Business at a Crossroads Leadership_1 doc

32 BUSINESS AT A CROSSROADS
more precious than yours. His salary and emoluments, as stated in the
annual accounts, tell you that he is worth 80 times more to your
company than you are. His performance bonuses and the options he
has recently exercised make his net worth two orders of magnitude
greater than yours.
He’s from a different planet. Wealthy beyond dreams of avarice, he
lives a life of luxury, pampered by personal flunkies, surrounded by
courtiers and counselors, and casually running up expenses each
month that would keep you in clover for a whole year. The company
he keeps, in the rarified CEO atmosphere, also sets him apart. He
spends as little time with his company colleagues, as he does with his
family. His intimates (the people he talks CEO talk with) are wealthy,
external professionals (investment bankers and analysts, lawyers,
consultants and so on) dressed in the same tailored suits and hand-
made shoes, and wearing the mandatory Swiss watches costing as
much as a small car. His social life consists of hobnobbing with politi-
cians and journalists at sporting events and playing host to royalty at
concerts and charity galas.
He is a few years older than you and has a similar background, but
his life is as different from yours as the life of a medieval king was
different from that of a villein. He seems, somehow, to have found the
door to another world where the worth of its inhabitants is measured
by different standards.
We will explore the justification for and the implications of this striking
economic “class system” within large companies later. In this chapter, I
will explain why I think it emerged, and why it is (or has been until now)
generally accepted as the “natural order.” My explanation is evolutionary.
It takes us on a journey back in time to the origins of enterprise, long
before the company, as we know it, made its first appearance.
Business is natural

Business, trade and industry are manifestations of what Adam Smith
and the French physiocrats saw as “natural economic laws” embedded
in the logic of the human situation; of the need for shelter and suste-
nance, of the wish for warmth and convenience, of the ability to manip-
ulate and craft, and of differences in skills, aptitudes, experience and
environments. They have very little to do with “the company” as we
know it today, and for most of human history, they generated economic
activity without it.
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2 A FEUDAL HERITAGE 33
Smith argued that, while animals fend for themselves:
Among men … the most dissimilar geniuses are of use to one
another; the different products of their respective talents, by the
general disposition to truck, barter, and exchange, being brought, as
it were, into a common stock, where every man may purchase what-
ever part of the produce of other men’s talents he has occasion for.
1
Animals are not as self-sufficient as Smith supposed – we know now
that cooperation is quite common in the animal kingdom. But that
simply means his economic laws were more profoundly “natural” than
Smith knew. The hunger for wealth is more distinctively human, but
Max Weber believed it to be just as natural:
The impulse to acquisition, pursuit of gain, of money … has in itself
nothing to do with capitalism. This impulse exists and has existed
among waiters, physicians, coachmen, artists, prostitutes, dishonest
officials, soldiers, nobles, crusaders, gamblers and beggars … it has
been common to all sorts … of men, at all times and in all countries
of the earth, wherever the … possibil

ity of it is or has been given.

2
How these “impulses” were first expressed is shrouded in the mists
of pre-history, but business is probably as old as society itself, because it
is very hard to imagine how mankind could have emerged from the
caves without specialization, and the barter of goods and services. (The
first providers of professional services might have been the artists who
painted pictures of animals on cave walls and were given shares in the
kill in exchange).
Trade – exchanges of goods or services between, rather than within
tribal societies – came later. But it, too, was the consequence of innate
human dispositions, and the potential for win–win exchanges between
social individuals.
Matt Ridley tells the story of the Yir Yoront aboriginals who live at
the mouth of the Coleman river, on the York Peninsula, in north
Australia.
3
Until the 19th century, they were still Stone Age hunter-
gatherers with no crops, no writing, no money, no science and no
systems of government or law. (Or so it seemed to the white colonists
who first encountered them. As Karl-Erik Sveiby and Tex Skuthorpe
showed in their book, Treading Lightly – The Hidden Wisdom of the
World’s Oldest People,
4
Australian aboriginals developed very sophisti-
cated systems of government, law and leadership 60,000 or so years
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34 BUSINESS AT A CROSSROADS
ago. They have not been recognized as such, because they are very
different from their Western counterparts but, as we shall see later, they
may have much to teach us.)

The Yir Yoront used axes, with stone heads and wooden handles, for
cutting wood, digging, hunting and fishing, but lived 400 miles or so
from the nearest quarries. They could have walked south for the stone,
but there was no need. Plenty of axe heads reached them from the
tribes that lived near the quarries, through a line of trading partners
who passed them north, in exchange for spears tipped with stingray
barbs passed south through the same hands.
The trade developed, not because of a plan to make spears and swap
them for axes, but because of differences in price.
A Yir Yoront could exchange y axe heads from a neighboring southern
tribe for x spears, and sell y axe heads to a northern neighbor for more than
x spears. Because there was profit in the arbitrage, the axe heads moved
north and the spears moved south automatically. The trade emerged spon-
taneously from the “natural economic law” named, by the 19th century
economist David Ricardo, the “Law of Comparative Advantage.”
No human gene codes for trade. The potential for trade exists when
different people value tradable goods differently, have different abilities,
and command different resources. The potential will be realized when
beings smart enough to see profit in the differences begin experi-
menting. When mutually profitable trades were seen to have occurred,
the trade “meme” (a term coined by the evolutionist Richard Dawkins
to denote a unit of memory
5
) spread all over the world.
Early trade
6
Salt and stone may have been the first “traded” goods. The Chinese are
thought to have boiled brine in small pans of saline soil from desert basins
more than 4,000 years ago. Obsidian (a dark volcanic glass formed when
molten rock reaches the surface and hardens too quickly to crys t

allize) is
a unique indicator of trade, because it was widely used by early peoples
for weapons and cutting tools and contains trace elements that identify
its origins. Recent studies have shown it was being traded by hunter-
gatherers during the late glacial period 15,000 years ago. The Mayas
were still using it in the 16th century. David Landes says that when the
Spanish invaders first encountered them in the Yucatán the Mayas “did
not know hard metal … but they had weapons – slings, poison darts,
clubs set with razor-sharp pieces of obsidian.”
7

