanced distribution of foodstuffs Collective to provide full and proper aliment to each person. But what such a distribution ought to be can be difficult to ascertain. A second possible arrangement is a collective, where indi- For example, there are significant hurdles in understanding vidual ownership is partially surrendered, some or all aliena- (Packard 2019; Witt 2001) and communicating (Packard and ble (i.e., non-personhood) resources instead being conjointly Burnham 2021; Polanyi 1962) idiosyncratic needs. What ‘owned.’ Because ownership is herein understood as the con- one can understand of another’s needs is comparatively little trol of a resource, we do not mean by conjoint ownership and difficult to ascertain. Thus, where the collective is not that one or the other actor cannot control a resource without universally relieved of strongly autarkic motives, the gov- the permission of the other, although such an arrangement ernance function necessarily breaks down and production might be made. Instead, what conjoint ownership means withers. is that the rights to exclusion implied by ownership are removed. Thus, like the single autarky scenario, the notion Cooperative of ownership here is trivial. The abolishment of private ownership entails significant The third possible arrangement is a cooperative, where eco- ownership and governance difficulties in dealing with scar - nomic production is cooperatively conjoined. In a coopera- city and resource consumption. The collaborative actors tive, ownership of property remains autarkic, but the entre- must somehow allocate those scarce resources aptly—deter- preneurship function and the governance of production does mining both what they should and should not be used for— not. Such forms of organization facilitate more complex pro- according to their conjoint objectives and charge, such as to duction activities, as many tasks are too difficult or complex minimize conflict between them. Such collective ownership for a single actor to accomplish alone, and even more simple and governance are difficult, as decisions regarding resource tasks can often be performed more efficiently through a divi- allocation must be done conjointly or, else, one must defer to sion of labor (Durkheim 2014; Smith 2007). Management of the other. This may cause problems of incentives and equity. more complex projects may (but need not) require that one The governance of collective resources is further impeded actor take on the managerial role, while the management of by a key incentive problem, colloquially referred to as the simpler projects will tend to be done conjointly. ‘tragedy of the commons’ (Hardin 1968). This references The principal problem overhanging this form of organ- the incentive problem that arises when productive efforts are izing is the sharing of the entrepreneurship and governance untethered from the consumptive benefits that such efforts functions. That is, who in the partnership determines what is engender. When one does not reap the benefits of their own (and is not) to be produced, as well as when, and how? Thus, 418 S. L. Mitchell et al. this organization runs into similar challenges as the collec- The market order also necessitates the same need to pro- tive, as it is not always clear who merits control over pro- tect one’s property that is observed in separated autarkies duction efforts under what circumstances. In an ideal case, and in cooperatives. But again, there is a natural dampening the decision should be unanimous but, in reality, the idi- of the incentive to violate properties in order to maintain the osyncratic needs of the partners are in tension. Thus, should more efficient market order—violations would result in the entrepreneurship and governance be allocated according to comparatively inefficient separated autarkies. knowledge and ability or to need, and how would such fac- In general, economists have found market orders to be tors be fairly ascertained? Even if an acceptable balance of comparatively efficient in most economic circumstances, and the entrepreneurship and governance functions could be generally more efficient than the three previously outlined struck, the order of productive operations may also induce organizational forms. However, when transaction costs are tension within the cooperative, as the partner who benefits high, they can cause inefficiencies that may be overcome first may benefit more and longer than the partner who gets with a hierarchical form of organization (Williamson 1967, control of production later. Here, Hayekian knowledge prob- 1975). lems (Hayek 1945) begin to arise—each partner’s knowledge is distinct, much of it tacit (Polanyi 1958), which makes Hierarchy efficient governance and management of the cooperative by one or the other necessarily inefficient, the active governor The final possible arrangement of two actors, then, is a hier - unable to efficiently employ the other’s knowledge. archy, such as employment. In the hierarchical relationship, Finally, because property is individual, there may be need ownership is autarkic, but one partner is subjugated beneath for personal property protections, as in separated autarkies. the other such that only one performs the entrepreneurship However, because violations of properties would upset part- and governance functions, while the other performs subser- ners’ willingness to participate in the cooperative and could vient duties. The subjugated actor (agent) acts at the behest thus lead to the less-efficient order of separated autarkies, of the entrepreneur-governor (principal), who grants to the there is some natural dampening of the incentive to violate agent some compensation for their productive efforts. the partner’s property claims. The hierarchical form occurs when one actor voluntar- In short, a cooperative is viable but inefficient, and ily subjugates themself to the governance of the other. One must rely to a great extent on selflessness in order to be might subjugate themself in a hierarchical form, rather than sustainable. some other form of organizing, for at least three reasons: (1) if the agent is less talented or capable than the principal Market and, thus, would do better under the principal’s leadership and tutelage (i.e., apprenticeship), (2) if the two actors’ risk A fourth possible organization is a market order, which preferences vary significantly, or (3) if the principal owns entails autarkic entrepreneurship by both partners, the indi- superior properties such that the agent would benefit more vidual outputs of which can then be cooperatively exchanged from such a relationship than via any