Social Aspects of Enterprise in the Large Corporation [Reprint 2016 ed.] 9781512803006

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SOCIAL ASPECTS OF ENTERPRISE IN THE LARGE CORPORATION

SOCIAL ASPECTS OF ENTERPRISE IN THE LARGE CORPORATION « by

G E O R G E B. H U R F F

Philadelphia

U N I V E R S I T Y OF PENNSYLVANIA 1950

PRESS

Copyright

1950

UNIVERSITY OF PENNSYLVANIA PRESS Manufactured

in the United

States

of

America

LONDON: GEOFFREY CUMBERLEGE OXFORD UNIVERSITY PRESS

PREFACE

H I S volume does not purport to deal with the full width or depth of its subject matter. To the contrary, it represents deliberate selection and limitation based on the premise that it is better to whittle part of a stick than not to whittle at all. Business leaders, judges, legislatures, and students of business still grope for adequate and workable concepts of the nature of business enterprise in the large corporation. If this brief study of a few aspects of the subject moves a small step toward the development of such concepts it has served its purpose. A specific limitation should be noted. Although this study was completed in the summer of 1947, conditions beyond the control of the writer have delayed publication nearly three years. During this interval, significant work in the field has been published. Although some of this work has been cited, the writer regrets that circumstances have not permitted more adequate attention to these contributions. Finally, the writer wishes to acknowledge a specific debt for skilled criticism and advice given during the development of this study by a friend and former teacher and associate— Professor Raymond T. Bye, of the University of Pennsylvania.

T

GEORGE B . H U R F F G A I N E S V I L L E , FLORIDA

February, 1950

CONTENTS

Chapter I.

Page

INTRODUCTORY AND HISTORICAL

II.

1

CORPORATE BIGNESS AND OWNERSHIP

13

III.

T H E SOCIAL FUNCTIONS OF ENTERPRISE

25

IV.

H U M A N RELATIONS IN CORPORATE ENTERPRISE

43

V.

T H E DIVISION OF ENTERPRISE AND T H E

CONCENTRATION

OF P O W E R VI.

THE

POSITION

67 OF DIRECTORS:

ATTORNEYS FOR

STOCK-

HOLDERS OR TRUSTEES FOR T H E INSTITUTION?

96

APPENDIX A N O T E ON S O M E IMPLICATIONS FOR ECONOMIC THEORY

122

LIST OF W O R K S CITED

128

INDEX

135

Chapter INTRODUCTORY

AND

I HISTORICAL

O

UT of the many-faceted problems accompanying the rise of the large quasi-public corporation, this study centers upon the locus and character of enterprise functions in this institution. Our purpose is to explore what is meant by enterprise and how it is divided and exercised in this setting. The corporation is looked at as a social institution, as a method of giving effect to cooperative and controlled purpose, and as an object of control in a society marked by rapid economic change. It is regarded as an institution for human organization importantly influencing and contributing to the lives and social relations of those who comprise its members.

Today there are three chief streams of thought concerning the large corporation. One is concerned with the character and consequences of monopolistic competition; especially its effect upon production, prices, and employment. These questions will not be dealt with here. A second current of thought fastens upon the large groups of people immediately affected by corporate actions together with the broad public consequences of these actions. This current of thought is concerned with the fact of concentrated economic power and seeks to render it more accountable to public as distinguished from private interests. A third stream of thought is directed toward the problems of safeguarding and asserting the stockholders' proprietary interest in the large corporation. In this study we shall deal with the second and third of these three problems. A s accountability to the proprietary interest preceded in time the development of the idea of public accountability, it is appropriate to follow the same sequence here. 1

2

SOCIAL ASPECTS OF ENTERPRISE

The relationships between the suppliers of corporate equity capital and those who directly control its use in the conduct of the corporation, that is, the correlative rights and duties between shareholders, directors, and executives, begin with the organization of the corporation and end with its dissolution. Although these relationships are importantly affected by the incidents attending birth, such as by-laws, articles of incorporation, the compensation of promoters, and the terms upon which the corporation securities are marketed, the focus of attention in this study is on the going concern. No attempt is made to deal with the specific phases of capital supply, with dissolution, receivership, and recapitalization, nor in fact with most of those elements commonly included in works on corporate finance. The nexus between shareholders and management has received scant attention from economists until recently. 1 In the afterwash of the depression years 1930-35, legislative hearings, judicial proceedings, and reorganizations uncovered an embarrassingly large number of instances of management negligent of, or faithless to, its fiduciary responsibility to shareholders, as well as outright fraud. Public concern, coupled with these disclosures, resulted in legislation as well as some critical literature dealing with this pathology of corporation management. 2 Study of the abnormal often contributes to an understanding of the normal in human and institutional behavior. Instances such as the McKesson and Robbins case, in which warehouses and inventories were merely the figment of a criminal imagination; or the English case involving the Royal Mail group of companies, headed by Lord Kylsant, which continued to pay dividends out of secret reserves and thus 1 Outstanding exceptions are two ground-breaking studies: W. Z. Ripley, Main Street and Wall Street; A. A. Berle, Jr., and G. C. Means, The Modern Corporation and Private Property. 2 See John T. Flynn, Graft in Business, Part II, as a superior example.

I N T R O D U C T O R Y AND H I S T O R I C A L

3

avoided disclosing the current unprofitability of operations; or the Ivar Kreuger case, in which security holders were robbed by the substitution of worthless for sound pledged assets owing to a strange complaisance and a purblind confidence on the part of those having a fiduciary duty to the investors; these and scores of other less notorious cases point to power unrestrained by adequate checks and balances. Pointing in the same direction, although the cases are in quite a different category, are those instances involving representative (stockholders') suits alleging excessive compensation to executives. The Bethlehem Steel Company and the American Tobacco Company litigation in the early 1930's are wellknown examples of this class of case. These are merely a few of the many different types of the abnormal, but they suffice to suggest the range. Such instances are not, of course, to be construed as characteristic of managerial responsibility in large corporations. On the contrary it should be stressed that the management of most large corporations is today composed of highly responsible men. Yet these pathological cases suggest the existence of institutional defects that economists have been slow to recognize. Lawyers seem earlier to have been concerned over these infirmities of the corporate institution, doubtless in part, because judges were obliged to decide litigation involving issues of corporation management. But their treatment has frequently been circumscribed by the legal point of view, chiefly directed toward the setting up of legal safeguards or securing redress for shareholders. These questions of institutional functioning and economic behavior clearly mingle the fields of economics and law.3 Economists have been prone to apply to the corporation the basic generalizations derived from their analysis of the relationships between the suppliers 3 The collaboration of lawyer and economist in the Berle and Means study recognized this overlapping.

4

SOCIAL ASPECTS OF ENTERPRISE

o f c a p i t a l a n d the i n d i v i d u a l business e n t e r p r i s e o r the partn e r s h i p . A l t h o u g h the v a l i d i t y of this p r o c e d u r e is o p e n to s e r i o u s question, v e r y l i k e l y it did r e l a t i v e l y little v i o l e n c e to the facts, a s long a s d i r e c t o r s a n d officers w e r e

substantial

s t o c k h o l d e r s , but it c o u l d n o t b e a p p l i e d to the l a r g e quasip u b l i c c o r p o r a t i o n in w h i c h o w n e r s h i p is w i d e l y diffused a n d the stake o f m a n a g e m e n t n e g l i g i b l e . How

Economists

Have

Viewed

the Large

Corporation

A d a m S m i t h , w r i t i n g at a t i m e w h e n the few c o r p o r a t i o n s o r joint-stock c o m p a n i e s that existed w e r e chiefly l a r g e enterp r i s e s e n g a g e d in f o r e i g n t r a d e , in which c o n t r o l a n d ownership w e r e l a r g e l y s e p a r a t e , c o n c l u d e d that these e n t e r p r i s e s would n e c e s s a r i l y be n e g l i g e n t l y a n d w a s t e f u l l y m a n a g e d : The trade of a joint stock company is always managed by a court of directors. This court, indeed, is frequently subject, in many respects, to the control of a general court of proprietors. But the greater part of those proprietors seldom pretend to understand anything of the business of the company; and when the spirit of faction happens not to prevail among them, give themselves no trouble about it, but receive contentedly such half yearly or yearly dividend as the directors think proper to make to them. This total 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 any private copartnery. Such companies, therefore, commonly draw to themselves much greater stocks than any private copartnery can boast of. . . . The directors of such companies, however, being the managers rather of other people's money than of their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own. Like the stewards of a rich man, they are apt to consider attention to small matters as not for their master's honour, and very easily give themselves a dispensation from having it. Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company. 4 * The Wealth of Nations, II, 232-33.

