Firm Governance in the Knowledge Economy Michael Dietrich and Jackie Krafft

Basic idea in 3 statements: 1.Firm governance appears to be complex and multi- faceted, and this complexity exists for sound reasons 2.Any analysis of firm governance that suggests a single, optimal set of structures and procedures is probably inconsistent with this empirical observation. 3.The fundamental issue involved with the complexity of firm governance concerns the management of knowledge as well as the management of authority. Paper unravels these issues.

Plan 1. Examine standard approach to governance (briefly). 2. Discuss why this should be questioned. 3. Consider the governance of knowledge as a major issue. 4. Present a general (and simple) framework that can account for governance diversity.

Standard approach to governance Agency theory: firms are accountable to shareholders Based on optimal incentives: executive remuneration structure and conduct of company boards effective market for corporate control Consistent with: Hart and property rights approach Williamson and transaction cost economics Efficient governance based on shareholder locus of authority

Diversity of governance in practice Shareholder locus of authority suggests a single approach to governance. Need not be inconsistent with empirical diversity. Different governance systems may be converging but institutional embededness of governance Paper goes further all governance systems are complex must be at least as complex as the environment it is controlling e.g. venture capital (start-up) funding in Anglo-Saxon systems not typically Anglo-Saxon

Governance failure illustrates governance complexity inadequacy of locus of authority reasoning not simply accounting failure Key issue: knowledge of company activity need not be transferable. Locus of authority governance requires knowledge transferability to shareholders Required to develop efficient incentives Indirect transferability possible if firms in an industry are similar Can ex-post observe industry characteristics and impute firm characteristics But with idiosyncratic firms average ex-post knowledge not useful for future firm activity: requires steady state reasoning

In the paper knowledge transferability is examined in detail: knowledge can be tacit knowledge can be part of an organisational system knowledge can be complex Undermines knowledge transfer to external owners. Need to consider locus of knowledge as well as locus of authority. With increased knowledge based activity reduces ex-ante knowledge transfer

To examine governance issues: two extreme possibilities: firm authority requirements low or high firm knowledge requirements low or high Authority = ex-post ability to respond to anticipated events (standard definition) Knowledge (not information) = need for ex-ante strategy development (consistent with recent writing) Low authority requirement = predictable world High authority requirement = unpredictable world Low knowledge requirement = follower firm High knowledge requirement = knowledge is a core strategic asset

2*2 matrix of possible authority & knowledge combinations Ex-ante knowledge requirement LowHigh Low Ex-post authority requirement High

Low authority and low knowledge: text book world Ex-ante knowledge requirement LowHigh LowMarket governance: arms-length contracting Ex-post authority requirement High

Unpredictable world & low knowledge traditional locus of authority reasoning emphasis on organisational hierarchy: efficient structure Anglo-Saxon governance manages ex-post coordination

Column defines NIE approaches to governance Ex-ante knowledge requirement LowHigh LowMarket governance: arms-length contracting Ex-post authority requirement HighLocus of authority: organisational hierarchy

Low authority & high knowledge ex-ante strategy development important environment is predictable Schumpeter and Galbraith world monopoly increases predictability technostructure is an organisational knowledge team cannot use a centralised hierarchy governance = stakeholder bargaining (Aoki)

Ex-ante knowledge requirement LowHigh LowMarket governance: arms-length contracting Locus of knowledge: organisational team; dynamic monopoly. Ex-post authority requirement HighLocus of authority: organisational hierarchy

High authority (& high knowledge) cannot ex-ante predict competitor strategies ex-post adaptation required Austrian theory of entrepreneurship adaptation reveals knowledge (High authority &) high knowledge Schumpeterian entrepreneurs Anglo-Saxon governance: venture capital funding required For large firms: interactive and cooperative organisational actors required if not interactive relationships: organisational turbulence

Ex-ante knowledge requirement LowHigh LowMarket governance: arms-length contracting Locus of knowledge: organisational team; dynamic monopoly. Ex-post authority requirement HighLocus of authority: organisational hierarchy Competitive entrepreneurial capability; corporate entrepreneurship

Brief conclusion It is possible to analyse governance diversity and complexity by recognising authority and knowledge issues. To reiterate: a governance must be as complex as the environment it is controlling. Merci Thank You