other form. First, the in mutually beneficial trade. Thus, both production and gov - apprenticeship organizational format is effective where one ernance remain autarkic, while engaging in limited coop- possesses highly valuable knowledge and skills that the other eration post-production to gain the benefits of a division does not. This organizational form allows the ‘apprentice’ of labor. to learn these skills over time, while giving the ‘master’ The benefits of a market organization are highly similar significant gains from the division of labor in the mean- to a cooperative, while resolving the problems of conjoint time. Second, one may voluntarily subjugate themself in entrepreneurship and governance by leaving the entrepre- an employment relationship in exchange for a guarantee neurship function autarkic, while the governance function is of income, any additional gains (losses) being kept (sur- intersubjective. By ‘intersubjective,’ we mean that the par- rendered) by the principal (entrepreneur) (Mises 1951). ties, while free to self-govern, may voluntarily agree to some Finally, employment may be chosen out of necessity, where institutional rules to govern the exchange relationship, which a cooperative is infeasible due to significant differences in are overseen and enforced individually. Because the entre- owned resource. For example, if actor A owns fertile land preneurial function is autarkic, complex productive tasks and actor B’s properties are infertile, B may voluntarily that require the efforts of both actors may become difficult, enter an employment arrangement to reap benefits from A’s requiring negotiated agreements that can be difficult to reach when the value output is not easily divisible. Intersubjective governance also introduces transaction costs to the order Hierarchy could alternatively take a master–slave form, where only (Coase 1937), which can reduce total economic efficiency one has ownership and the other has none. For obvious reasons, this under certain circumstances. order is morally untenable and not worth elaboration. Decentralizing corporate governance? A praxeological inquiry 419 properties. Subjugation is likely to be preferred in this case prevailing view today generally holds that markets and hier- only if B cannot find some other productive activities that archies are the most economically advantaged and least dis- could engender a sustainable market arrangement. advantaged, and so these tend to attract the bulk of scholarly The hierarchical form introduces the well-known prin- attention (e.g., Anderson and Brown 2010; Bylund 2014; cipal-agent problem and the mechanics of agency theory Halevy et al. 2011; Halevy et al. 2012; Williamson 1973, (Jensen and Meckling 1976). More specifically, hierarchy 1975). Most modern economic production in fact occurs is faced with critical challenges due to the idiosyncratic via some hybrid of these organizational forms (Foss 2003; motives (Menger 2007; Rothbard 1956) and knowledge Makadok and Coff 2009), to be elaborated later. (Hayek 1937, 1945) of the principal and agent. This agency problem—that ‘agency conflicts arising from a divergence Adding a third actor between agents’ and principals’ utility functions, creat- ing potential for mischief’ (Lan and Heracleous 2010, p. Let us continue our deductive analysis by adding one more 294)—has been widely discussed in both the agency theory actor. A third actor brings up several new problems and pos- (e.g., Bosse and Phillips 2016; Eisenhardt 1989; Jensen and sibilities. Moving forward, we will not further elaborate the Meckling 1976; Lan and Heracleous 2010) and transaction less efficient autarky, collective, or cooperative forms of cost (e.g., Argyres and Zenger 2012; Bylund 2021; Klein governance, as we admit that an efficient order would not 2010; Williamson 1994) literatures. It is also the primary take any of those forms. We will merely observe that add- impetus for arguments for decentralization, i.e., the relega- ing additional actors to these forms only further exacerbates tion of decision authority to lower-level employees (Foss their weaknesses (although a third would also augment a et al. 2015; Hempel et al. 2012). collective and cooperative’s benefits of task complexity). In Also and less widely recognized, Hayekian knowledge contrast, adding additional actors can augment the efficiency problems are not constrained merely to interorganizational of market and hierarchy orders, which will thus tend to be interactions, but applies equally to intra-organizational preferred. processes—i.e., there are ‘internal Hayekian knowledge problems’ (Ng 2020, p. 464). These problems arise within Market hierarchy from the fact that the principal cannot fully know and thus exploit the idiosyncratic knowledge of the agent, Adding a third actor to a market form, in contrast to the other and that the agent cannot effectively employ their own forms, significantly magnifies its strengths, while only mod- knowledge and skills most effectively toward the principal’s erately exacerbating its weaknesses. Specifically, the com- ends due to a thick tacit knowledge barrier. All that can be plexity of productive tasks that the market could achieve is communicated is an explicit task and its purpose, which are increased, and the division of labor increases. Hayek (1988) detethered to some necessary extent from the tacit needs argues that it is no coincidence that the most densely popu- and aims underlying the requested task. This knowledge lated societies also enjoy the highest average standard of barrier must inhibit the agent from employing the entirety living, as the efficiencies of a division of labor intensify of their own knowledge toward innovative solutions to the exponentially. principal’s needs. The principal is also vastly limited in their The problems of markets also grow with increased mar- innovative capacity to only that knowledge they themselves ket actors. Primarily, the threat of property infringements possess as well, perhaps, as a limited amount of knowledge increases with more possible malefactors. This may divert about the agent’s knowledge and skillset, curtailing possible greater productive effort toward oversight efforts, such as tasks to a limited and inefficient set. As a result, hierarchi- property protections, which can reduce market efficiency. cal governance generally leaves a vast trove of knowledge Certain transaction costs (e.g., search costs) may also unused. This problem also inhibits the principal’s knowledge increase somewhat with a growth in market participants, of the agent’s needs, which may inhibit satisfactory compen- but