INTRODUCTORY AND HISTORICAL

5

John Stuart Mill, in his exquisite restatement and refinement of classical economics, viewed the corporate form with skeptical distrust. Indeed, he concluded that the defects of this form equal those of administration by a government officer: The third exception which I shall notice, to the doctrine that government cannot manage the affairs of individuals as well as the individuals themselves, has reference to the great class of cases in which the individuals can only manage the concern by delegated agency, and in which the so-called private management is, in point of fact, hardly better entitled to be called management by the persons interested than administration by a public officer. Whatever, if left to spontaneous agency, can only be done by joint-stock associations, will often be as well, and sometimes better done, as far as the actual work is concerned, by the state. Government management is, indeed, proverbially jobbing, careless, and ineffective, but so likewise has generally been joint-stock management. The directors of a joint-stock company, it is true, are always shareholders; but also the members of a government are invariably taxpayers; and in the case of directors, no more than in that of governments, is their proportional share of the benefits of good management equal to the interest they may possibly have in mismanagement, even without reckoning the interest of their ease. It may be objected that the shareholders, in their collective character, exercise a certain control over the directors, and have almost full power to remove them from office. Practically, however, the difficulty of exercising this power is found to be so great, that it is hardly ever exercised except in cases of such flagrantly unskilful, or at least unsuccessful management, as would generally produce the ejection from office of managers appointed by the government. Against the very ineffectual security afforded by meetings of shareholders, and by their individual inspection and inquiries, may be placed the greater publicity and more active discussion and comment, to be expected in free countries with regard to affairs in which general government takes part. The defects, therefore, of government management do not seem to be necessarily much greater, if necessarily greater at all, than those of managment by joint-stock. 5 Both Smith and Mill based their distrust of the corporate form chiefly on the ground that the actual managers lacked a 5

Principles

of Political

Economy,

chap. II, sec. 2, pp. 960-61.

6

SOCIAL A S P E C T S OF E N T E R P R I S E

sufficient personal stake in the enterprise. Without such a capital commitment, they believed that the management would necessarily lack a spur to diligent and zealous effort. There is no evidence that they anticipated conflicts of interest between management and owners, except insofar as the conflict existed between the managers' preference for the paths of least resistance as against the owners' interest in the most effective management of the enterprise. Alfred Marshall, writing in the light of the later nineteenth and early twentieth centuries' experience, observed with a gratified astonishment that modern English corporations were generally honestly managed, despite the temptations to defraud shareholders involved in the divorce of management and ownership. This result he attributed to a general improvement in business ethics.® Thorstein Vehlen regarded the development of the large corporation with widely diffused ownership as an exaggerated form of the genus "absentee ownership." He wrote: B u t there remains the competition between the captains of industry and these absentee owners in whose name and with whose f u n d s the captains do business. In the typical case, a modern business enterprise takes the corporate f o r m , is organized on credit, and therefore rests on absentee o w n e r s h i p ; f r o m which it follows that in all largescale business, the owners are not the same persons as the managers, nor does the interest of the manager commonly coincide with that of his absentee owners, particularly in the modern " b i g b u s i n e s s . " 7

Having other fish to fry, he contented himself with this statement of the dichotomy and the conflict of interest. Werner Sombart, discussing the "new leaders" in the advanced stage of capitalism, pointed out the tendency to separate the enterprise function from the possession of capital. 6 7

Principles of Economics, pp. 302-3. The Engineers and the Price System, pp. 125-26.

I N T R O D U C T O R Y AND H I S T O R I C A L

7

He saw " a movement away from the owner or single enterprise to the social enterprise, especially the corporation, and thereby from the owner enterpriser to the employed manager." 8 The Question of Motive Both Smith and Mill tacitly or expressly assumed the dominance of the pecuniary motive and relied upon it to call forth the maximum contribution of management. Marshall, on the other hand, in emphasizing the restraining role of business ethics, by implication left place for other motives that he did not stay to develop. Berle and Means have pointed out how the profit motive has become distorted in the large corporation. Insofar as profits induce investors to risk their capital, they fulfill their traditional role. But the authors press further and observe that if the courts, following the traditional logic of property, seek to insure that all profits reach or be held for the security owners, they prevent profits from reaching the very group of men (management) whose action is most important to the efficient conduct of the enterprise. Only as profits are diverted into the pockets of control do they, in a measure, perform their second function.

However, they go on to attenuate reliance upon this incentive to management by urging that the size of the "surplus profits" potentially arising from the large corporation is so great as to render the motivating influence of successive increments subject to rapidly diminishing returns. In concluding that the identification of effective motive is largely a matter of conjecture, they suggest that more could be learned of the motives that influence managers of large corporations " b y studying the motives of an Alexander the Great, seeking new 8

Das Wirtschaftsleben

p. 14.

im Zeitalter Des Hochkapitalismus

(Erster Halbband),

8

SOCIAL ASPECTS OF ENTERPRISE

worlds to conquer, than by considering the motives of the petty tradesmen of the days of Adam Smith." 9 Arthur Dewing, discussing the motives of corporate expansion, believes that corporation executives are motivated less by economic than by psychological impulses. He distinguishes four main motives: ambition, the creative impulse, profits, and speculation. 10 By ambition he means the desire for distinction—the craving for a place in the sun. Dewing attaches a special meaning to the term "speculation," using it to denote the enjoyment of pitting ability and knowledge against the uncertainties of business operation. But Dewing holds that, to management planning expansion, profit seeking is less a motive than a rationalization of one or more of the other fundamental psychological impulses. Profit seeking, since no other motive can sufficiently justify the investment of other people's money, is an argument held out as an inducement to investors to supply the funds. "They [the stockholders] are asked to contribute the stakes, while the managers play the game." 11 Since the executive, like other fallible human beings, is usually unaware of the psychological sleight of hand that gives ascendancy to motives other than this ostensible one, no hypocrisy is involved. Closely related to the vexed question of motive are the ideas that have been evolved purporting to identify the essential features of enterprise. They are closely related because these concepts involve express or tacit assumptions about the nature of the inducements to supply capital and services of direction to business undertakings. At this point our interest in these concepts is to note briefly their evolution within the setting of the single enterprise and the difficulties of adapting them to the framework of corporate enterprise. » Op. cit., p. 350. 10 The Financial Policy oj Corporations, pp. 854-57. » Ibid., p. 857.

INTRODUCTORY AND HISTORICAL

9

Concepts of Enterprise According to Frank H. Knight, "The essence of enterprise is the specialization of the function of responsible direction of economic life, the neglected feature of which is the inseparability of these two elements, responsibility and control."12 But the meaning attached to the term "responsibility" is not clear. Is it simply the staking of business reputation or is it participation in the hazard of money loss? If either of these meanings is accepted, where does this kind of responsibility reside in the modern corporation? Knight holds that meeting uncertainty is the salient feature of responsible direction. But to whom, in the large corporation, can the reality of these abstractions be jointly attached? It is suggested by Knight that "the nearest approach to an entrepreneur only would be a man who borrowed all the resources for operating a business and then hired a manager and gave him an absolutely free hand." 13 But elsewhere he observes that "such a person [the independent entrepreneur] typically furnishes both property and labor services to a business, meaning by labor services, personal activities which might be hired and paid for with a fixed wage."14 The former seems close to the usual concept of the promoter, the latter to the customary notion of the entrepreneur. If this concept is typical, it is so only of individual enterprise. Clearly, it does not describe the relation between property and managerial services in the large corporation. F. B. Hawley held a similar view, stressing "responsibility" and regarding control and risk bearing as inseparable.15 But 12 Risk, Uncertainty, and Profit, p. 271. 13 Ibid., p. 300. 14 Ibid., p. 305. It should be noted that Knight later mentions the splitting of enterprise in the large corporation. See "Profits," Enc. Soc. Sei., XII, 482. 15 "The Orientation of Economics on Enterprise," American Economic Review, XVII (1927), 409-28; Enterprise and the Productive Process.