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2 A FEUDAL HERITAGE 35
By 3000 bc the Euphrates river was a busy trade route transporting
semi-precious stones, baskets and carpets between Iraq and Egypt.
Sargon of Akkad, conqueror of the Sumerian city-states, spoke of ships
laden with goods moored outside his capital in 2370
bc. The Canaan-
ites, the indigenous people of the Levant, were trading with Egypt in
the early Bronze Age, using donkey caravans.
As the civilizations of Sumer, Assur, Nineveh and Babylon rose and
fell, new markets in slaves, food, wine, wool, livestock, metal and wood
developed in Iraqi ports, the organization of donkey caravans improved
and trading ships steadily increased in size.
The precursors of companies
As a legal form, the company can be traced back to Roman times and
company-like bodies were often used to organize monasteries, craft
guilds and universities in the Middle Ages. But, as R. H. Tawney noted,
“pecuniary transactions were a fringe on a world of natural economy”
in medieval times, and “there was very little large-scale organization.”

The typical craftsman was a “master,” employing two or three jour-
neymen and apprentices.
8
The craft guilds, the immediate precursors of companies, were not
much admired, either then or later. “They were first and foremost, monop-
olists,” according to Tawney, “and the cases in which their vested interests
came into collision with the consumer were not a few.” John Wyclif, the
14th century religious reformer, did not mince his words: “all new fraterni-
ties and guilds made of men seem openly” to conspire “to bear up each
other … and oppress other men in their right by their wit and power.”
Wyclif’s invective against corporations and guilds had a religious and
an economic rationale. He claimed associations for mutual aid were in
the first place unnecessary, because people were already obliged by
God’s commandments to help each other, and in the second place were
a conspiracy against the public.
Such criticism has haunted the company ever since. It was used in
the 16th century as an argument for state control of industry and
commerce and, with the market’s “invisible hand” substituting for
“God’s commandment,” by Adam Smith and others as an argument for
free competition.
Trade declined after the Roman Empire fell, but resumed its growth
in the Middle Ages. It was further stimulated by the appearance of
much larger ocean-going ships in the 15th and 16th centuries. New sea
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36 BUSINESS AT A CROSSROADS
routes between Europe and the East reduced the prices of Asian imports
and merchantmen gradually replaced caravans.
The discovery of the Americas led to trade in tobacco and wood and
Spain’s imports of gold, silver and precious stones from Mexico and
Peru stimulated trade in the other direction, by giving Europe commod-

ities in demand in the Far East.
As long-distance trade grew, merchants began to experiment with
new forms of organization. In Holland it became common after 1500
for “shareholders,” rather than captains to own ships, because owning
“shares” in several ships allowed them to divide their goods among
vessels bound for different ports.
But it was not until the great voyages of discovery in the 16th and
17th centuries that an obviously corporate organizational form made its
appearance, and even then these proto-companies were barely recog-
nizable as the forerunners of modern companies. They were profit-
seeking, to be sure, but they were also the creatures and servants of
states, and states would later become their executioners.
They emerged from a new kind of commercial rivalry between
nations that developed in the 15th and 16th centuries, known as
mercantilism, in which competing states assumed such sovereign rights
over trade as they could secure through diplomacy and force.
But such rights were worthless until attempts were made to exploit
them. In the early 17th century European states privatized them by
dividing the globe into areas and selling exploitation rights, or “char-
ters,” to companies of merchants. The new chartered companies took
their original form from the medieval fraternities and guilds Wyclif had
railed against. There were two main types. In regulated companies, the
members had their own stock and traded at their own risk. In joint stock
companies, the members held a joint stock and earned profits (or incurred
losses) in proportion to their shares.
The regulated company became extinct as a corporate form, although
one can see a remnant in the highly regulated utility companies of the
present day. The joint stock company, however, was eventually to evolve
into the most dominant form of business organization the world has
ever seen.

The trade of a joint stock company was managed by “directors,”
who were subject to the control of a general court of proprietors (the
modern general meeting). But as Adam Smith pointed out:
the greater part of those proprietors seldom pretend to understand
anything of the business of the company; and when the spirit of
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2 A FEUDAL HERITAGE 37
faction happens not to prevail among them, give themselves no
trouble about it, but receive contentedly such … dividends as the
directors think proper to make them. This … exemption from
trouble and from risk, beyond a limited sum, encourages many
people to become adventurers in joint stock companies, who
would, upon no account, hazard their fortunes in a private
co-partnery. Such companies, therefore, commonly draw to them-
selves much greater stocks [capital] than any private co-partnery
can boast of.
(This quality of the joint stock company would be characterized by
Berle and Means 200 years after Smith described it, and after the insti-
tution had become ubiquitous and dominant, as the “divorce of owner-
ship and control” – see Note 12, Chapter 3.)
Smith conceded that the joint stock company had a role to play in
trades such as banking, insurance and water engineering, where the
operations can be “reduced to what is called a routine, or to such a
uniformity of method as admits of little or no variation.” It didn’t seem
to occur to him that the “division of labor” he advocated would greatly
extend the variety of trades in which the operations could be “reduced”
in this way.
But that was much later. It would take another three centuries for
the joint stock company to achieve the dominant position it enjoys
today and it would acquire, during this long apprenticeship, some char-