such increases are not foregone. sation for work done on the principal’s behalf, which can lead to the breaking of the relationship. Hierarchy Adding a third person into the hierarchical form exacer- Conclusions bates both the agency problems and the Hayekian knowl- edge problems, as it introduces a third idiosyncratic will and Of the five possible economic arrangements of two collo- more idiosyncratic and tacit knowledge. It also introduces cated actors, each has key drawbacks that generally derive new ‘structural’ opportunities. First, the hierarchical struc- from the benefits and complications of sharing versus divid- ture may remain ‘flat,’ i.e., the principal may govern both ing the entrepreneurship and governance functions. The agents as their manager and supervisor. The management 420 S. L. Mitchell et al. task entails judgment over the resources and tasks assigned and complex firms (hierarchies) as islands of specialization. to the agents. The task of supervision is the monitoring of But here, the Hayekian knowledge problems of hierarchy activities to limit shirking (Jones 1984), partially alleviat- previously described become a central issue. ing the agency problem. A second option is for the function and subfunctions of entrepreneurship and/or governance to Knowledge as an organizing problem be delegated, creating a ‘tall’ or ‘vertical’ hierarchy. This offers different structural configuration possibilities. For Knowledge is always and necessarily individual (Polanyi example, one agent may be tasked with the management 1958), and it is always at least partially subjective (Scheler and/or oversight of the other, the principal maintaining the 1980). There is no ‘social knowledge’ and what is widely roles of entrepreneur and of governor over the former. Alter- known is always known individually through a unique, natively, the tasks of entrepreneurship might be delegated, subjective interpretive lens (Gadamer 2006; Ricœur 1981). the agent effecting ‘derived judgment’ (Foss et al. 2007) over For example, while we all know that ‘the sky is blue,’ the principal’s resources, including the other agent. By del- it can never be ascertained whether the experience that egating the entrepreneurial task to a ‘middle manager’ and another has of ‘seeing the blue sky’ perfectly reflects one’s granting them authority to make entrepreneurial judgments, own self-same experience (e.g., do we all see the same the internal Hayekian knowledge problem is partially alle- ‘blue’?). Because of this, subjective knowledge is neces- viated, but only to an extent. The middle agent still cannot sarily tacit, i.e., it cannot be communicated, at least not in know the lower agent’s full knowledge, nor can they fully its entirety (Polanyi 1962). Beyond the problem of literal know the principal’s mind and intent. incommunicability of tacit knowledge, there are also prac- tical limitations to knowing others’ explicit knowledge. The problem of production While one can communicate their explicit knowledge, certainly not all of it can be communicated, and so one Continuing our analysis, we will build our governance the- must be very selective in deciding what knowledge and ory atop the theory of the firm. Bylund (2016a) advances information is worth sharing. the basic insights of ownership and entrepreneurship, the The idiosyncratic nature of knowledge led Hayek (1937, division of labor, and the separation of knowledge into a 1945) to discuss the problems of economizing such knowl- theory of the firm based in an organizational problem he edge effectively. He concludes: terms the ‘specialization deadlock.’ In short, the speciali- ‘[I]t would seem to follow that the ultimate decisions zation afforded by the division of labor is limited by the must be left to the people who are familiar with these extent of the market. Contract laborers are incentivized to circumstances, who know directly of the relevant be generalists in order to attract many bidders. Specializa- changes and of the resources immediately available tion in complex and specific skills can have extremely high to meet them. We cannot expect that this problem asset specificity. Thus, specialization itself suffers from the will be solved by first communicating all this knowl- ‘holdup’ problem (Williamson 1985). While this is not a edge to a central board which, after integrating all problem in simple markets, advanced societies run into this knowledge, issues its orders. We must solve it by holdup, the specialization deadlock, quite often. some form of decentralization’ (Hayek 1945, p. 524). As entrepreneurs innovate increasingly complex solutions to consumer problems, the production of such complex solu- In a firm, as an island of specialization, entrepreneurs tions becomes extremely costly. Their costs can be severely invest in labor with firm-specific human capital, which curtailed by an advanced division of labor, but this runs into is then managed by the entrepreneur or a hired manager the specialization deadlock problem. Contracted laborers are to enact the entrepreneur’s plans and vision for produc- unwilling to develop such asset-specific skills without some tion. The separation of the entrepreneurial vision from guarantee of long-term employment. Thus, to overcome this the skills and knowledge to achieve it can cause complex specialization deadlock, an entrepreneur may form a firm management problems. These are resolved either through as an ‘island of specialization’ (Bylund 2016a, p. 6), which strict supervisory tactics to ensure a particular vision is is in essence a ‘nexus of contracts’ of employment (Jensen enacted or else by relaxing the vision to be more adap- and Meckling 1976; Kim and Mahoney 2010). As such, tive to the inputs and ideas of the laborers who enact the the entrepreneur promises guaranteed, long-term wages in vision (Burgelman 1983b; Ouchi 1977). These distinct exchange for the laborer’s development and application of approaches (as well as hybrids) offer distinct advantages ‘firm-specific human capital’ (Hashimoto 1981), assuming with respect to the inherent Hayekian knowledge prob- on themselves the risks of entrepreneurial loss (Mises 1951). lems but are weak in others. For example, strong super- In short, in large societies, the typically optimal economic vision ensures that the entrepreneur’s knowledge is suc- organization is a market economy, with increasingly large cessfully applied by the hierarchy but leaves most of the Decentralizing corporate governance? A praxeological inquiry 421 rest of the hierarchy’s knowledge and skills on the table constrains, externally or internally sourced, the firm