10

SOCIAL ASPECTS OF ENTERPRISE

whatever the validity of these ideas in terms of their historic economic setting, it is evident that they are inapplicable to the large corporation of today, where the separation of these two elements is often nearly complete. In a paper specifically devoted to the "corporate entrepreneur," B. F. Lewis asserts that "typically the corporate entrepreneur will be located in the common stockholder." 16 His reasoning follows the paths of Knight and Hawley in looking for a recipient of profits and a bearer of uncertainty or risk who must be one and indivisible. C. A. Turtle's view that stockholders hire a captain of industry and his staff at a stipulated wage, and that he is responsible to them as the ultimate collective entrepreneur, is notable chiefly for its sublime unreality.17 Among economists writing in English prior to the appearance of Berle's and Means's work, Charles O. Hardy is distinguished by his explicit recognition that risk bearing, profit appropriation, and the exercise of control are in fact separated in the large corporation.18 Moreover, he pointed out that the association of this triad, summed up in the term "ownermanager," is the basis of much of our law of property as well as most of our orthodox economic theory: In fact, the whole modern organization of production through a separation of "entrepreneurs" from capitalists and laborers is grounded on the assumption that the risk of loss f r o m any undertaking can best be carried by those who are directly responsible for the policies which may bring about the loss, and conversely that the responsibility for control can best be exercised by those who c a r r y the burden of risk. Our whole tradition of the right of the individual business manager to freedom from outside interference is derived "The Corporate Entrepreneur," Quarterly Journal of Economics, LI, 537. 17 "The Function of the Entrepreneur," American Economic Review, XVII (1927), 13-25. 18 Risk and Risk-Bearing. 16

INTRODUCTORY AND HISTORICAL

11

from this conception, just as is our traditional acceptance of his claim to the entire profits of the enterprise. "Whatsoever a man soweth, that shall he reap also," is in theory the essence of the whole system of private property and free initiative. Partly because men are believed to work more efficiently when they themselves profit or lose as their enterprises prosper or decay, partly because we have felt it unjust for one man to suffer from the results of another's mismanagement, control of business has been delegated to the risk-bearing factor rather than the lending or laboring factor in the joint enterprise. 19 T h r o u g h o u t his discussion o f the r o l e of the e n t e r p r i s e r in distribution, h e c a r e f u l l y limited the s c o p e o f his a n a l y s i s b y e m p l o y i n g t h e p h r a s e " o w n e r - m a n a g e r " in p r e f e r e n c e t o " e n t r e p r e n e u r " b e c a u s e the l a t t e r t e r m h a s been loosely a p p l i e d to l a r g e diffused stock c o r p o r a t i o n s a s well a s c l o s e l y h e l d o r unincorporated

organizations,

with consequent

confusion.20

H a r d y c l e a r l y s a w the tenuous q u a l i t y o f the r e l a t i o n s h i p e x isting between s t o c k h o l d e r s in the l a r g e c o r p o r a t i o n a n d those who e x e r c i s e c o n t r o l : In legal theory, of course, the common stockholders are the ultimate owners of the business, assuming the primary burden of risk and exercising the final control, but in the case of large corporations whose stock has been distributed among investors the control exercised by most of these investors is wholly imaginary. Actually the control is exercised by the relatively small group—officers, creditors, or active stockholders, who are interested enough and have ability enough to exercise it, and the results of the control exercised by this group fall only slightly on themselves. The investor's reliance is primarily on their good faith and ability as witnessed by past performance, not on any close association between control and its consequences. 21 It is c l e a r that o u r present troubled c o n c e r n with c o r p o r a t e e n t e r p r i s e is not o f recent origin. T h e quasi-public c o r p o r a ls Ibid., p. 364. Ibid., p. 365, n.: "The essence of entrepreneurship is the union of control and risk-bearing; in a public corporation these are not united." 20

21

Ibid., p. 365.

12

SOCIAL ASPECTS OF ENTERPRISE

tion played a minor role in economic life during the time of Smith, Mill, and even Marshall's earlier years, and so did not long detain their attention, yet each expressed his distrust. The basic nature of the problem is inveterate; what is new is its magnitude and its ramifications.

Chapter II CORPORATE BIGNESS AND OWNERSHIP

INCE Brandeis assailed some of the curses of bigness thirty-odd years ago, the ascendancy of the corporate form of business organization in the economy has been clearly established, and the concentration of corporate wealth has proceeded apace. Thorp, in testimony before the Temporary National Economic Committee, estimated the volume of business done in 1937 by all corporations (numbering fewer than 500,000) to be 6 0 % to 6 5 % of all business activity.1 In the same year the total business population numbered roughly two million concerns.2 Berle and Means, in The Modern Corporation and Private Property, first showed the dominant position of the large corporation in their extensive study of the 200 largest nonfinancial corporations for the year 1929. These corporations, with assets of $50 million and over, were estimated to control about 4 9 % of the assets of all nonfinancial corporations. The National Resources Committee continued and refined this earlier study of the 200 largest nonfinancial corporations. In the report of this work, it is stated that "together, these 200 largest corporations controlled, in 1933, approximately 1 9 % to 2 0 % of the national wealth, between 4 6 % and 5 1 % of the nation's industrial wealth and approximately 6 0 % of the physical assets of all nonfinancial corporations."3

S

1 Willard Thorp, TNEC Hearings, Part I, p. 97; for approximations of the volume of business done by corporations in major branches of industry, see ibid., p. 96. · 2 Ibid.., p. 227. This figure excludes financial, professional, and agricultural enterprises. 3 National Resources Committee, The Structure of the American Economy, Part I, p. 105, and Table 5, p. 106.

13

14

SOCIAL ASPECTS OF ENTERPRISE

Before citing further comparisons and measures of corporate size, it is necessary to discuss briefly certain limitations of the statistical base. Tax reports to the Bureau of Internal Revenue are the source of the data. In some years prior to 1934, parent corporations were permitted, but not required, to file consolidated statements including all subsidiaries in which 9 5 % voting stock was held. For 1934 and subsequently, corporations were not permitted to file consolidated returns even for wholly owned subsidiaries (an exception was made for railroads). Regrettably, this change and limitation of data has restricted concentration comparisons to 1933 and earlier years. 4 Since 5 0 % ownership confers power to control, the list of 2 0 0 largest corporations compiled by the National Resources Committee lumped with the data for the parent all such unconsolidated subsidiaries. It must therefore be kept in mind that the asset figures represent control but not complete ownership. The question of what item of the accounting data is the best measure of corporate size is, of course, related to the purpose of the user. Since the primary purpose here is to indicate the degree of corporate concentration, the asset item is superior. However, "total assets" do not represent true consolidated figures but include both the assets held by subsidiaries and the stock held by parents in subsidiaries as well as short-term credit extended to them. This double counting is largely eliminated by deducting the item "taxable securities" from total assets. Yet this causes some understatement of assets since it also eliminates investments in corporations outside the corporate control unit. Despite the error of overcorrection so introduced, the item "total assets less taxable 4 The restriction was imposed by the limited funds and staff available to the National Resources Committee. The importance of bringing our knowledge up to date, especially through the war years, can scarcely be questioned.

CORPORATE BIGNESS AND OWNERSHIP

15

i n v e s t m e n t s " is p r e f e r a b l e t o " t o t a l a s s e t s " a s a m e a s u r e

of

corporate concentration.5 Corporate

concentration

over

the

five

years

1929-33

s h o w n in T a b l e I . C o m p a r i s o n o v e r a l o n g e r p e r i o d

is

shows

TABLE I Proportion of assets of all nonfinancial corporations held by 2 0 0 largest nonfinancial corporations, 1929-33® b

b

b

1929

1930

1931

1932

1933

Total assets (involves some duplication) 49.4

54.0

57.0

55.5

57.0

Total assets less taxable investments (involves slight duplication) 47.9

54.3

55.5

54.8

54.8

Land, Buildings, and Equipment, Less Depreciation, Plus In52.4 ventories

c

C

c

59.7

Land, Buildings, and Equipment, Less Depreciation (involves no 58.0 duplication)

60.1

63.3

63.1

64.2

%

%

%

%

%

Taken from National Resources Committee, op. cit., p. 107. Ratios for years 1930-32 are merely estimates rather than tabulated totals. For the method used see above source, pp. 294-96. c Inventories not available in terms of method used. a

b

p r o n o u n c e d g r o w t h ; the holdings of the l a r g e s t

corporations

increased from a p p r o x i m a t e l y one-third of the assets

(exclu-

sive of intercorporate securities) of all nonfinancial c o r p o r a 5 For an extended discussion of the statistical problems and limitations, see National Resources Committee, op. cit., Part I, pp. 104-6, and Appendix I, especially sees. 1 and 4. For other analyses of corporate size, see Twentieth Century Fund, Big Business, Its Growth and Its Place; R. A. Gordon, Business Leadership in the Large Corporation, pp. 13-23; TNEC Hearings, Part I, pp. 95-112.