acteristics that have become liabilities in our own time.
THE ENGLISH EAST INDIA COMPANY
In December 1600 England’s Queen Elizabeth I granted a charter to
“The Governor and Company of Merchants of London Trading into
the East Indies,” conferring a trading monopoly in Asia, Africa and
America, the only restriction on which was that the company should
not contest the existing trading rights of “any Christian prince.”
The new company was managed by a governor and 24 directors,
chosen from its wealthy, aristocratic stockholders. In its early voyages it
ventured as far as Japan, but established its first “factories” (trading
posts, run by “factors”) in Madras and Bombay in 1610 and 1611.
Having absorbed several rivals and acquired more rights from the
crown, the English East India Company (EEIC) established itself as a
major power in India at the end of the 17th century.
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38 BUSINESS AT A CROSSROADS
After the victories of EEIC officer Robert Clive, over the French at
Arcot in 1751, and Bengali prince Suraj-ud-Dowlah (perpetrator of the
Black Hole of Calcutta massacre), at Plassey in 1757, the EEIC became
the dominant power in India. All European challenge to its rule ended
with Clive’s defeat of the French at Pondicherry in 1761.
But military prowess was no defense against the consequence of the
EEIC’s position as the chartered holder of sovereign rights. Its charter
was renewed several times during the 18th century, but each time it was
obliged to make financial concessions to the crown. In 1773 the govern-
ment appointed Warren Hastings the governor-general of India and
greatly reduced the company’s administrative role. An India Depart-
ment of the British government was created by the 1784 India Act, to
assume political, military and financial control of the EEIC’s affairs, and
the company’s monopolies of the Indian and Chinese trades were

removed in 1813 and 1833 respectively.
The company continued to play a significant administrative role in
India until the Sepoy Mutiny of 1857–58, but the Act for the Better
Government of India of 1858 transferred its governmental duties to the
Crown and absorbed its 24,000 troops into the British army. On
January 1 1874 the company was finally dissolved by the East India
Stock Dividend Redemption Act.
It’s not known whether EEIC shareholders resented the govern-
ment’s withdrawal of powers from and dissolution of their company,
but it seems unlikely that senior EEIC “officers” raised objections.
Many became so fabulously rich, during their tours of Indian duty, that
they acquired the nickname “nabobs” (the English version of the Indian
nawab). Robert (later Lord) Clive, victor of Plassey, had amassed a
personal fortune by his 35th birthday probably unmatched by an indi-
vidual until our own time. His share of reparations for the Black Hole
of Calcutta massacre extracted after the battle of Plassey, was some £90
million in today’s money and that wasn’t the half of his wealth.
The “nabobs” exemplified a weakness of these early companies
which survives until this day – too much of the value they created
ended up in the pockets of the officers. Clive only became a signifi-
cant shareholder in the EEIC after he had amassed a huge fortune as
its employee. In modern parlance, EEIC officers imposed heavy
“agency costs” on shareholders, partly because the company was
operating too far away for shareholders to control its managers, and
partly because there was and there remains to this day a conflict
between the interests of the shareholders of a joint stock company
and the interests of its managers.
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2 A FEUDAL HERITAGE 39
The Abbé Morellet, a contemporary of Smith, counted 55 joint

stock companies for foreign trade formed in Europe since 1600, which
had failed, due to mismanagement, despite monopoly privileges. Smith,
the most perceptive economic observer of his age, regarded the new
species as a pernicious evil; a creature of the dark side of human nature;
a system for indulging in the sin of avarice by distorting the free inter-
play of market activity in ways that benefited the incorporators, at the
expense of potential competitors and society at large.
From mercantilism to capitalism
The early companies were the agents of mercantilist states, rather than
independent businesses, and most failed because politics too often
compromised their economics. But, although mismanagement and
nationalization took a heavy toll of the early joint stock trading compa-
nies in the 17th and 18th centuries, there were some survivors; the
Hudson’s Bay Company, for instance, and the joint stock system itself.
A brief history of the impressively adaptable Hudson’s Bay Company
(now owned by a U.S. private equity firm) will be found at the end of
this chapter. Adam Smith would have been astonished by its longevity,
but he was aware that it was different from the general breed of joint
stock trading companies that he so heartily despised. He approved of its
small size and modest ambitions:
a joint stock company, consisting of a small number of proprietors
with a moderate capital approaches very nearly to the nature of a
private co-partnery, and may be capable of nearly the same degree of
vigilance and attention.
He was referring to his famous and still relevant criticism of the joint
stock company, namely that its directors:
being the managers … of other people’s money … it cannot well be
expected that they should watch over it with the same anxious vigi-
lance with which the partners in a private co-partnery frequently
watch over their own.

These remnants of mercantilism lived to see the emergence of a new
economic order in which the joint stock company would eventually,
long after the Industrial Revolution was complete and, as we shall see,
more because of good luck than any inherent merit, find a new role.
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40 BUSINESS AT A CROSSROADS
Although not named by its arch-enemy, Karl Marx, until the mid-
19th century, the origins of modern capitalism date back to long before
Adam Smith’s description of its main principles in An Inquiry into the
Nature and Causes of the Wealth of Nations (1776).
Defined as a self-regulating system in which both land and capital
are privately owned, economic activity is coordinated through the inter-
actions between buyers and sellers (markets), and the owners of land
and capital and suppliers of labor (workers) are all free to pursue their
own interests, “capitalism” existed in a primitive form in a number of
ancient societies. It is, in a real sense, the natural system.
Full-blooded, industrial capitalism, which in our time has all but
vanquished its only serious challenger, communism, as a system for
coordinating economic activity is of European and particularly of
English origin. It was an adaptation of the mercantile capitalism
(mercantilism), which flourished between the 15th and 18th centuries,
to the opportunities and problems presented by industrialization.
Mercantilism embraced the principles of private property, and used
markets to coordinate economic activity, but, unlike capitalism, its focus
was the interests of the sovereign or state, rather than the individual
owners of economic resources. The concern of states in the mercantilist
era was to accumulate wealth in the form of gold and silver and, since
most nations lacked a natural abundance of such metals, the only way
to acquire them was through trade.
State governments controlled production and exchange and favored