and as untapped potential. On the other hand, decentralized its operatives must operate within and the policing of those approaches allow much more of that various knowledge constraints. to be used productively but can easily result in diversions Building from these foundations, and from the theoreti- of resources toward too many and too unrelated projects cal scaffolding laid in the prior sections, we can easily see that stretch resources thin and delay production. Thus, that modern corporate governance theory is premised upon appropriate governance of knowledge and resource use a presumption of hierarchical organization. Thus, as we becomes vital. have observed, firms suffer from knowledge and agency problems, which lead to governance breakdowns. Modern governance theory Misconduct in hierarchy Having laid the logical groundwork of organization and Let us adapt Hayek’s (1945) problem of ‘the use of knowl- the role of governance therein, let us now add complexity edge in society’ to the use of specific, governance-related and realism to our basic toward developing a more useful knowledge within a firm. Specifically, we shall assume, and robust theory of corporate governance. From our dis- realistically, that governance-relevant knowledge is hetero- tinctive aprioristic approach, we have derived two general- geneous, at least partially tacit, and that explicit knowledge ized socioeconomic value mechanisms underpinning dif- is (at least somewhat) costly to communicate. By govern- ferent forms of organizing. First, productivity is enhanced ance-related knowledge we mean idiosyncratic knowledge through cooperation and a division of labor to coordinate of external rules, of personal values, and of the various individual (often tacit) knowledge. However, a division resources that the firm controls. This knowledge is gained of labor also implies that there be exchanges, which have idiosyncratically and, so, is necessarily unique to each indi- transaction costs. And second, because ownership means vidual—particularly their highly tacit knowledge of personal control over resources, private ownership is exclusionary, values. Because this knowledge is idiosyncratic and hetero- while shared ownership and control is problematic and geneously dispersed, challenges arise in effectively estab- difficult to govern. Private ownership, in conjunction with lishing and enforcing effective governance policies. colocation that accompanies a division of labor, requires In fact, it is precisely this knowledge heterogeneity, in complex governance practices to protect properties and conjunction with hierarchical production structure that interests. underlies the motivation and opportunities for misconduct. To remind the reader, governance has herein been Misconduct ranges from simple and comparatively incon- defined somewhat more strictly and narrowly than is sequential ‘shirking’ to egregious and consequential mis- common in modern governance theory. Traditionally, conduct such as theft and fraud. Agency theory (Jensen and governance theorists have adopted the Cadbury Report’s Meckling 1976) asserts that these issues are, essentially, (1992) definition of corporate governance as the ‘system Hayekian knowledge problems, or information asymmetries by which companies are directed and controlled,’ or ‘the (Akerlof 1970), between principal and agent. The corporate formal structures, informal structures, and processes that context is almost universally hierarchical to some extent, exist in oversight roles and responsibilities in the corporate the principal delegating the firm’s complex tasks to special- context’ (Hambrick et al. 2008, p. 381). Here, however, we ist agents. The agent, with delegated access to the firm’s have adopted Mitchell et al.’s (2021) definition: ‘govern- resources, are often in a position to exploit their privileged ance establishes norms and values, defines and prioritizes access to and knowledge of resources. purposes and aims, and sets the operative rules within Cressey’s (1953) well-known fraud triangle pinpoints which the ownership functions must operate… [and] also motive or pressure, opportunity, and rationalization as nec- oversees and polices these regulatory boundaries.’ essary to corporate misconduct. Others have added capa- This definition helps us avoid conflating the decision- bility as a fourth factor (Schuchter and Levi 2016; Wolfe making responsibilities of the entrepreneur regarding pro- and Hermanson 2004). However, we might leverage entre- duction activities with the governance activities that con- preneurship theory to distinguish the ‘third-person opportu- strain those activities within certain regulatory boundaries, nity’ for someone from the ‘first-person opportunity’ for me externally dictated or self-imposed. Governance includes (Haynie et al. 2009; McMullen and Shepherd 2006), which political, market (social), industry, and corporate sources implies capability. First-person opportunities for misconduct of regulation of firms’ activities. Although external con - arises from an individual’s unique, idiosyncratic knowledge straints are ‘involuntary,’ internal governance must choose of a firm’s governance of its resources—and particularly to comply or else skirt such regulations. Thus, corporate the flaws in that governance—that enable the exploitation governance entails the determination of which rules and 422 S. L. Mitchell et al. of others’ ‘unknowledge’ (Shackle 1983) of those same viable form of social organizing—market orders are also weaknesses. viable. This insight is the centerpiece of decentralized gov- ernance theory, which we shall now outline. Hierarchical oversight Let us offer some clarification up front, as our intention here is to theoretically explore the possibilities of market This agency problem has been the centerpiece of decades orders within firms’ boundaries. This, of course, seems to fly of research into effective governance practices to mitigate in the face of common understanding, which holds internal misconduct. Standard agency theory highlights the role of firm organization as an explicit alternative to market orders oversight to ensure that agents are not misbehaving (Jensen (e.g., Williamson 1975). But the essence of the market order and Meckling 1976). Oversight can take many forms, with is autarky, as we have outlined above. The artificial bound- managerial oversight and audits being the most common. ary of a firm is not inherently obviating of autarky—many The goal of such oversight is to reduce opportunity for firms are decentralized, ‘flattening’ their hierarchy. Some misconduct (Gomulya and Boeker 2016; Pierce