16

SOCIAL ASPECTS OF ENTERPRISE

tions in 1909 to over 54% in 1933.® It is interesting to note the greater proportion of physical assets, as contrasted with total assets, held by the 200 largest corporations. The question sometimes raised, whether the heavy weighting of concentration by the inclusion of these "natural monopolies" does not vitiate the significance of the concentration, although pertinent for some points of view, is irrelevant to our purpose here since the problems of enterprise functions are similar in all large corporations. 7 The evidence marshaled here indicates that all corporations account for well over half of all economic activity. The importance of the very large corporations among all nonfinancial corporations is shown by the fact that the 200 largest control approximately 6 0 % of all such physical assets. These large corporations do not control more than about one-fifth of the national wealth, but they do control approximately half of the nation's industrial wealth. Beyond the importance to be attributed to this quantitative position is a less measurable but even more significant factor: the influence of the pattern of leadership set by the large corporation upon other business organizations. This influence has its roots not merely in the share of total business activity carried out by the large corporation but specifically and importantly in the fact that the large corporation has, in the nonagricultural sphere, contributed most to the dramatic spread of modern mass consumption. The existence of this pervasive influence is everywhere visible in the industrial and commercial community. It is seen in methods of administrative control, in industrial relations practices, merchandising methods, and many other fields. Its play is especially extensive over the middle-sized corpora6 National Resources Committee, op. cit., p. 107. The figure for 1909 is based upon less satisfactory data than 1933, but suffices to show the approximate magnitude. 7 On this question see W. L. Crum, "On the Alleged Concentration of Economic Power," American Economic Review, XXIV (1934), 69-83.

CORPORATE BIGNESS AND OWNERSHIP

17

tions.8 In this restricted sense, the large corporation has become the representative institution of American industrial and commercial life. The Distribution

of

Ownership

For our purpose there are two questions of chief importance concerning the distribution of ownership in the large corporation. The first is how great is ownership by management; the second, how great is the ownership held by the larger stockholders and what is the relative dispersion of ownership, that is, among how many smaller shareholdings are the remaining shares divided. A few years ago no answer to either of these questions could have been furnished; thanks to the extensive data prepared by the SEC and to the work of R. A. Gordon, it is now possible to answer the first.9 As will be seen, the data bearing upon the second question contain many elements of bias precluding other than a very general conclusion. The Size of Management's

Stake

The participation of management in the ownership of large corporations has been shown to be small. The study of the 200 largest nonfinancial corporations, with assets of $60 million or over, prepared by the Securities and Exchange Commission for the Temporary National Economic Committee, has supplied a great amount of basic data. Gordon has 8 The total assets of all corporations with assets of $1 million or over in 1933 represented 85% of all corporate assets. See Statistics of Income, 1933, and Gordon, op. cit., p. 17. 8 R. A. Cordon, "Stockholdings of Officers and Directors in American Industrial Corporations," Quarterly Journal of Economics, LII (1934), 367-79. In his Business Leadership in the Large Corporation, pp. 23-45, is an excellent and extended discussion of the SEC data and his own earlier work. TNEC, The Distribution of Ownership in the 200 Largest Non-Financial Corporations, Mon. 29, prepared by the staff of the SEC. Unless otherwise noted all references in this chapter to the SEC pertain to this monograph.

18

SOCIAL A S P E C T S OF

ENTERPRISE

refined the S E C data by eliminating 2 4 corporations because they were subsidiaries of corporations included within the list of 200. It should be kept in mind that companies ranging from the extreme concentration of ownership instanced by the Ford Motor Company to the wide diffusion of ownership found in the American Telephone and Telegraph Company are included in the list. Gordon found that the median holding, per company, by management, of all voting common stock ( 1 9 3 9 ) for the 176 companies was 2 . 1 1 % . 1 0 In the 115 industrial companies included, the median holding of officers and directors was 3 . 4 9 % . For 3 8 public utilities it was 0 . 5 2 % , and for 23 railroads 0 . 3 8 % . In 6 3 of the 176 companies, officers and directors owned less than 1 % of the voting common stock. In 120 companies, management owned less than 5 % . In only 16 companies did management own as great a fraction as 2 0 % . Viewing the stockholdings of officers and directors separately, the median holdings by officers of industrial companies is found to be 0 . 8 1 % ; of public utilities 0 . 1 0 % ; of railroads 0 . 0 2 % . The median holdings of all officers in the three classes is 0 . 3 2 % . Directors (nonofficer) of industrial companies held a median of 2 . 3 3 % ; in public utilities 0 . 2 9 % ; in railroads 0 . 3 6 % . The median holdings of all nonofficer directors in the three classes is 1 . 1 1 % . The typical size of the collective stake of management in the large corporation is clearly very small. However, it is significantly greater in industrial companies than in public utilities and railroads. The holdings of officers in each of the three 1 0 This means that the median stands for directors and officers considered as a unit. The positional measure (median) shows that in one-half the companies management held more, and in one-half less, than this fraction. The existence of extreme items which distort the arithmetic mean bars the use of that measure. Gordon, Business Leadership, p. 27.

CORPORATE BIGNESS AND OWNERSHIP

19

fields is much smaller than that of directors in corresponding fields. The proportionate stockholdings of officers have been shown here to be very small. This suggests, although it does not conclusively demonstrate, that those who exercise direct and continuous leadership in the large corporation typically derive their principal money gain in other ways than profits of ownership. Nevertheless, officers frequently share in "profits" by a variety of plans. Fixed salaries together with bonus or participation schemes typically form their chief compensation. An analysis of the relative importance of dividends as elements of executive income, versus salary and bonuses, has been made by Gordon. He concludes that, as compared with dividends from stock held by executives in their companies, "salary and bonus seem clearly to be the dominant financial incentive."11 The proportionate ownership of directors, while significantly greater than that of executives, is likewise small. Although comparisons of dividends from stock held in companies they serve as board members cannot be made with other elements of their income, it seems probable from the indirect evidence of the composition of boards, that typically such dividends are not their principal income. To be sure, a number of men accept directorships in a company either to protect their own stake or the stake of others whom they represent. Yet studies of the composition of boards suggest that this is not typically the case. An analysis of the composition of the boards of 31 large companies showed that only 19% of the directors represented a substantial ownership interest.12 Another more extensive study of some 500 small and large 11 Business Leadership, p. 301; for an extended analysis of these elements of income, see pp. 297, 304. 12 P. E. Holden, L. S. Fish, and H. L. Smith, Top Management Organization and Control, p. 220.

20

SOCIAL ASPECTS OF ENTERPRISE

corporations, taking the questionnaire replies at their face value, indicates that only about 2 1 % of the 2,625 directors dealt with were chosen to give representation to stockholding interests.13 A later study by the same agency again showed that about one out of every five directors holds or represents substantial shareholdings. However, it is important to note that these studies show that the large companies have a lesser proportion of big shareholders on their boards than do the smaller companies. This is emphasized by the fact that the later study found that over one-fourth of the companies with assets over $50 million reported no nonofficer directors holding or representing substantial ownership.14 Of course, the direct and visible compensation of directors, in the form of fees, is not commensurate with the level of responsibility and the time and effort called for by their functions. Since it appears that the two elements of the groups exercising leadership do not typically derive their principal money gains from ownership participation in the fluctuating earnings of the corporations over the destinies of which they preside, the nature and direction of their motivation, incentives, and behavior are clearly root problems. These questions will be more extensively considered in Chapters V and VI. The Distribution of Shareholdings The second question raised at the beginning of this section was: how are the shares in these large companies divided among small and large shareholders. Before this question can be dealt with, however, certain facts and reservations concerning the data must be noted. That all the data here used refer to shareholdings rather than to individual stockholders is a fact which must be em1 3 National Industrial Conference Board, Prevailing Practices Regarding Corporation Directors, Studies in Administrative Control, No. 2, Table 13, p. 13. 1 4 NICB, Compensation and Duties of Corporate Directors, pp. 4-5.