low wages to discourage imports, encourage exports and so generate
trade surpluses with other states that would be paid for in gold.
Trade was fundamental to mercantilism and ships, from the “stately
Spanish galleon” of the second verse of Masefield’s poem, right up to
their final, mercantilist incarnation in the speedy and elegant tea clippers
of the late 19th century, were mercantilism’s primary instruments. Under
capitalism, ships assumed a humbler role as the servants of industry.
States abandoned mercantilism and embraced the new capitalism
when they realized that the real wealth of any nation was not its hoard
of gold, but its ability to produce goods and services.
The relationship between wealth and production, rather than wealth and
trade, was first explored by the physiocrats in France. In his Tableau
Économique (1758), François Quesnay traced a natural flow of money and
goods through an economy consisting of three classes: a productive class
(engaged in agriculture, fishing and mining), a proprietorial class (land-
owners and their dependants) and what he regarded as a sterile artisan class,
who merely “transformed” and circulated the output of the productive class.
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2 A FEUDAL HERITAGE 41
Quesnay and the other physiocrats, including Pierre Samuel du Pont
de Nemours and Victor Riqueti, also argued that there were natural
economic laws with which the state should not interfere.
The physiocrats’ attacks on the state interference associated with
mercantilism were later developed by Adam Smith into a rout of the
entire mercantilist system. Smith explained how the combination of
self-interest, private property and competition leads “as if by an invis-
ible hand” to an unintended end; the well-being of society.
He shared the physiocrats’ belief in a natural economic order that
works best when the state does not interfere, but took issue with them
on their assertion that only agriculture, fishing and mining created

wealth. Au contraire, he saw, in the transforming activity of Quesnay’s
“artisan” class, the division of their labor and the coordinating power of
free markets, infinite potential for wealth creation.
Thomas de Quincey, a friend of Wordsworth and Coleridge and
author of Confessions of an English Opium-Eater, identified two kinds of
literature: the “literature of knowledge” and the “literature of power.”
9

“The function of the first is to teach; the function of the second is to
move: the first is a rudder, the second an oar or a sail.”
An Inquiry into the Nature and Causes of the Wealth of Nations was an
example, perhaps even the exemplar, of the literature of power. Its illumina-
tion of the inherent dynamics of industry and commerce began to influence
government policy throughout Europe as soon as it was published. Apart
from what seem in retrospect to have been brief, 20th century flirtations
with modified forms of mercantilism (communism and socialism) advo-
cated by Karl Marx who gave capitalism its name, Smith’s descriptions of
natural economic forces have remained unchallenged and his policy prescrip-
tions have been generally heeded by Western governments ever since.
Smith had no time for the joint stock company, and would have
been amazed by the role it has come to play in the system he described.
But he, more than any other writer, established the philosophical
rationale the company needed if it was to transcend its origins as the
instrument of mercantilism and become the dominant institution of
industrial capitalism.
The Industrial Revolution
At the start of the Industrial Revolution the company was equipped
with two valuable and distinctive qualities – the ability to trade on joint
stock, and the beginnings of bureaucratic organization.
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42 BUSINESS AT A CROSSROADS
But it also had other qualities less suited to the very different circum-
stances of the Industrial Revolution. Because of their close links with
the crown, and their dependence on monopoly privileges in the crown’s
gift, the trading companies were owned and directed by aristocrats and
courtiers, rather than entrepreneurs. They did not need entrepreneurs
to farm their monopolies. And, because they were all “armed busin-
esses,” with many more military than civilian personnel, they inherited
the military class system that separated commissioned officers from
other ranks.
It was their possession of this power of officers in an ostensibly
wealth-creating enterprise that allowed Clive and the other nabobs to
indulge their impulse of acquisition so extravagantly. This was the origin
of an economic feudalism that survives to this day.
The joint stock company’s defects offset its advantages and denied it
more than a negligible role in the dramatic surge of industrial develop-
ment that exploded in the mid-18th century. The prime movers of the
Industrial Revolution were entrepreneurs and their families – the Darbys,
Huntsmans, Bessemers, Cadburys and others. Many were Quakers. The
family businesses and partnerships, such as the steam engine partnership
of Watt and Boulton, or the pottery partnership of Bentley and Wedg-
wood, were not what we would recognize today as companies.
The fact that some of these businesses assumed the form of, or were
absorbed by, companies subsequently doesn’t alter the fact that the
modern, industrialized world was created not by companies but by
entrepreneurs. By most accounts, the English Industrial Revolution was
complete by the time the modern company made its appearance.
An accidental birth
The large, limited liability, publicly listed joint stock company is so
firmly established that we take its dominance of the business world for