et al. 2015). firms (e.g., Valve, The Morning Star Company) have no When a manager is regularly looking over an agent’s shoul- hierarchy whatsoever, operating essentially as an internal der, it is difficult for that agent to find opportunity to mis- market. behave. Regular audits have a similar effect—fear that an A mountain of research extolls the virtues (and costs) auditor will discover the misconduct ensures that such mis- of decentralizing production processes, allowing for more conduct is avoided (Neville et al. 2019; Velte 2021). autonomy (autarky) in determining productive activities. Firms also attempt to reduce the motivation to misbehave. Some of these virtues include greater job satisfaction (Car- Firms will often compensate their top agents (executives), penter 1971; Wheatley 2017; Worthy 1950) and less stress who have the greatest access to the firm’s resources, with (Ivancevich and Donnelly 1975) and turnover (Liu et al. equity, stock options, restricted stock, or long-term incen- 2011), more proactivity (Den Hartog and Belschak 2012) tive payouts (Burns and Kedia 2006). These forms of com- and innovativeness (Damanpour 1991; Klein et al. 2019; pensation reduce managers’ motivation to misbehave, as Pierce and Delbecq 1977), and better teamwork (Griffin misconduct would come at the expense of the firm’s perfor - et al. 2001; Yang and Choi 2009). mance and would, thus, hurt their own financial well-being. Virtually no research yet exists, however, with regard to Beyond this, firms will often attempt to mitigate miscon - the decentralization of governance practices. In large part, duct at the lower hierarchical levels by establishing a posi- this is because no firms, to our knowledge, practice such tive culture and employee buy-in to the firm’s purpose (Liu governance decentralization. But this is something of a 2016). Where there is cultural buy-in, agents are less likely chicken or egg problem—it is not clear whether no such to undermine the firm’s efforts through misbehavior. practices exist because it is inefficient or due to mimetic These top-down approaches tend to be costly and only isomorphism to standard practices of centralized govern- partially effective. Even strict and severe oversight cannot ance. We propose that it may, in fact, be the latter, which is inhibit all possible misconduct. There are cracks in every bolstered by the fact that conformity to standard centralized system that can escape even the most careful manager or governance practices is, in many countries, required by law auditor. Indeed, evidence suggests that, over time, improving for public corporations. oversight methods and technologies are being met by equally But let us pull on the thread a little more to theoretically improving deception and obfuscation techniques (Paine and unravel the processes of governance were these systems to Srinivasan 2019). Efforts to mitigate misbehavior motivation be decentralized. are also only partially successful—it is impossible to ensure sufficient buy-in from all to avoid misconduct. Decentralized governance: an introduction Thus, top-down governance solutions have been remark- ably unsatisfactory in mitigating corporate misbehavior. Yet, Let us begin our conclusionary analysis with an introduction despite these flaws, they remain the standard for corporate to what decentralized governance means and what such gov- governance. ernance might look like in practice. At a glance, it may seem strange to conceive of governance as potentially decentral- ized, which is essentially the practice of allowing employ- Decentralized governance theory ees to ‘govern themselves.’ Yet, self-governance, far from We now arrive at the crux of our theoretical argument. The challenges of modern governance just reviewed are, again, inherent to hierarchical forms of organizing. However, as 4 These virtues are not ubiquitous or universal, and there is scope for our theoretical analysis has shown, hierarchy is not the only centralization also (Cummings, 1995; Foss & Klein, 2022). Decentralizing corporate governance? A praxeological inquiry 423 an absurdity, is in fact thought to be economically efficient a hefty annual subscription fee. Subscription also meant (Barzel 1987). agreement to abide by common rules of order, with fines In decentralized governance systems, the rules of gov- levied on rule-breakers. Because some were uncoopera- ernance are emergent rather than imposed. Members of the tive with the new rules, the group was disintegrated and organization voluntarily agree to the rules and are able to a new exclusive exchange, the LSE, was formed. Because propose revisions. Such rules are ‘softer’ than top-down gov- its rules were self-enacted and self-enforced, various rules ernance, as the body of members attend to the ‘spirit of the were tried and scrapped until it codified its rulebook in law’ rather than to the minutiae of codified rules. This allows 1812. In 1877, the government recognized that the LSE’s for some variance in rule abiding. Questions and concerns decentralized self-governance was ‘capable of affording about rules and rule breaking are brought before the entire relief and exercising restraint far more prompt and often organization or else a designated committee to determine an satisfactory than any within the read of the courts of law’ appropriate ruling. (quoted in Stringham 2002: 13). Policing of the rules is done by the group members themselves. In some cases, the self-reporting of viola- The Maghribi traders tions may be encouraged through leniency mechanisms. For example, some regulatory agencies offer reduced pen- Another interesting example is the 11th Century Maghribi alties for voluntary disclosure of regulatory violations, Traders’ Coalition (Greif 1989, 1993). During the Middle which lower policing costs (Short and Toffel 2007; Tof- Ages, trade across the Mediterranean regions was fraught fel and Short 2011) and tend to result in more effective with peril. Land shipping was slow, and sea shipping was remediation (Innes 1999). Rather than risk discovery and risky. Storms were a severe threat, as was piracy. Further- the more severe consequence it entails, some may instead more, it was easy for a hired shipping agent to simply steal voluntarily disclose their misbehavior. However, much of the goods—they could easily claim the goods were lost or the policing and enforcement of rules would be done by stolen. There was at best a crude legal system that was inca- constituent members of the organization. Impetus for such pable of policing and prosecuting such malefactors. Thus, policing efforts is not just preservation of the