CORPORATE BIGNESS AND OWNERSHIP

21

phasized. Since any stockholder may have shareholdings in several corporations, as well as in more than one issue, the number of individual stockholders is smaller than the number of shareholdings. Unfortunately, it is not practicable to refine the data for this part of our analysis so as to exclude the 2 4 subsidiary companies from the list of 200. This precludes direct comparison with the managerial ownership previously discussed. It also signifies that the distribution is given a marked bias in overstating the concentration of ownership. A further bias is introduced by the inclusion of bank and broker holdings for others. Since this results in counting many holdings as one, it thereby overstates concentration. It should also be noted that corporate holdings are not distinguished from individual holdings and that reservations concerning the mingling of collective and individual ownership apply here. 15 The combined effect of these facts is to understate the proportion of ownership in small shareholdings. With these reservations in mind, let us now look at the distribution. It shows that 88% of the total of more than seven million shareholdings of common stock consisted of 100 15 There are two distinct questions involved in appraising the meaniag of the extensive ownership in these large corporations by other corporations. One question is statistical in the sense that it looks at the fact that corporate ownership is itself an aggregate of individual owners. The second relates to the character and extent of control that different types of corporations may exert over the corporations in which they hold stock. In the absence of data permitting analysis of the distribution of ownership in the stockholding corporation, which would make possible a proportionate allocation of ownership to individuals, of the corporation in which it holds stock, we are obliged to treat the stockholding corporation as a multiple of an unknown number of individuals. So viewed, it is clear that corporate ownership cannot be lumped with individual ownership, since the classes are unlike and to treat the corporation as unity would grossly inflate the index of concentration of ownership. On the other hand, it is equally clear that the extent of concentration of control would be seriously understated by the omission of corporate ownership. Corporate control is directly comparable with control exercised by individuals although different types of stockholding corporations may be expected to show wider variations in the use of their influence than do individuals.

22

SOCIAL ASPECTS O F E N T E R P R I S E

shares or less, yet this 1 to 100 share class accounted for only about 18% of the total of nearly one billion common shares in the 200 companies.1® Because the information for these 200 corporations was furnished in a form permitting only two size classes of shareholdings (100 shares and less, and over 100 shares), we must turn to other data to learn the smaller and intermediate holdings. It is revealing to look first at the distribution of holdings in large and small corporations, including both common and preferred stock.17 Here we find a clear-cut tendency for the proportion of the smallest class of holdings (1 to 10 shares each) to rise with an increase in size of the corporations. Shareholdings in all of the size groups over 100 shares showed an equally pronounced tendency to decline in percentage of total number of shareholdings as the assets of the corporation rose. In other words, the shareholdings with the smallest number of shares tend to account for a greater proportion of the total number of shareholdings in large corporations than in smaller ones. The proportion of common stock shareholdings comprising 1 to 10 shares each, increased from about 13% of the total shareholdings for corporations with assets under $1 million to around 37% for companies with assets of $500 million or more; for preferred stock this proportion increases from about 33% to around 48%. Since we are primarily concerned with the large corporation, let us now confine our attention to the dispersion of shareholdings in listed companies with assets of $50 million and over. We note first the holdings of common stock in 238 ie SEC, op. cit., Table 23, p. 284. 17 This data is taken from TNEC, Survey of Shareholdings in 1710 Corporations with Securities Listed on a National Securities Exchange, Mon. 30, Tables 31 and 37. The data reflect the situation as it existed in 1937-39. Again it must be noted that differences in the number and identity of the companies included bar comparison with the 200 largest.

CORPORATE BIGNESS AND OWNERSHIP

23

such corporations, covering 2 4 5 issues. The total shareholdings of the 1 to 10 share class here amounted to about 3 5 % of all shareholdings (numbering more than 7.5 million) in these companies. Yet these smallest sized shareholdings accounted for only about 1 . 7 % of the total number of shares. Now going up the scale of smaller shareholdings so as to include all common stock holdings of 1 to 100 shares, we find that this enlarged but still small class amounted to 8 8 % of the more than 7.5 million shareholdings. Again, however, this 1 to 100 class of shareholdings accounted for only about 1 9 % of the nearly one billion outstanding shares of these large corporations. Extending the class a further step to include holdings of 1 to 500 shares shows that these accounted for nearly 9 8 % of the total shareholdings and approximately 3 5 % of the shares. If we now move up so as to combine all of the shareholding's classes comprising 1 to 5,000 shares, we find that 9 9 . 8 % of the total number of shareholdings accounts for about 5 5 % of the outstanding shares. Since the broad pattern of distribution was essentially the same for preferred stock, it is needless to examine this in detail. However, it may be pointed out that the 1 to 10 share class of preferred shareholdings accounted for a substantially greater proportion of total holdings and of total issued shares as well. Conversely the class comprising over 5,000 shares accounted for a smaller percentage of both total shareholdings and total outstanding shares. In summary we note four points: 1. This analysis clearly confirms common opinion that small shareholdings make up a very much larger part of all shareholdings in large corporations than in small ones. 2. Shareholdings numbering 1 to 5 0 0 shares account for nearly 9 8 % of total holdings and include about 3 5 % of issued shares.

24

SOCIAL ASPECTS OF E N T E R P R I S E

3. Shareholdings numbering 1 to 5,000 shares account for about 99.8% of total holdings but include only 5 5 % of the outstanding shares. 4. Any conclusions as to relative concentration or dispersion must be drawn in the light of the qualifications concerning the nature of the data set forth at the beginning of this discussion. Duly noting that the data have a strong bias toward overstatement of concentration of ownership, we must be content to conclude that wide diffusion exists side by side with a marked concentration of ownership. We have seen that corporate bigness combines with its typical diffusion of ownership a significant concentration, part of which is attributable to holdings by other corporations. It is outside the scope of this study to deal with the control that may be exercised by this concentrated ownership, which, although by no means as typical as it has been construed, is frequent enough to pose a bristling set of questions. 18 We are chiefly interested here in noting two facts: first, that the ownership of management is typically very small; second, that approximately 9 8 % of the shareholdings are accounted for by holdings of from 1 to 500 shares. Clearly these holders contribute no leadership but are merely passive receivers of profits or losses. Some of the implications of this situation will be developed in Chapters V and VI. 18 A preliminary exploration of these problems has been made by Gordon, Business Leadership, especially Chaps. VII, VIII, and IX. The SEC study (Mon. 29) attempted to locate the ownership of the stockholding "control groups" in each of the 200 corporations. This procedure involved a measure of arbitrary decision, and the conclusion set forth in that monograph—that control through minority ownership is the typical situation in the large corporation— is questionable. See op. cit., pp. 103-31, especially pp. 103-14. For a critical appraisal of the SEC interpretations, see Gordon, ibid., pp. 38-45.

Chapter THE

SOCIAL

FUNCTIONS

III OF

ENTERPRISE

S

OME misconceptions concerning the nature of business enterprise must first be cleared away before we can attempt to identify its social functions. Of these misconceptions, some were embedded in the thinking of the early English writers. Although French writers early made a clear distinction between the provision of capital and the furnishing of business power to operate an enterprise, this was not observed by classical English economists. Richard Cantillon, in his Essai sur la Nature du Commerce (1775), used the term "entrepreneur" to designate the dealers who "buy the wares of the country— give for them a fixed price, to sell them again wholesale and retail at an uncertain price."1 The bearing of uncertainty was here fastened upon as the outstanding characteristic of the entrepreneur. Coupled with the distinction between the capitalist, as a passive investor, and the entrepreneur was the corresponding distinction between interest and profit. J. B. Say, in his Traite d'tconomie Politique (1803), criticized English economists for combining the gains of the capitalist and the entrepreneur.2 This practice of merging interest and profit income under the single term "profit," and associating this with the single term "capitalist," persisted among English writers down to J. S. Mill. As we saw in Chapter I, classical economics, grounded on the individual owner-manager, is not applicable to the modem setting. The restoration of attention to the special importance of the entrepreneur and to profit separated from interest on borrowed funds is commonly cred1 Quoted by Maurice Dobb, "Entrepreneur," Enc. Soc. Sei., V, 558. 2 Bk. XI, chap. VIII, sec. 2.