granted and rarely question the reasons for it. When we do, we tell
ourselves that it is natural, and was thus inevitable. Big is best in busi-
ness, so big companies achieved dominance.
But the use of the joint stock company for industry, as opposed to
commerce, is a recent innovation; much more recent than the use of the
unlimited liability partnership in law and accountancy. And the circum-
stances of the birth of this “industrial” version of the company do not
suggest the inexorable working out of some natural economic law. On
the contrary, the birth of the modern company was an accident, literally.
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2 A FEUDAL HERITAGE 43
The accident in question occurred in October, 1841, on the Western
Railroad in America, between Worcester and Albany. Some scheduler
had blundered and two passenger trains collided. A conductor and a
passenger were killed, and 17 others were injured. Although hardly a
disaster by modern standards, news of these first fatalities for the young
railroad industry caused great alarm. The Massachusetts legislature
launched an investigation and the Western appointed an internal
committee of inquiry.
In its “Report on Avoiding Collisions and Governing Employees”
the Western committee proposed, according to the company’s histo-
rian, “the assignment of definite responsibilities for each phase of the
company’s business, drawing … lines of authority and communication
for the railroad’s administration, maintenance and operation.” The
distinguished business historian, Alfred Chandler, argued that the
implementation of the committee recommendations created “the first
modern, carefully defined, internal organizational structure used by
an American business enterprise,” and in the process “the first
[company] … to operate through a formal administrative structure,
manned by full-time salaried managers.”

10

According to Chandler, the reformed Western Railroad was the first
example of the “multi-unit business enterprise” (MuBE); the modern
company.
But suppose there had been no accident. It would probably not have
occurred, if the telegraph had been introduced a few years earlier than
it was. What then? Was the emergence of the MuBE inevitable, or might
the evolution of business organization have taken quite a different path,
had the Western scheduler been more alert, or been warned of the
danger by the ring of a telegraph? We will return to this question in
Chapter 7.
The birth environment
When explaining why a particular life form came to be how it is,
evolution theorists talk of its “environment of evolutionary adapted-
ness” (EEA) – the combination of time and circumstances for which
it appears to have been “designed.” There is no designer, of course,
apart from chance and time, but adaptation often gives the illusion
of design.
Since no biological or organizational form can be adapted (except
by chance) to the present or future, the EEA of the modern company
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44 BUSINESS AT A CROSSROADS
has to lie in the past. It is, therefore, “unfit” for the present insofar as
its EEA differs in significant respects from the modern environment.
Adaptation is never perfect. Although we humans adopted an
upright stance five million years ago, we still endure the back prob-
lems and hernias that afflict four-footed animals when they walk on
the toes of their hind feet.
As the eloquent evolutionist Stephen Jay Gould put it:

Our world is not an optimal place fine tuned by omnipotent forces
of selection. [Each life-form] is a quirky mass of imperfections,
working well enough (often admirably); a jury-rigged set of adap
-
tations, built of curious parts, made available by past histories in
different contexts.
11
Each new species, biological and social, is a creature of its time
invoked into being by a particular set of circumstances that will never be
repeated. The company is a “jury-rig,” and the scale and nature of the
changes in its environment in recent years are such as to make one
doubt whether its “quirky mass of imperfections” will continue to work
well enough to maintain its dominance.
Chandler effectively described the company’s EEA when he explained
the MuBE’s emergence in eight propositions, which he summarized as
follows:
The visible hand of management replaced the invisible hand of
market forces where and when new technology and expanded
markets permitted a historically unprecedented high volume and
speed of materials through the processes of production and distribu-
tion. Modern business enterprise was thus the institutional response
to the rapid pace of technological innovation and increasing
consumer demand in the United States during the second half of the
nineteenth century.
But it was a response that carried a lot of baggage; a “quirky mass
of imperfections” accumulated over three centuries. Its bureaucracy
was designed for monopoly-farming, rather than for innovation. Its
structure was a hierarchy based on the military class system where
power was concentrated at the top. Its distribution of value added
bore the marks of a feudal world, where fabulous wealth co-existed

with grinding poverty.
9780230_230941_04_cha02.indd 44 09/09/2009 10:00
2 A FEUDAL HERITAGE 45
Medieval tournaments
We can now help the executive with whose musing on her own and her
CEO’s wealth and status we began this chapter. We can help her to
understand why, for example, a February 2008 study of 45 randomly
selected, publicly listed U.S. companies by The Wall Street Journal and
the Economic Research Institute found that executive pay rose by over
20 percent in 2007, revenues grew less than 3 percent, the median pay
of U.S. workers rose 3.5 percent to $36,140 (according to the U.S.
Bureau of Labor Statistics), and CEOs of the 45 companies studied
were paid, on average, $18.8 million.
Do the math – the average CEO was paid 520 times the median pay
of U.S. workers.
It’s because of the peculiar nature of the modern company; because
of “agency costs” imposed on owners by its over-mighty “officers”; but
most of all because its hierarchical structure, inherited from its military
precursors, leads to “winner-takes-all” competition.
Roger Federer, Lewis Hamilton and Tiger Woods are not rewarded
for their abilities as a tennis player, racing driver and golfer. They are
rewarded for winning. Winner-takes-all competitions shaped the social
and economic environment into which the company was born. Doughty
and skillful medieval warriors willing to risk their lives in their sover-
eign’s service in wars, were rewarded with land and titles. In peacetime
the crown’s patronage was also determined by physical prowess – by a
man’s willingness to risk his life tilting with a lance in jousting tourna-
ments. The distribution of land and power in medieval Europe was
assigned, not by ability in a general sense, but by the strength, aggres-
sion and reckless courage of men who hungered for wealth and status.