organiza- traders would personally accompany their goods on such tion’s resources but also the maintenance of the organiza- journeys, costing them dearly in productive time. It was this tion’s integrity and reputation. Penalties for rule breaking inefficiency that the Maghribi coalition addressed: would vary according to the severity of the infringement, The Maghribi traders overcame the contractual prob- ranging from internal discipline, to expulsion and profes- lems associated with agency relationships by organ- sional ostracism, to legal prosecution. izing such relationships through a nonanonymous organizational framework, the coalition. Within the coalition an internal information-transmission system The London stock exchange served to balance asymmetric information and a repu- tation mechanism was used to ensure proper conduct. As a compelling exemplar of self-governance, Stringham This reputation mechanism explains the observed (2002) offers the history of the London Stock Exchange ‘trust’ relations among the traders. The ‘trust’ did not (LSE). After an act was passed in 1696 ‘To Restrain the reflect a social control system or the internalization of Number and the Practice of Brokers and Stockjobbers’ norms of behavior (although these factors play a role (ibid: 5), a number of London’s quickly growing stockbro- in any economic system). Rather, the Maghribi traders kerage profession began to skirt the new law by leaving the established a relationship between past conduct and Royal Exchange and participating in informal exchanges, future economic reward. As a result, agents resisted often in coffeehouses. Outside of the formal regulations of the short-term gains attainable though deception, since the State, informal market governance practices began to the reduction in future utility resulting from dishon- emerge to deal with the presence of fraudsters and default- est behavior outweighed the associated increase in the ers. The first self-governance mechanisms entailed shun- present utility. Since this fact was known beforehand to ning and banning of defaulters, but its enforcement over all traders, agents could acquire a reputation as honest time was difficult. In an attempt to better exclude default- agents. (Greif 1989: 881) ers and fraudsters from the profession, the more reputable brokers formed an exclusive club in 1762. After an ousted The trade coalition did not operate with a top-down hier- member brought suit against the club, the group was forced archical governance structure, but self-policed with repu- to open admission to any who paid a daily fee. But it was tation and trust penalties or even, when necessary, expul- soon realized that the daily fee was not enough to keep out sion and ostracism. As a result, it enjoyed a high degree of disreputable brokers, so the group began to instead require reliability and strong reputation, putting them at significant 424 S. L. Mitchell et al. advantage in the shipping industry, for an enduring period systems and mechanisms that agents actually use, leaving of time. governance gaps that are opportunities for misbehavior. If governance is decentralized, agents far more familiar with Decentralized governance and agency and knowledgeable of those systems can place that indi- and knowledge problems vidual knowledge toward better oversight, reducing or elimi- nating those gaps that centralized governance audits so often To theoretically validate the promise of decentralized gov- overlook. ernance, let us reconsider the principal-agent problem and other Hayekian knowledge problems through market organi- Decentralization and governance innovations zational mechanics. In any multi-person collaborative sys- tem (collective, cooperative, market, hierarchy), there are One of the more interesting features of decentralized gov- knowledge asymmetry problems. In collectives and coop- ernance is that the ‘softness’ of established rules allows for erative, as previously reviewed, these asymmetries tend to governance innovations. Hayek (1978, pp. 62–63) explains: result in a tragedy of the commons. In hierarchies, these There is an advantage in obedience to such rules not can manifest as principal-agent problems as well as other being coerced, not only because coercion as such is systemic flaws that result in opportunities for corporate bad, but because it is, in fact, often desirable that misdeeds. rules should be observed only in most instances and For markets, however, knowledge asymmetry problems that the individual should be able to transgress them are largely mitigated due to the maintaining of autarkic when it seems to him worthwhile to incur the odium rights to property, production, and self-governance, with which this will cause. It is also important that the intersubjective governance by mutual agreement or govern- strength of the social pressure and of the force of ment. As a result, each individual’s distinct knowledge is habit which insures their observance is variable. placed at that individual’s own behest, their utility maxi- It is this flexibility of voluntary rules which in the mization efforts further bolstered by mutually beneficial field of morals makes gradual evolution and sponta- exchange. Not all such asymmetries are thus mitigated, how- neous growth possible, which allows further expe- ever—intellectual property protections and lemons problems rience to lead to modifications and improvements. (Akerlof 1970) can leave persistent inefficiencies. Yet, in Such an evolution is only possible with rules which Akerlof’s used car example, even these asymmetry prob- are neither coercive or deliberately imposed—rules lems have been largely mitigated over time with innovative which, though observing them is regarded as merit market solutions. and though they will be observed by the majority, Internally to organizations, decentralization of govern- can be broken by individuals who feel that they have ance produces many of the same benefits, but only to the strong enough reasons to brave the censure of their extent that organizational agents are motivated to optimize fellows. Unlike any deliberately imposed coercive the organization’s governance. As with the LSE and the rules, which can be changed only discontinuously Maghribi traders, market competition typically provides and for all at the same time, rules of this kind allow this impetus. Stakeholders are incentivized to mitigate mis- for gradual and experimental change. The existence conduct within the organization so that it can effectively of individuals and groups simultaneously observing compete in the market and preserve its long-term financial partially