25

26

SOCIAL ASPECTS OF E N T E R P R I S E

ited to F. A. Walker. 3 To Walker, the function of the enterpriser was to "furnish technical skill, commercial knowledge, and powers of administration; to assume responsibilities and provide against contingencies; to shape and direct production, and to organize and control the industrial machine." 4 One prolific source of confusion among writers on the theory of enterprise has been the tendency to identify the entrepreneur with the functions of which he is merely the instrument, withal a very active instrument. Since the concept of an owner-manager clearly is not applicable to the large corporation, the term "entrepreneur" cannot be applied to any part of it. But it is equally clear that some very important entrepreneurial functions are nevertheless exercised by somebody in the corporate organization. If, however, we fail to distinguish between the function and the instrument, then we shall have difficulty in isolating the functions because we are unable to pin the button upon a single person or class of persons. Enterprise is not to be identified with a person but with a function or set of functions. These functions are not to be identified with "engineering," with securing the maximum physical output from the minimum physical input. Nor are they to be confused with the closely related responsibilities of directing the operations and processes of production. Since the error of so identifying enterprise is more clearly shown in connection with the interaction of business decision with the price system, which is dealt with in the latter part of this chapter, the supporting analysis for these statements will be found there. Nor is the function to be found in risk-bearing. While executives and directors of large corporations bear some risks, the major risks fall on the suppliers of capital and on wage earners. It has been shown that the proportionate investment 3

The Wages Question. See especially pp. 243-83.

* Ibid., p. 245.

SOCIAL FUNCTIONS O F E N T E R P R I S E

27

of executives and directors is very small, although in some instances this stake may represent a substantial part of personal wealth. Yet typically, money risk is assumed by the stockholders who furnish the stakes while the managers play the game. Management estimates and selects risks to be borne by the stockholders. The major kind of risk shouldered by management is best described as the psychological wear and tear of facing uncertainty. Risk arises from uncertainty and involves the hazard of money loss to the suppliers of funds, the loss of professional repute to management, and loss of employment to wage earners. In discussing the owner-managed firm, Joseph Schumpeter clearly distinguished the capitalist from the entrepreneur, and pointed out that it is the suppliers of capital who bear risks, but, in that setting, the entrepreneur who receives the bulk of the transient profits.5 Why is it, then, that the entrepreneur has been regarded by some writers as preeminently the risk-bearer of business?8 Doubtless it is because he has been so situated strategically that the consequences of economic change fall first upon him, causing his income to fluctuate widely. This point has been particularly emphasized by Knight. Regarding the entrepreneur (in the owner-managed firm) as the recipient of profits, he points out that there would be no profits in a stationary state. In this conceptual world, free from unpredictable change, there would be, therefore, no place for enterprise. Profits arise from uncertainties, and uncertainties exist only in a world of change. In the absence of change, a business manager could be so completely informed that he would incur no losses and his competitors could likewise be so well informed that he would make no gains; therefore there would be no profits. He concludes that in a society "free from progressive change, no managerial 5 The Theory of Economic Development, pp. 64-90. β Notably F. B. Hawley.

28

SOCIAL ASPECTS O F E N T E R P R I S E

decisions would be called f o r " ; that is, there would be no scope for enterprise. 7 Although the nature and causes of profits are peripheral and incidental for this study, we are interested insofar as profits theory contributes to an understanding of the functions of enterprise. The theory that profits spring from the uncertainties which face the business manager in a dynamic economy helps toward such an understanding, for it is essentially the function of enterprise to adapt the economic process to a changing world. That is the answer to the basic inquiry of this chapter. In attempting to delimit more precisely the relationship between enterprise and change, Schumpeter points out that economic change may arise from shifts in consumer demand, and exhaustion and discovery of physical resources. Changes of this kind are regarded as changes in the " d a t a " to which economic life tends to adapt itself. But this is not the only kind of economic change: "There is another which is not accounted for by influence on the data from without, but which arises from within the system, and this kind of change is the cause of so many important economic phenomena that it seems worthwhile to build a theory for it." 8 This kind of change he terms "new combinations" (elsewhere he calls it innovation). "The carrying out of new combinations we call enterprise; the individuals whose function it is to carry them out we call entrepreneurs." 9 The entrepreneur is distinguished from the inventor, whose brain children induce no economic change until taken up and exploited by the entrepreneur. 10 7

Knight, Risk, Uncertainty and Profit, and "Profit," Enc. Soc. Sei., XII, 484. This is the theory of economic development, Theory, p. 64. »Ibid., p. 74. 10 Ibid., pp. 82-89. Maurice Dobb has similarly emphasized this point that the actual adoption and exploitation of new techniques or inventions is importantly a very different matter from the invention itself. With discernment, he says: "It [exploitation] will need the combination of two rather subtle qualities, about which at present we have little precise knowledge. First, it will need the 8

SOCIAL FUNCTIONS OF ENTERPRISE

29

S c h u m p e t e r points out that his c o n c e p t s a r e at o n c e b r o a d e r a n d n a r r o w e r than the u s u a l ones. T h e y a r e b r o a d e r b e c a u s e they a r e not confined to the o w n e r - m a n a g e r , the independent b u s i n e s s m a n , but i n c l u d e a l l w h o c a r r y out the function, even if they are, as is becoming the rule, "dependent" employees of a company, like managers, members of a board of directors, and so forth, or even if their actual power to exercise the entrepreneurial function has any other foundation, such as the control of a majority of shares. As it is the carrying out of new combinations that constitutes the entrepreneur, it is not necessary that he should be permanently connected with an individual firm; many "financiers," "promoters" and so forth, are not, and still they may be entrepeneurs in our sense. On the other hand, our concept is narrower than the traditional one in that it does not include all heads of firms or managers or industrialists who merely may operate an established business, but only those who actually perform that function. 1 1 Although Schumpeter selected only one outstanding aspect, the c a r r y i n g o u t o f new c o m b i n a t i o n s , a n d confined his definition o f e n t e r p r i s e to t h a t a s p e c t , this r e s t r i c t i o n w a s a p p r o p r i a t e to this p u r p o s e s i n c e it s e r v e d t o b r i n g into s h a r p e r r e l i e f h i s e m p h a s i s u p o n the d i s r u p t i o n o f established business p l a n s . H e e x p l i c i t l y r e c o g n i z e d t h a t the carrying out of new combinations can no more be a vocation than the making and carrying out of strategic decisions, although it is this function and not his routine work that characterizes the military intuitive quality of choosing between numerous alternatives and choosing the right one, a quality which will require a certain power of imagination—the power to grasp and to conceive future possibilities. Second, it will need a certain courageous self-confidence—confidence enough to make the choice, and courage enough to force it into effect even in the face of opposition and when there is very little scientific basis to render the outcome anything but extremely uncertain. Bitterest skepticism before making a choice, persistent and unerring faith in the choice when it is made—these are both necessary if decisions are to be the right ones, and if the enforcement of them is to be carried to success. In social life this quality is essentially the creative quality. The loss of it spells stagnation, however bright may be the genius of science and however great the devotion of those who toil." Capitalist Enterprise and Social Progress, p. 33. 11 Theory, pp. 74-75.

30

SOCIAL ASPECTS OF ENTERPRISE

leader. Therefore the entrepreneur's essential function must always appear mixed up with other kinds of activity, which as a rule must be much more conspicuous than the essential one. Hence the Marshallian definition of the entrepreneur, which simply treats the entrepreneurial function as "management" in the widest meaning, will naturally appeal to most of us. We do not accept it simply because it does not bring out what we consider to be the salient point and the only one which specifically distinguishes entrepreneurial from other activities. 12

At this point, it may contribute to clarity in further discussion to distinguish three ways in which business management is involved in initiating or making adjustments to change. These are: innovation, internal adaptation, and external adaptation. Innovation means the voluntary introduction of changes in the operations of a business on the initiative of the management. It is illustrated by the adoption and exploitation of an invention or new process. It is equivalent to Schumpeter's "new combinations," described above. It is volitional because it is not imposed on management by any compulsion of circumstances; it is internal in the sense that the inducement to adoption originates within the motivations of the economic system, although the invention or process itself may have originated in physical or chemical discovery. By internal adaptation, we mean volitional change borrowed by management from some other part of the economy and reshaped to its own uses. For example, Henry Ford is said to have borrowed the idea of the conveyor as used in the Chicago meat-packing houses and developed it into the assembly-line system. The line between innovation and internal adaptation is often blurred. This is readily seen if we consider the case of a railroad induced by the competition of aircraft and automobiles to introduce passenger trains with 12 Ibid., p. 77.