In economic theory, the rewards for work are based on more prosaic
criteria. They’re supposed to reflect the economic value employees add
for their employers. But there is a problem. You can measure the value
added by machine-tool operators objectively, by counting the pieces
they make, and you can pay them on piece rate. But the value added by
executives who don’t make things is hard to measure objectively.
Rewards in hierarchical organizations, therefore, are based, faute de
mieux, on “relative” rather than “absolute” worth, and their currency
is not pay rises, but promotions. The pay rises come later, as conse-
quences of the promotions.
Promotion is a winner-takes-all competition. The absolute worth of
the loser, if it could be measured, may be virtually identical to the worth
of the winner, but the winner will take all the enhanced status and pay
9780230_230941_04_cha02.indd 45 09/09/2009 10:00
46 BUSINESS AT A CROSSROADS
increase associated with the promotion. (It is also a competition open
to abuse, because it’s as much in the interests of competitors to sabo-
tage the candidacies of their rivals, as to promote their own. This is one
reason why there is so much of the back-stabbing, turf wars and politics
in large companies that many people find so distressing.)
But why should the winner’s reward be so enormous? It is not as if
executives take their lives in their hands when they compete for a CEO
job. The answer offered by Edward Lazear (former chair of ex-president
George W. Bush’s Council of Economic Advisors) and the late Sherwin
Rosen is that the purpose of the huge rewards of high corporate office
is to motivate people to seek them, and that this motivation will only be
effective if the rewards on offer are very substantial.
12
This is known as
“tournament theory.” Managers cannot be motivated by piece rate pay,

because their pieces cannot be valued objectively, but they can be moti-
vated to work very hard if the prize for the promotion that is the reward
for hard work is large enough. Or as Lazear himself put it, “The salary
of the vice president acts not so much as motivation for the vice presi-
dent as it does as motivation for the assistant vice presidents.”
13
Tournament theory means, therefore, that the remuneration pack-
ages of senior executives (salaries, share options, bonuses, pensions and
so on) are rewards, not for the work they do in their jobs, but for the
work they have done to get the jobs. This helps to explain why the
distribution of rewards in large companies is so compressed at the
bottom and extended at the top. Those who are already enjoying
substantial improvements in living standards, as a result of their latest
promotions, will need prospects of even greater rewards for subsequent
promotions if they are to remain motivated.
The idea of the diminishing marginal utility of money in classical
economics supports this expectation. The more money you have, the less
you value an additional dollar. In other words, the higher an executive’s
current rewards, the less eager he or she will be to compete for a $10,000
raise. Make that next raise $100,000 and you might get some action.
This also helps explain why already wide differentials are getting
even wider. All executives are getting richer, so they all value an addi-
tional dollar less and all require promises of even more at their next
promotions to remain motivated.
Simple versions of such winner-takes-all tournaments take place in
professional firms, when associates are put up for partnership. This is
the crucial career step for young accountants and lawyers, because, once
they are partners, their remuneration switches from salaries to profit-
sharing and large professional firms tend to be very profitable.
9780230_230941_04_cha02.indd 46 09/09/2009 10:00

2 A FEUDAL HERITAGE 47
This helps to explain the trend toward oligopoly (when the market
is dominated by a few large players) in professional services. The firms
have been getting larger over the past two decades or so, not just
because their corporate clients have been getting larger and more
global, as the professions themselves claim, but also because size
generates rich rewards for partners. The rewards of partners rise as the
ratio of partners to associates (professionals who are not yet partners)
falls. Partners favour growth, because it allows them to reduce their
partner/associate ratios, and so increase the proportion of value added
they share out among themselves.
As a prescription for motivating employees, “tournament theory” is
not compelling for several reasons. It encourages back-stabbing and
other kinds of destructive “system-gaming” behavior; it takes no
account of and so penalizes people who are not or not primarily moti-
vated by money; it leads to distributions of income and wealth that are
perceived by those inside and outside the organization to be unfair.
As a description of how value added is actually allocated in large
hierarchical organizations, however, it is much more persuasive.
The evolutionary puzzle
Why has it turned out like this? Why have companies retained these
medieval qualities, which impel ambitious people to devote most of
their energies and talent to fighting their way to the top (or as close to
the top as they can get) of company hierarchies? It’s not on the face of
it an efficient use of energy and talent.
Evolutionists will argue that it’s in our nature, or at any rate in the
nature of men, to be obsessed with status and power, in the same way
male chimpanzees compete aggressively with each other for the posi-
tion of alpha male. “It’s natural selection” they will say. Although it
might seem cruel and wasteful, it serves a vital evolutionary purpose;

the elevation of the best individuals [which is to say the “strongest” in
the cases of chimpanzees and medieval knights] to positions of domi-
nance, where they improve the stock by monopolizing females and
maximizing the dissemination of their superior genetic heritage.
Company hierarchy-climbing does indeed select a “best” and it is
undeniably a better “best” for business than physically strongest. But is
the best at climbing company hierarchies the best “best” for business?
Companies don’t serve the same evolutionary purposes as chimpanzee
hierarchies and medieval jousting tournaments. Their purpose is to
9780230_230941_04_cha02.indd 47 09/09/2009 10:00
48 BUSINESS AT A CROSSROADS
create wealth for their shareholders, not to elevate strong males to posi-
tions of dominance, where they can disseminate their superior genetic
heritage by claiming droit de seigneur.
Engaging in business is a creative, not a procreative activity. It is
competitive to be sure, but its competition selects, or should select (in
the Darwinian sense) those organizational forms able to create wealth.
If the fittest companies are the most creative, why do today’s dominant
business institutions concentrate power in the hands of people who
have proved most adept at climbing corporate hierarchies? Why have
other forms, that do not concentrate power in one person and in which
exceptionally creative people (engineers, scientists, designers, artists,
philosophers and so on) are accorded a higher status and given a freer
rein, so far failed to demonstrate their superior fitness and rendered this
medieval, military model of organization obsolete?
I have suggested, in this chapter, that part of the answer to this ques-
tion is time. The model survives, despite its denial of self-respect to
employees and its relative lack of creativity, because, although its origins
are very old, it is itself still young in an evolutionary sense. It’s still
colonizing business space liberated by the spread of liberal democracy