different rules provide the opportunity for prospects, and thus their own financial stake. Misconduct selection of the more effective ones. undermines competitiveness and can sully the organiza- tion’s reputation. While such behaviors may be appealing to As a result of such flexibility and the innovations it individual agents with little personal stake in the organiza- affords, decentralized governance is expected to improve tion’s long-term success, those in the organization that have its governance practices over time, as the history of the a greater stake are incentivized to protect their organization LSE exhibits. from such malefactors. The success of decentralized govern- Certainly, it is possible for centralized governance to ance, then, hinges on the benefit and interest of agents in the innovate also. But, like centralized production decisions long-term viability of the organization. (Burgelman 1983a, 1991; Ouchi 1977, 1980), innovative- The primary advantage of governance decentralization is ness in governance is severely hampered by the bureau- that greater and more specific knowledge of the resources cracy of centralization, where new ideas are liable to be and access points can be employed in governance practices. shot down by upper-level managers wary of and resistant In typical centralized governance practices, managers and to change. Moreover, in centralized governance systems, auditors watch for standard signals of wrongdoing, these sig- new rules are imposed from the top, leaving the rule-mak- nals are often untethered from the specific resource access ing to regulators that often know very little of the systems Decentralizing corporate governance? A praxeological inquiry 425 that they regulate. Thus, changes to rules—such as the treatment in particular discusses the impetus for integrat- Public Company Accounting Reform and Investor Protec- ing activities within an organization’s hierarchy versus tion (Sarbanes–Oxley) Act of 2002 (Romano 2005; Zhang leaving or disintegrating such activities to the market—the 2007) and the Wall Street Reform and Consumer Protec- classic make-or-buy decision. Certainly, hybrid forms have tion (Dodd-Frank) Act (Bainbridge 2010; Dimitrov et al. been put forth that integrate components of both market 2015)—tend to be inefficient and ineffective. While such and hierarchical features within the firm (e.g., Foss 2003; inefficiencies in centralized governance systems tend to Makadok and Coff 2009). Also, there is growing interest in persist and, if anything, are prone to ‘correction’ through and practice of the decentralization of production activities increased complication, which tends toward exacerbation, in ‘flat’ hierarchies (Foss et al. 2015; Hempel et al. 2012; decentralized governance is more capable of correcting Klein et al. 2019). inefficiencies by abandoning bad rules and innovating bet- Yet, despite this growing interest and advocacy of ter solutions. employing a market order form within the firm for more optimal productive output, there has been no discussion of the possibility of such market orderings for the perfor- Discussion mance of the governance function. We have herein defined the function of ‘governance’ to be ‘to constrain, conscribe, Our aim herein has been to address the arms race between and regulate’ production to within ethical and strategic improving corporate governance and corporate miscon- boundaries, and to police and enforce those boundaries duct, both of which are growing in complexity and effec- (Mitchell et al. 2021, p. 14). As our analysis reveals, there tiveness. It appears that corporate governance is losing is nothing innately distinctive between the production and this race. governance functions that would make one more effec- tive via market order and the other via hierarchical order. ‘The recent spate of behavioral complaints against Instead, the advantages and disadvantages of these dis- senior corporate leaders has raised questions about tinct organizational forms are highly similar for both eco- board oversight of executive conduct and caught nomic functions. Thus, it is possible and even advisable numerous boards off guard. On a different front, in some (perhaps many) circumstances for governance to various companies have suffered serious breaches of be decentralized. cybersecurity that have exposed a lack of prepared- The decentralization of governance may seem somewhat ness and resulted in significant reputational damage; counterintuitive given the long-standing tradition of cen- others have been tripped up by data privacy concerns tralized governance. Are we really to expect employees to and are facing political and user backlash. Environ- govern themselves? Of course, at an organization level, a mental disasters, labor abuses in the supply chain, market economy is essentially defined in terms of allowing mistreatment of customers—these are other exam- firms to govern themselves—central (political) governance ples of the new breed of risk management issues that of economic production is the hallmark of a socialist politi- are consuming the attention of boards. The broaden- cal structure. It is also widely accepted that sole-proprietor ing menu of risks has created a challenge for tra- entrepreneur self-governance is possible. But we rarely see ditional practices of internal controls and is testing such decentralized governance as viable or even possible at the ability of boards to provide adequate oversight.’ an individual level within firms. This is likely due to prin- (Paine and Srinivasan 2019, p. 15). cipal-agent problems that are inherent to employment and To turn the tables and get corporate governance prac- which can undermine the incentive to self-govern in accord- tices in front of its malcontents, we will need a more radi- ance with the principal’s governance requirements. cal rethinking of standard governance practices. Certainly, the challenges of the principal-agent problem Toward this end, we have developed, through ration- are real and consequential, which may justify the use of hier- alist analysis, a theoretical framework that encompasses archy to monitor agent behavior. However, hierarchy as a the general array of socioeconomic ordering alternatives solution to the principal-agent problem brings with it other by which agents can structure and govern their produc- challenges, such as information asymmetry problems (Keil tive interactions. Perhaps unsurprisingly, the two domi- et al. 2004) and disempowerment problems (Hempel et al. nant socioeconomic ordering forms for economies of 2012). It is not altogether clear, then, that hierarchy is always many agents are markets and hierarchies (Williamson the best governance structure for even large organizations. 