SOCIAL FUNCTIONS OF E N T E R P R I S E

31

speed schedules, features, and comforts hitherto without counterpart. Here what is borrowed is simply the idea of modernization; the specific form given to it may be regarded as an innovation. By external adaptation is meant all nonpurposive change such as may be imposed by wars, natural disasters, or the exhaustion or accidental discovery of new resources. Here the source of the change does not reside in management or in the motivations of the economic system, but management is obliged to make purposive adjustments to the new situation and the burden of adjustment may be quite as heavy as in the first two classes. This kind of adaptation is illustrated by the full-scale exploitation of synthetic rubber during the recent war. Knowledge of the processes had long existed, but it was not until this country was cut off from its chief natural rubber sources by war that it was fully applied. Viewing economic society as a complex organization of human effort, of which the large corporation is an especially highly organized part, we cannot accept Schumpeter's restriction of enterprise to innovative change. The exhaustion of natural resources leads to induced change, which becomes purposive change in the development and introduction of substitutes. Although less frequent, such adventitious or external change, quite as well as innovation or volitional adaptation, may bring about extensive change in economic organizations. The changes induced by war as well as changes in consumer preferences must be included in these external changes, and it cannot be maintained that the rude impact of war induces economic change less violent or abrupt than innovative change. From the viewpoint of the entire economy, the disruptive disturbance of business plans upon which Schumpeter's attention was fixed may arise from either internal or external sources, and the burden of adjustment may be equally heavy.

32

SOCIAL ASPECTS O F ENTERPRISE

Moreover, a concept of enterprise confined to innovation, however appropriate to Schumpeter's purpose as a part of the foundation of his Theory of Economic Development, would have unfortunate consequences if generally followed. Such a restricted concept continues to focus attention upon enterprise as consisting solely of material and operational change, upon things and techniques, to the exclusion of its human aspects. This emphasis involves a too-easy acceptance of the traditional (but mistaken) view that labor is merely a factor of production coordinate with materials and machines. It would leave undisturbed the convenient (but unreal) abstraction of labor as so many individual and indivisible units of man power moved about donkeylike and induced to do what is required merely by changing the size of the bunch of carrots held out in front of them. In short, to exclude all but innovative change is to omit from business enterprise a large part of change affecting the organization of human effort. The participation of human beings in the productive processes, their ways of work and living, are often no less importantly affected by adaptive change than by innovative change. The application of organizing or social skill to the problems of adjusting people engaged in the productive processes to the impact of such change is quite as vital a part of enterprise as operational or technical innovation. Schumpeter's restricted concept is rejected here for another reason. In the evolution of business institutions, the decline of the independent owner-manager and the rise of the very large quasi-public corporation has been paralleled by a diminished prominence in business leadership of those qualities of daring, intuitive judgment, pioneering courage, and so forth. 13 This is not to imply that they are no longer important or non-existent. It is merely that large business units and 13

Doubtless Schumpeter would agree with this; see his Capitalism, and Democracy, pp. 131-34, and Business Cycles, pp. 96-97.

Socialism

SOCIAL FUNCTIONS OF ENTERPRISE

33

their associated specialization tend, through engineering estimation, cost accounting, budgeting, marketing methods and surveys, personnel management, and the like, to routinize and systematize the conduct of business. Similarly, the growth of government regulation and of the power and practices of organized labor restrict the range of managerial decision. The disappearance of major population movements and the reduction in the rate of population growth have changed the setting. The functions of enterprise are now divided, in the large corporation, between executives and directors and sometimes shared by a stockholder minority; it follows from this that we cannot speak of an "entrepreneur" in this connection. Sombart saw this: We observe . . . a tendency toward increasing . . . specialization of the enterprise activity, not in departments but (the opposite) in functions. This tendency shows itself particularly in the more and more evident development of the pure enterprise, that is to say, in the stripping off of all secondary functions. We have observed this process in its beginning in the early capitalistic epoch. Now this process comes to its completion. A generation ago, the enterpriser himself had to concern himself with supervision, the perfection of technology, the commercial guidance—all these functions are now taken over by hired specialists. 14

The concept of enterprise developed here includes, then, both innovative change and adaptive change. 15 Adaptation consists, on the one hand, of making adjustments to adventitious or external change and, on the other, in borrowing, reshaping, and giving new application to existing methods, devices, and organization practices. Innovation consists of the introduction of new and improved methods, products or services, and organization practices. Here we turn to the creation of change as opposed to adjustment to change initiOp. cit., p. 14. Dobb has also developed a view of enterprise stressing innovation and adaptation as the central entrepreneurial functions. See op. cit., pp. 26-41. 14

15

34

SOCIAL ASPECTS OF ENTERPRISE

ated elsewhere. This is the pioneering drive, which dares to bring into play changes that may increase the fruits of human toil. In view of this analysis, enterprise may be defined as that factor in the productive process which is responsible for adjusting a business organization to a dynamic world through innovation and adaptation. Historically and currently, in the large corporation, this factor is identified with general executives and directors. The Mechanism, of Adjustment We have yet to examine the mechanism that diffuses change through the economic structure. Innovations and adaptations are partly matters of cost-price adjustments. These are found in the meshing of business decision with the price system. This mechanism underlies and is interwoven with economic change as the means of communicating and ramifying its effects whenever change is introduced in the economy. This is clearly seen if we examine the effects of the several kinds of change. Innovative change may lead to an improved product at the same cost or the same product at a lower cost. In effect each case results in lowered cost, and the tendency will be to force competitors to seek ways to lower their costs and in this way to lower prices. Adaptive change, whether resulting from borrowing and reshaping innovation introduced elsewhere or as a consequence of adventitious change, such as the exhaustion of natural resources, will similarly be diffused through the operations of the price system. It will be reflected in a series of price disturbances that will involve a series of "readjustments" or business decisions changing the kind and volume of resources employed. If the adaptation is to innovation introduced elsewhere, it will be induced through pressure to lower costs or to improve the product. If it is adaptation to exhaustion of natural resources, it will be

SOCIAL FUNCTIONS OF ENTERPRISE

35

brought about by increasing scarcity coupled with a progressively higher price for these resources, which impels search for substitutes. As substitutes are found, their application will involve change. Closely connected with the price mechanism in the making of business decisions, and therefore in the process of adjusting the economic process to change, is the problem of allocating resources. The social goal here is to direct the resources in such a way as to maximize satisfactions. In a stationary economy, allocation could be a matter of exact calculation. But in an economy subject to rapid change, it is a matter of guesswork. Allocation is therefore a derivative function of enterprise and it is carried out as a part of the process of adjusting the business firm to change. Although the function of allocation is not primary in the logical sense of having an independent origin, it is not subordinate, in its social importance, to the principal function of enterprise. In our system, allocation is linked with the institution of private property and the play of the proprietary interest in the decisions of businessmen. These decisions are the kind that determine the type and volume of production as distinguished from the decisions involved in directing the operation of the facilities and the processes of physical production. It is these decisions that control the allocation of resources. Since these decisions are basic to enterprise and change, we shall refer to them collectively as the function of allocation. The importance of this function and its identification with the appropriate business class that serves as its instrument has been so obscured, confused, or lost sight of, that some attention must be given to restating and viewing it afresh. Historically, and for a fraction of the economy today, the owner-manager, combining a proprietary stake with direct control of a business, has reacted to price changes in a way to minimize or to avoid losses or to maximize earnings when

36

SOCIAL ASPECTS OF ENTERPRISE

possible. If the price of corn falls and the price of hogs rises, the farmer converts corn into hogs and so provides more pork, but in so doing reduces the supply of chicken feed and bourbon whisky. This shift in the allocation of resources by the play of the pecuniary motive in reaction with prices presumed to reflect intensity of demand is little questioned when cited from a simple state of agriculture. In the more complex field of industry, although the rationale of the control of resources is the same, its visibility and location have not been as patent. But a chief source of obscurity, confusion, and oversight has been those writers who have stressed physical or engineering economics, sometimes to the complete exclusion of human or volitional economics. Consequently, they have failed to perceive that the function of directing and operating the productive processes is wholly unlike, and therefore to be separately distinguished from, the function of making decisions determining what will be made and how much of it. The intellectual paternity of these writers must be attributed, however reluctantly, to Yeblen, who has set forth the physical or engineering view in baldest terms: T h e s e expert men, technologists, engineers, or whatever name may best suit them, make up the indispensable General Staff of the industrial s y s t e m ; and without their immediate and unremitting guidance a n d correction the industrial system will not work. It is a mechanically organized structure of technical processes designed, installed, and conducted by these production engineers. Without them and their constant attention the industrial equipment, the mechanical appliances of industry, will foot up to just so much junk. The material welfare of the community is unreservedly bound up with the due working of this industrial system, and therefore with its unreserved control by the engineers, who alone are competent to m a n a g e it. To d o their work a s it should be done these men of the industrial general staff must have a free hand, unhampered by commercial considerations a n d reservations; for the production of the goods and services needed b y the community they neither need nor are they in any