and is still consolidating its power locally, through privatizations, demu-
tualizations and other forms of incorporation. Fitter business models
have not had time to emerge and challenge its dominance.
The argument so far
The modern company is not as we would like it to be, but nor is it a crea-
ture of natural economic laws. It is a jury-rig, consisting of remnants inher-
ited from mercantilist institutions and military organization. It cannot,
therefore, be expected to be well adapted to the modern environment.
Seen in this way, the large company or, as Alfred Chandler called it, the
multi-unit business enterprise (MuBE), loses its appearance of permanence,
because a jury-rig can be re-rigged for a changed environment. How the
MuBE’s environment has changed is the subject of the next chapter.
Hudson’s Bay Company
Hudson’s Bay Company (HBC) was created in 1670, when Charles II of England
granted a charter to his Bohemian cousin and ally,
P
rince
R
upert, and 17 others,
giving them a monopoly over trade in the regions watered by streams flowing into
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2 A FEUDAL HERITAGE 49
Hudson’s Bay. In this vast territory, known as Rupert’s Land, the HBC was given the
power to pass laws, exact penalties for their violation, erect forts, build warships and
make war on, or peace with, the natives.
Although HBC’s monopoly went unchallenged for over a century, Adam Smith
recorded that, by 1776, the company only employed 120 people in “habitations which
they have honored with the name of forts.”
Th
ere was no need for any more, because

the trade, although highly profitable, involved no more than the barter of three or four
shiploads of British goods per year for a roughly equal weight of furs and skins.
The company’s formation provoked a conflict with the French, which escalated
into open war, eventually resolved by Britain’s conquest of Canada in 1763. This
made Rupert’s Land accessible by land, as well as sea, and trade increased dramati-
cally.
T
he company was hit by another outbreak of war with the
F
rench, but was
strong enough by then to carry the losses.
A more serious threat was the private trappers, who coveted
HBC’s fulsome
profits. In 1783, a group of speculators formed the North West Fur Company of
M
ontréal, and began to compete.
T
he companies merged in 1821 and their combined
territories were extended to the Arctic in the north and the
Pacific in the west. The
enlarged HBC acquired the sole rights to the trade in this area for 21 years in 1838.
At the expiry of the license in 1859, the trade monopoly was abolished and in 1869
R
upert’s
L
and was bought by the
D
ominion of Canada for £300,000 and a land grant
of seven million acres.
Part of the remnant of this once vast land empire was sold and the proceeds were

invested in other areas. During World War I, HBC operated a steamship line with over
300 vessels, shipping food and munitions to F
rance and Belgium.
E
arlier, in a fine
example of a
S
tephen Jay
G
ould jury-rigged adaptation “of curious parts, made
available by past histories in different contexts,”
H
BC turned its
H
udson’s Bay
Company
S
tores, a network of trading posts throughout northern Canada originally
serving the fur trade, into the Bay department stores chain. Some downtown
H
udson’s Bay Company stores were later transformed into boutiques.
The first department store opened in Winnipeg, Manitoba in 1881 and it was to
Winnipeg that the company’s head office moved from London, in 1970, on the
company’s 300th birthday. Later, when HBC expanded eastwards, head office func-
tions were moved to
Tor
onto in
O
ntario.
T

here are now four retail brands –
T
he Bay,
Zellers,
Home Outfitters, and Fields.
The company’s London warehouse, Beaver House, became the center of the
international fur trade and the fur trading business expanded outside Canada to
R
ussia.
T
he Canadian fur auction business was sold in 1987, however, and in 1991
T
he Bay stopped selling fur in response to pressure from animal rights groups. But
demand for fur persisted and The Bay fur salons were re-opened in 1997.
I
n recent years,
H
BC has diversified, through joint ventures, into credit cards,
mortgages and personal insurance.
After a prolonged battle, H
BC’s board agreed to recommend acceptance of a bid
for the whole company from minority shareholder, Jerry Zucker, a
South Carolina
9780230_230941_04_cha02.indd 49 09/09/2009 10:00
50 BUSINESS AT A CROSSROADS
billionaire, in 2006. Zucker was appointed “Governor” and CEO, but was succeeded
as Governor by his widow, Anita, after his death in April 2008. Two months later
NRD
C
E

quity
P
artners, owner of two American department store chains, announced
its purchase of the company.
F
rom an
E
nglish fur trapping company owned by a Bohemian prince in the late
17th century, to a subsidiary of a
U
.S. private equity firm in the early 21st century,
shows evidence of impressive adaptability.
References
1 An Inquiry into the Nature and Causes of the Wealth of Nations, Adam Smith, Ward, Lock,
1776.
2 The Protestant Ethic and the Spirit of Capitalism, Allen & Unwin, 1930.
3 The Origins of Virtue, Viking, 1996.
4 Karl-Erik Sveiby and Tex Skuthorpe, Allen & Unwin, 2006.
5 The Selfish Gene, Oxford University Press, 1976.
6 The next sections draw on An Unfinished History of the World, by Hugh Thomas (Hamish
Hamilton, 1979) and The Wealth of Nations.
7 The Wealth and Poverty of Nations, Little, Brown, 1998.
8 Religion and the Rise of Capitalism, John Murray, 1926.
9 “The Poetry of Pope,” North British Review, August, 1848.
10 The Visible Hand: The Managerial Revolution in American Business, Harvard University
Press, 1977.
11 The Flamingo’s Smile, W. W. Norton, 1985.
12 “Rank-Order Tournaments as Optimum Labor Contracts,” Edward Lazear, Sherwin
Rosen, Journal of Political Economy, October, 1981.
13 Personnel Economics for Managers, John Wiley, 1998.