1973, 1975). What is interesting to us, however, is that As with incomplete contract theory (Grossman and Hart the virtues and challenges of these distinct socioeconomic 1986; Hart and Moore 1990), which argues that contracts ordering forms are almost always delimited at the bound- can never account for all contingencies, top-down govern- ary of the firm itself. Williamson’s (1973, 1975) classical ance is also always incomplete. There are endless possible 426 S. L. Mitchell et al. ways to skirt established rules and their enforcement. As a examples of decentralized governance warrant deeper sci- result, governance mechanisms have to adapt to ever-chang- entific examination. ing rule-breaking and are necessarily always lagging. Also, we expect that this research may cause a stir among As corporate governance practices continue to lag behind corporate governance scholars as we proffer new theo- innovative malefactors, what becomes revealed is that mis- retical foundations for the field. In some ways, our theory behavior is always an issue, first and foremost, of self-gov - rebuilding efforts through the praxeological method have ernance. Assuming that agents know and understand the confirmed (and better explained) long-standing theory on principal’s governance goals and standards, and those of the challenges of governance within the context of hierar- society (e.g., government regulations), misbehavior is always chical organization. Agency theory (Jensen and Meckling a case of some agent willfully contravening those standards 1976) in particular stands the test of deductive rigor, but for personal gain, broadly defined. Modern corporate gov - only for the hierarchical context. Our analysis reveals that ernance, then, is intended to catch or prevent such malefac- hierarchy is only one organizational option, and that internal tors after they have had a self-governance breakdown. market forms are viable, not only for organizing productive Recognizing this, decentralized governance theory seeks activities, but for performing the governance function also. to address (1) how to best improve employee self-govern- Thus, our efforts better theoretically contextualize prevailing ance and (2) how to most effectively catch self-governance governance research and open new avenues for additional breakdowns before they result in substantial resource mis- research. For example, we note with others (e.g., Foss 2003; allocations or losses. Regarding the former, we posit that Makadok and Coff 2009) that hierarchy and markets are ends governance decentralization proffers alternative ways to of a spectrum, with gradients between them. Hybrid govern- think of and motivate self-governance. In fact, we suggest ance forms, then, should be the subject of future research. that centralized governance may do much to undermine self- governance, much in the same way that overbearing political governments can undermine socioeconomic self-determina- Conclusion tion (Bylund 2016b; Easterly 2013; Holcombe 2018). Regarding the latter, decentralized governance theory Corporate governance theory is in a deep rut. Despite dec- suggests that centralized governance suffers from knowl- ades of significant and rigorous academic work, severe polit- edge asymmetries that may, if organized effectively, be par - ical and regulatory interventions in the wake of some of the tially mitigated by decentralizing governance oversight, to largest corporate scandals in world history, and widespread the lower levels of an organization’s hierarchy. As a result, corporate interest in misbehavior prevention, corporate mis- those closest to and most familiar with resource allocation behavior has remained surprisingly constant. Efforts to miti- processes can monitor the gaps in such processes and ensure gate such misdeeds have either been altogether ineffective the protection of those resources. Said differently, those clos- or else malefactors have been as innovative in misbehaving est to the resource allocation processes can best monitor as the overseers have been at detecting such misconduct. It those resources allocations to ensure no loss or leakage. might be time to fundamentally rethink standard corporate Centralized governance is, simply, too removed from those governance practices. specific processes to allow sufficient knowledge of whatever We have herein developed, through rationalist-deductive gaps there may be in the resource allocation process, which methodology, a refined and elaborated framework for under - present opportunities for misbehavior. standing governance practices. This framework implies that Space and scope constraints preclude us from pursuing market-type decentralization of governance is not only possi- an elaboration of what decentralized governance might look ble but may in fact be advantageous to traditional centralized like in practice—what are its primary governance mecha- governance practices, if effectively implemented. This is not nisms, what are the incentives that compel self-governance to say that all organizational contexts call for decentralized and peer monitoring, and how it might be most effectively governance—the most effective form and type of governance implemented. We leave such elaborations to future research. will expectedly depend on the type of organization. But it Fortunately, decentralized governance is not the eccentric is time we move on from a ‘gold standard’ view of central- meanderings of theoretical unrealism—there are various ized governance and to a recognition of a broader array of real-world examples of such decentralized governance in governance approaches that reflect the distinct advantages practice that may offer opportunities for inductive theoriz- and disadvantages of centralization versus decentralization. ing on and empirical testing of such practices and theories. 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International Journal of Disclosure and Governance – Springer Journals

Published: Dec 1, 2022

Keywords: Corporate governance; Agency theory; Knowledge asymmetry; Ownership; Management; Praxeological method; G30; G34; O16; B53; D82; D86

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Decentralizing corporate governance? A praxeological inquiry

Decentralizing corporate governance? A praxeological inquiry

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Decentralizing corporate governance? A praxeological inquiry

Decentralizing corporate governance? A praxeological inquiry

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