1 A Naturalistic Approach to the Theory of the Firm: The Role of Cooperation and Cultural Evolution Christian Cordes Evolutionary Economics Group November 2006

2 Introduction In many organizations, employees cooperatively contribute to their organization’s goals Why do employees identify with organizational goals? Do organizations depend entirely on motivating agents through their selfish interest? Our hypothesis: Firms are organizations within which a cooperative regime based on evolved social predispositions can be established.

3 A Naturalistic Approach to the Firm Processes of cultural transmission: - Evolution of corporate cultures - Learning biases Some behavioral dispositions: - Insights from cognitive science, psychology, anthropology, etc. - Social dispositions The role of the entrepreneur: - Theory of cognitive leadership - Socialization processes The method: - Recursion equations - Depicts the frequency of a cultural variant in a population

4 The Dual Inheritance Theory In human organizations, cooperation can emerge spontaneously The dual inheritance theory explains why humans are capable of large-scale cooperation A disposition for cooperation has evolved by a process of cultural group selection Culture can maintain intergroup variation that responses to groups selection: the conformity bias Groups with prosocial norms have an advantage over competing groups in this process

5 Cultural group selection set in motion a process of gene-culture coevolution Prevailing social transmitted institutions in a group exert selection on innate human social dispositions → evolution of a social psychology that facilitates cooperation This process also explains the evolution of moralistic strategies → altruistic punishment Biases in cultural transmission: –Inclination toward group-beneficial cultural contents –Inclination toward selfish or opportunistic behavior –A model-based bias

6 The Theory of Cognitive Leadership The entrepreneur plays an important role in the evolution of corporate culture Cognitive constraints: cues are employed to discriminate among information and are organized into cognitive frames (biases belong to these cues) A business conception provides a shared cognitive frame that coordinates employees’ activities and can build upon humans’ social predispositions A business conception can motivate people to contribute to a common goal instead of private interests Cognitive frames are implemented via social learning → group size effects and socialization

7 The General Model The general model is of the form: cultural evolutionary forces (biases). We observe two cultural variants, c “cooperative behavior”, and o “opportunistic behavior”. p denotes the frequency of c in the group Biases as cultural evolutionary forces: –A model-based bias –Two direct biases

8 Cultural Transmission and Socialization (1) (2) - The entrepreneur’s influence is represented by: - The weight of a member of the peer group is given by: - The relation represents the entrepreneur’s charismatic potential

9 Peers Table 1 The probability of agents acquiring trait or given a particular set of models that have different total weights (,). ………… 0 Entrepreneur/Leader Cultural Variant of Probability That an Agent of the New Cohort Acquires Cultural Variant

10 -The partial recursion for the socialization phase: (3) -The partial recursion for the individual learning phase: (4)

11 -The complete recursion: (5) (5a) -The equilibrium frequency of c: (6)

12 -The derivative of with respect to n is negative for all n → given a certain charismatic potential of the entrepreneur, the level of cooperation within a firm is decreasing with firm size -The derivative of with respect to is positive → the larger an entrepreneur’s charismatic potential, the higher the level of cooperation in the group for fixed n

13 The Firm’s Growth Process -A recursion for the firm’s growth process: (7) Profit due to cooperation Loss due to opportunism

14 The dynamic system Two coupled recursions describe the development of p and n in time: (8) (9)

15 -The equilibria in the case of symmetrical profits and losses: (10)(11) - Substituting (11) into (10) gives us: - The equilibrium atand is stable.

16 -The equilibrium’s properties: If p<0.5, the number of group members will decrease until p reaches 0.5 and n stabilizes As long as p>0.5, the firm grows, until the decreasing influence of the entrepreneur causes p to fall to 0.5 A high value of shortens the firm’s growth process when p>0.5 and accelerates its decline when p<0.5 and vice versa

17 -Dropping the symmetry between and yields: (12) and (13) - If is large relative to, the firms’ numbers of employees are large and the frequency of cooperative agents is low. - If is relative large, the firms’ sizes are small and the level of cooperation is high.

18 Some Implications for the Theory of the Firm Given a certain charismatic potential of the entrepreneur, the level of cooperation is decreasing with firm size. Depending on this potential, firms have different growth potentials – a cognitive constraint to firm development. At this point organizational innovations are required → monitoring regime or subdivided entrepreneurship

19 Proposition 1: An entrepreneur’s capability to convey a business conception to a firm’s employees is subject to cognitive constraints. As a result, in the course of a firm’s growth process, the level of cooperation is decreasing. Contingent on the entrepreneur’s charismatic potential, firms have different growth potentials in this stage of their existence.

20 Proposition 2: If an entrepreneur’s charismatic potential is insufficient to sustain firm growth, the firm’s stagnating final size mainly depends on the relative strength of the learning bias favoring the opportunistic cultural variant.

21 Proposition 3: If the costs of opportunistic behavior are high, firm size stays small, thereby facilitating a higher level of cooperation within the group. If these costs are low, relatively few cooperative employees can support a large firm.

22 If the costs of opportunistic behavior are high, then firm size stays small – collectively shaped cognitive frames enable a high degree of cooperation in small groups In this case, cognitive leadership can keep in check potentially costly opportunism A side remark: these findings differ from those in transaction cost based analyses of firm sizes.

23 Proposition 4: In her prominent role as a social model, an entrepreneur’s general behavior influences the evaluation and subsequent dissemination of cultural variants with the firm. A business conception that explicitly emphasizes the selfish purpose of the firm, for example, one that is solely focusing on profits, may also foster the concept of selfishness within the firm or group. The firm’s engagement in social or environmental responsibility can assign a higher general value to cooperative and altruistic behaviors and the underlying cultural variants, thereby promoting their transmission.

24 Conclusions Why do firms exist? –Firms enhance the opportunity for entrepreneurs to inculcate their cognitive frame in employees compared to dealing with market buyers and sellers at arms length. –As regards the question of the relative efficiency of markets and organizations, an important element of the advantages of organizations such as firms is that they offer a more powerful setting to implement a regime of cooperation than market transactions could do.