9780230_230941_04_cha02.indd 50 09/09/2009 10:00
51
3 The steam-age
corporation
We have seen how the idea of trade and the dynamics of comparative
advantage emerged from the economic logic of the human situation.
Trade was a fire that, once lit, was sure to spread. Moreover, the trade idea
brought with it other ideas, such as “price,” “exchange rate,” “profit” and
“arbitrage.” Although not named as such until much later, all of these
ideas were understood and probably widely discussed in the Stone Age.
We have seen how the company evolved from the medieval guilds, and
took its place in the world of commerce alongside and sometimes in
competition with private adventurers and co-partneries. For a long time
it was less successful than either, despite its possession of monopoly privi-
leges granted by charter in its role as the agent of mercantilist states.
In his Pulitzer-prize-winning book,
1
Alfred Chandler suggested that
a new kind of company emerged in the U.S. railroad industry in the
mid-19th century when a military-style bureaucracy was added to the
joint stock limited liability model. The 1841 collision on the Western
Railroad and the recommendations for reform that followed led to a
period of organizational innovation in the U.S. railroads, from which
the “divisional line-and-staff” organization emerged as the standard.
The line-and-staff organization adds to the simple line management
system a staff department that supports and advises line managers. In
theory it has two separate hierarchies: departments in the line hierarchy
(manufacturing, selling and so on) generate revenue, and are respon-
sible for achieving the organization’s goals, while those in the staff hier-
archy (accounts, maintenance, HR, IT and so on) consume revenue

and support line functions. In practice, modern management jobs
usually have elements of both.
Chandler suggested that, by the outbreak of the American Civil War
in 1861, the “modern American business enterprise” had been born:
The needs of safety and then efficiency had led to the creation of a
managerial hierarchy, whose duties were carefully defined in organi-
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52 BUSINESS AT A CROSSROADS
zational manuals and charts. Middle and top managers supervised,
coordinated, and evaluated the work of lower level managers who
were directly responsible for the day-to-day operations.
Chandler called the new organizational form a “multi-unit business
enterprise” (MuBE) and explained its rise to dominance in the late 19th
and early 20th centuries with eight “propositions.” They amount to a
description of the large modern company’s EEA (environment of
evolutionary adaptedness).
This chapter uses Chandler’s propositions, with a modern commen-
tary on each, to examine the extent to which the environment of today’s
large company differs from its EEA, and thus describes the adaptive
challenges it currently faces. The modern commentaries should on no
account be interpreted as a criticism of Chandler’s book. In my view,
The Visible Hand is one of the best books about business (it is not
strictly a “business book”) ever written.
Why the MuBE emerged
Chandler’s first three propositions explained the emergence of the
MuBE – why it appeared when it did, and where it did. Insofar as they
no longer prevail, it is reasonable to question whether MuBEs would
have emerged in response to today’s business challenges.
Proposition 1
Chandler’s MuBE replaced small traditional enterprises whenever and

wherever:
■ The routinizing of transactions reduced transaction costs.
■ The linking of the administration of producing, buying and distrib-
uting units reduced information costs.
■ The internalization of many units permitted the administrative
co ordination of flows of goods between units, leading to more effec-
tive scheduling, more intensive use of facilities and personnel, increased
productivity, lower costs, more certain cash flow and faster payment.
Chandler believed savings from reduced information and transaction
costs were not nearly as significant as those from “administrative
co

or
dination,” which he saw as “the central function of modern business
enterprise.” In this he took issue with Ronald Coase, who had suggested
9780230_230941_05_cha03.indd 52 09/09/2009 10:01
3 THE STEAM-AGE CORPORATION 53
40 years before The Visible Hand was published that the reason why
integrated organizations had evolved was that, by suppressing the
internal price system, they saved the “transaction costs” that arose when
markets balanced supply and demand.
2
Coase’s ideas were later developed into a broad theory of the firm by
his student, Oliver Williamson. He suggested that: “The modern corpo-
ration is mainly to be understood as the product of a series of organiza-
tional innovations that have had the purpose and effect of economizing
on transaction costs.”
3
Williamson argued that transaction costs can be
large, because people are opportunistic, but not omniscient, and act in a

“boundedly rational,” rather than a purely rational way.
4
Williamson acknowledged that the reduction in transaction costs in an
integrated organization must be set against the growing “agency costs”
of management – the imperfect matching of supply and demand and
the tendency of managers to pursue their own ends (as did the English
East India Company’s nabobs – see Chapter 2) at the expense of share-
holders – as the organization grows. He saw the multi-unit company as a
solution to this problem, because its scale captured transaction cost econ-
omies, and the independence of profit centers controlled agency costs.
Modern commentary
Whether you are persuaded by Chandler’s view, that it was the cost
savings produced by administrative coordination, or the Coase and
Williamson view, that it was transaction cost economies, that gave the
MuBE its crucial competitive advantage over small, traditional enter-
prises, it’s hard to deny that the relative competitiveness of the MuBE
has been eroded in the past 30 years. Advances in information tech-
nology (IT) have reduced transaction and information costs in general,
and greatly increased the efficiency of markets, and thus the potential
efficiency of inter-firm coordination.
That many large, modern companies acknowledge this is demon-
strated by the growth of outsourcing in recent years.
Moreover, although pending the appearance of all-knowing
consumers and employees, rationality will always be “bounded” to
some extent, the impact of the internet on the availability of informa-
tion must have dramatically reduced transaction costs generated by
imperfect information.
Proposition 2
MuBEs required managers to assume the market’s resource allocation
role, if they were to capture the cost savings from internalizing the

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