Corporations in Evolving Diversity: Cognitions, Governance, and Institutions

Topics of pressing interest since the financial crisis of 2008 have been a reconsideration of the role of financial markets and the reestablishment of the fundamental relationship between financial and nonfinancial companies. The Tokyo Foundation’s Virtual Center for Advanced Studies in Institution (VCASI) has been conducting research into corporations to address this issue, one recent product of the project being this book, published by Oxford University Press. The following are excerpts from the book’s Introduction.

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Corporations are undoubtedly one of the most important societal devices that human beings have ever invented. Although the legal concept of corporations has been said to have originated in the Roman era, it was in medieval Europe that the corporation was initiated for various social functions and started to flourish in a variety of domains: religion, learning, politics, philanthropy, trade, and crafts.

Access to the corporate form was limited at this time to the elite, but this decentralized institutional innovation prepared “doorstep conditions” for Europe, allowing it to get one step ahead of other regions and to make an earlier transit to the modern democratic state and corporate economy.

As a reference point, a minimalist conceptualization of corporations can be verbalized as follows: Corporations are voluntary, permanent associations of natural persons engaged in some purposeful associative activities, having unique identity, and embodied in rule-based, self-governing organizations.

A corporation is a permanent entity that can do what individuals with limited biological longevity cannot do. The corporate ability to own property, backed up by the institution of share ownership and share transferability, makes the permanence of business corporations secure.

Actions, physical and cognitive, are also relevant, as corporations can organize associative activities among its members and can cognize and store what a mere collection of individuals cannot. The first prominent types of corporations that emerged in the early medieval period, such as universities and the Roman Catholic Church, were those founded for the encouragement and support of religion and learning. The primary functions of these types of corporations were to understand or interpret the world, accumulate, theorize, and bestow knowledge for future uses and advancement, and sustain culture as common knowledge.

The primary purpose of modern business corporations is to make money, not to learn. But even for them, the reasons why incorporation is vital for religious and learning activities are not entirely irrelevant. As knowledge use and creation (that is, innovation) become more important for the competitiveness of business corporations, this point cannot be overlooked.

Orthodox economic theory of contracts is premised on the idea that cognition can take place only within the mind of individuals, which lies at the heart of micro economics that theoretically supported the shareholder-oriented view of corporations in past decades. However, the recent development of experimental economics, cognitive neuroscience, and related areas increasingly provides evidence and theories that human cognition also takes place in more interactive ways at the group level. The way in which business corporations are organized as systems of associational cognition deserves no less attention than the financial aspects of the corporation.

The orthodox contract theory of the firm considers the human aspects of the business corporation only in terms of authority relationships between the management and the workers. This treats workers merely as “hands.” But in his classical treatise, Concept of the Corporation, Peter Drucker posited the idea of “knowledge workers” who can supply brains, not merely hands.

In a business corporation, cognitive activities, such as information collections, processing, uses, and storage are systematically distributed and interrelated between the management and the workers, as well as among the workers, while the investors supply cognitive tools to them. Such cognitive relations inside the corporate organization can be referred to as associational cognition.

If the potential importance of associational cognition is recognized, the questions that follow are: How are cognitions to be distributed and related among the members? How are they related to the system of tools of cognition, such as computers, the Internet, robotics, machines, digital files, and so on? Are the workers simply the bodily extension of the manager’s brain? Focusing on this aspect of corporate architecture appears to be particularly important in the era of information technology.

The question of what represents “purposeful activities” for a contemporary business corporation constitutes the crux of the matter we are concerned with: “What do corporations do?” Does it operate “exclusively for profit” as the shareholder-oriented view dictates or for something broader, as the stakeholder-oriented view claims. The proper answer theoretically depends on ways in which a system of associational cognition is architected in corporate organizations.

The shareholder-oriented model is one viable model under certain conditions, but there can also be another model that does not fall into the simplistic classifications of “management-oriented” (traditional American), “labor-oriented” (traditional German), or “state-oriented” (traditional French and Japanese). This model involves rather novel three-way relationships between management, workers, and investors, whose presence may grow with the rising importance of human cognitive assets in business.

It is telling that pre-business corporations, such as the Roman Catholic Church and municipalities, were not the immediate creations of the modern national state. They were voluntarily created, even though some of them needed the explicit or implicit approval of the rulers. As members of voluntary organizations, corporate participants must basically have consented to obey its own rather than any external authority.

This has implications for the inquiry into the nature of business corporations. We may inquire what kind of general rules for governance can be agreeable to and consented to by the constituent members of the corporation. Then we may ask whether those endogenous rules can be consistent with general rules prevailing in society. Without the first property, people would not participate in corporations voluntarily, while without the second property, corporations would not be sustainable in society. They are interrelated.

Social interactions are all games, regardless of whether payoffs are exclusively self-regarding, material-oriented, hedonistic, or otherwise. Those games recursively played in society can be called societal games, although there are different kinds of domains of play. Viewing the societal order as stable patterns of game playing has been expounded by many authors. I follow this tradition but try to go beyond a mere analogy by differentiating the discrete domains of societal games that embed corporate organizations—commons, economic, social, and polity—by discerning mutually distinct game forms and examining the interrelationship between those games and the organization games played internally within business corporations by their members, including workers.

One great advantage of the application of game theory is its ability to analyze mutual relationships between embedding society rules and corporate self-governing rules as stable outcomes of play, that is, as equilibrium phenomena, of the societal and organization games as linked.

“Equilibrium” refers to the stable and mutually reinforcing aspects of the societal order and its impacts on the structure of business corporations. However, nothing in the societal order is static in a strict sense. Business corporations adapt their associative activities in response to evolving market and society environments, while evolving corporate behavior impacts on the latter. The recent contributions of epistemic game theory suggest that in order for a stable societal order to evolve, something more may be needed, say, common backgrounds in information and inference, as well as various social cognitive categories, such as social symbols carrying some meanings, public propositions, such as laws and regulations acting as focal points for cognition, culture as common priors, and so on. In order to understand the basic nature of institutional evolution, the ironclad methodological individualism needs to be laid to rest.

Japan’s “Lost Decade” triggered by the 1992 burst of the financial bubble is a meaningful reference to the societal cognitive crisis than just the economic consequences of macropolicy and banking failures: That is, the state in which traditional rules could not be taken for granted any more. No consensus has yet emerged as regards what the new rules could be. Behind the crisis, the Japanese corporate landscape underwent a tremendous change, and it can no longer be characterized by a single “Japanese model” stereotype. This diversifying phenomenon is not necessary an isolated event limited to Japan, but there is a suggestion of similar phenomena evolving globally, albeit each one in a path-dependent, unique manner.

Evolving corporate diversity is not so much due to national characteristics but a ubiquitous phenomenon across economies exhibiting to differing degrees. It can thus be considered a product of global economic integration.

In order to derive the potential gains from the global process of a “convergence to diversities,” the global financial markets need to co-evolve as an infrastructure that will accommodate this evolutionary path, rather than exercise sovereign control over nonfinancial business corporations. The 2008 credit crisis revealed that relationships between financial intermediaries and nonfinancial business corporations are still uneasy. The painful process of a corporate recovery is to become a process of a search for a mutual fit between the two.

Link to Oxford University Press

Masahiko Aoki

  • Professor Emeritus, Stanford University