Competitiveness Matters: Industry and Economic Performance in the U.S.

5. American Corporate Finance: From Organizational to Market Control

CHAPTER 5 American Corporate Finance From Organizational to Market Control William Lazonick and Mary O'Sullivan Industrial Development Over time, the innovation process and the learning process that is its social substance have become increasingly collective and cumulative, and hence organizational (O'Sullivan 1996; Lazonick and O'Sullivan 1996b). Our perspective on industrial development identifies organizational integration and financial commitment as the social conditions that permit collective and cumulative learning to take place. Organizational integration describes the social relations that provide participants in a complex division oflabor with the abilities and incentives to integrate their capabilities and efforts within organizations so that they can potentially generate organizational learning. Financial commitment describes the social relations that are the basis for the ongoing access of a business organization to the financial resources required to sustain the development and utilization of productive resources. In combination, organizational integration and financial commitment provide social foundations for innovative business enterprise. In terms of inputs into the production process, organizational integration supplies skills, and financial commitment supplies money. In contributing to the innovation process, however, these inputs are not commodities. They reflect the social relations to the business organization of people who supply skills and money. The generation of innovation through organizational learning is inherently uncertain. The investment strategy that will result in a higher quality, lower cost product cannot be known in advance. What one learns as the innovation process evolves changes how one conceives of the problems to be addressed, the possibilities for their solution, and therefore the appropriate investment strategy for continued learning. Learning may make possible the attainment ofends that were previously considered impossible, and a restructuring of the learning process may be required to achieve these ends (O'Sullivan 1996). 106 American Corporate Finance 107 In allocating resources to organizational learning, strategic decision makers must know what the learning process is generating if they are to take account of opportunities for, and threats to, innovative success that learning reveals. In the innovation process, strategic decisions shape the direction and structure of learning, and the knowledge continually generated through learning can inform strategy. For such a dynamic interaction of strategy and learning to occur, strategists must be integrated into the network of social relations that underlies the generation and transmission of organizational learning. If, instead, strategic control is exercised by decision makers who are segmented from the process of organizational learning, the ongoing innovative success ofthe enterprise will be jeopardized because decision makers will have neither the abilities nor incentives to promote that success. The financial commitment required to sustain organizational learning on an ongoing basis means that strategic decision makers must exercise organizational control over the revenues of the enterprise. In contrast, those who exercise market control over enterprise revenues will favor financial liquidity, not financial commitment (O'Sullivan 1996; Lazonick 1992). Placed in the perspective of the process of industrial development, the distinction between organizational control and market control has great practical importance for current debates over corporate governance and corporate employment . In all of the advanced economies, different groups are currently contending for control over the allocation of vast corporate revenues. In making their arguments for creating value for shareholders, the proponents ofmarket control rely on a theory that touts the efficacy of the market mechanism for the allocation ofresources to their best alternative uses. But their theory offers no explanation of how the best alternative uses come into being or change over time. Currently, the United States (along with Britain) is considered a bastion ofmarket control.1 Yet, as we shall show, market control over the allocation of corporate resources is a relatively new phenomenon in U.S. industrial history. Until the 1980s organizational control dominated in the allocation of corporate revenues, ensuring committed finance to U.S. industry. In the United States, the separation of stock ownership from strategic control during the first decades of this century entailed the transfer of strategic control from owner-entrepreneurs to salaried managers. This transition to organizational control, characterized by organizational integration within the managerial structure and financial commitment on the basis of corporate retentions, provided social foundations for the rise of the United States to international industrial leadership during the first half of this century. During the second half of the century, however, the overextension of the U.S. corporate enterprise into diverse business activities, the challenges of more innovative indus- 108 Competitiveness Matters trial enterprises abroad, and the...