SOCIAL FUNCTIONS OF ENTERPRISE

37

degree benefited by any supervision or interference from the side of the owners. Y e t the absentee owners, now represented in effect, by the syndicated investment bankers, continue to control the industrial experts and limit their discretion, arbitrarily, for their own commercial gain, regardless of the needs of the community. 1 8

Veblen's prepossession with the antithesis between producing power (industry) and bargaining or withholding power (business) and their corresponding instrumentalists, the "production engineers" and the businessmen (absentee owners), was one of the factors causing him to overlook this regulatory function of business decision meshed with the price system. 17 It is only the stature of this parentage and its continuing influence which raises the "technologists" and other writers of similar nonvolitional emphasis to an importance warranting any extended comment upon the shortcomings of their views. 18 A mistake common among those influenced by Veblen or by Marx is the contention that "production managers" could absorb all of the technically necessary functions of the businessmen or "finance executives," if profits in the capitalist sense were eliminated. 19 Such writers appear so engrossed with the The Engineers and the Price System, pp. 69-70. Of course, there were other and perhaps more basic factors responsible. Commons believes it lay in an inability, shared by all physical economists, including Marx, to apply the distinction between a "flow of time" and a "lapse of time," which underlies the distinction between process and valuing. It must also be kept in mind that Veblen's formative observation and constructive thinking covered the years 1898 to 1914, when the robber barons dominated the industrial scene, and as Commons again has pointed out, before the double meaning of wealth as materials and ownership was fully articulated by the courts, and reasonable value by the commissions. See John R. Commons, Institutional Economics, pp. 673-74, 676. 1 8 Sombart noted Veblen's confusion: "Now the enterpriser delegates even the calculation of profit and loss to a subordinate; to the 'efficiency engineers' in the United States, of whom Veblen . . . reports such edifying things. We have, however, to keep constantly in mind, which Veblen does not always do, that these specialists are not enterprisers because they do not exercise any of the specific functions of the enterpriser." Op. cit., p. 14. 1 8 See, for example, James Burnham, The Managerial Revolution, pp. 77-95. 16

17

38

SOCIAL A S P E C T S O F E N T E R P R I S E

profit-making activities of the "finance executive" and the often excessive money gains which his strategic position bring to him that they fail to grasp the broader functional decisions made by this group. These decisions, which determine the allocation of scarce resources, are taken in terms of the price system. The essential social function of the price system is to reflect relative scarcity as balanced against utility. Technically expressed, the marginal cost of the factors employed in production should equal the marginal utility of the product. Moreover, in an economy of fair competition there would be a tendency to regulate the distribution of resources between alternative uses in such a way as roughly to equalize the marginal yield in all uses.20 In the market economy, prices are the guideposts, however defective and however unwittingly followed, to these social goals. The price system is a mechanism that governs the allocation of a limited amount of economic resources among a limitless series of alternative demands. Society is injured when scarce and costly materials and labor are devoted to the production of a "perfect" automobile while at the same time an urgent demand for aircraft or mechanical refrigerators goes unsatisfied. Despite the many and glaring imperfections of the price system, these "finance executives," who are guided by it with the object of maximiz2 0 The effective operation of this mechanism presupposes that the creation of artificial scarcity, with its consequent enhancement of pecuniary value which leads to misapplication of resources, will be avoided. This involves the elimination of monopoly, duress, coercion, unethical persuasion, and the general establishment of the common law concept of reasonable value. The establishment of fair competition is the business of legislatures via statutory law, of courts via common law, of government regulatory agencies via administrative law, and of the business community via the growth of ethical standards. Differences of appraisal of the measures adopted and of their effectiveness will cause controversy over the social acceptability of this means of distributing resources, as contrasted, for example, with rationing in a communist state. Such rationing would differ from this allocation by the supposititious elimination of artificial scarcity. But it would, according to communist economic theory, also eliminate pecuniary demand as an expression of consumer choices.

SOCIAL FUNCTIONS OF E N T E R P R I S E

39

ing the margin between money costs and money receipts, are nevertheless following the only legible guideposts available to them. Their decisions on this basis are the heart of the control or allocations system in a free enterprise economy. Such an economy is unplanned, but it is not without logical guidance or order; it is directed (whether well or badly is irrelevant here) through the influence of relative prices upon the decisions taken by the "finance executives." Allocation must equally be carried out and such critical decisions made when industry is state-controlled as when privately directed. It is incorrect and dangerously confusing to draw attention to the profit-making aspect, which is so prominent in the context of a finance capitalism economy, to the exclusion of those crucial functions that are indispensable in any type of specialized economy so long as the maximum use of scarce resources for the satisfaction of wants and the ideal of material progress hold place as major social goals. Although the function of allocation could conceivably be exercised by the engineer or works-manager of exceptional gifts, it cannot be lumped with his technical operational duties as plant executive. The abilities, training, knowledge, and techniques required of those who carry out this function are wholly different from those needed in the works-manager who, aside from personnel management, is engrossed chiefly with the engineering problem of securing maximum output with minimum input. It is not to be expected that enough men can be found in whom all these attributes are rolled together. And if such a talented breed should evolve, we may be sure that certain attributes would be more highly developed than others, in which case wise application of the principle of specialization would dictate that each be given the work for which he was most highly fitted. It is not the inventor or the engineer or the cost accountant or the marketing specialist (although all of these make a highly useful contribution) who can make

40

SOCIAL ASPECTS O F ENTERPRISE

the crucial decisions. Someone must stand outside the specialized field of each, weighing and appraising the facts and recommendations submitted. This function must be carried out whether it is done in terms of weighing money outgo against money receipts, as in finance capitalism, or real costs (that is quantities and qualities of resources) against social utility (consumers' satisfaction), as in a fully communized economy. This "someone" is today, for the corporate part of our economy, a composite of the general executives and directors. In a socialized state, he may be chairman of the central planning board, together with all of his policy-making subordinate officers, but clearly, he will not be the production engineer or works-manager. A different approach to this function of allocation, cast in different terms and emphasizing the actions of the individual businessman when making decisions in terms of relative prices, is found in Marshall's well-known principle of substitution. It is simply the exposition of another aspect of the same mechanism of business decision geared with the price system that we have just examined. With this principle, Marshall dispersed the mists of the earlier economists who relied upon natural law to explain the meshing of myriad individual decisions. 21 His statement has a classic simplicity. 22 The enterpriser, using money units as his yardstick, continuously compares costs and receipts with the object of maximizing the 21

Op. cit., pp. 341, 404-12. Ibid., p. 404: "In the modern world nearly all the means of production pass through the hands of employers and other business men, who specialize themselves in organizing the economic forces of the population. Each of them chooses in every case those factors of production which seem best for his purpose. And the sum of the pricee which he pays for those factors which he uses is, as a rule, less than the sum of the prices which he would have to pay for any other set of factors which could be substituted for them; for, whenever it appears that this is not the case, he will, as a rule, set to work to substitute the less expensive arrangement or process." 22

SOCIAL FUNCTIONS OF ENTERPRISE

41

margin of receipts over costs. In so doing, he shifts both the quantities and qualities of men, materials, and machines, always substituting a cheaper one for a dearer, when possible. Marshall observes that the advantages of economic freedom are never more strikingly manifest than when a business man endowed with genius is trying experiments, at his own risk, to see whether some new method or combination of old methods will be more efficient than the old. Every business man, indeed, according to his energy and ability, is constantly endeavoring to obtain a notion of the relative efficiency of every agent of production that he employs; as well as of others that might possibly be substituted for some of them. 2 3

Up to this point, our attention has centered upon economic change and the price system as instrumental to both change and the allocation of resources. Economic change has been analyzed chiefly in terms of its origins rather than in terms of the form it may take in the individual firm. Broadly stated, change may take the form of technological innovation and adaptation or of innovation and adaptation in the organization of human effort. Since change embodied in physical, chemical, or mechanical inventions, techniques, or discoveries commonly entrains change in the ways of applying human effort, the distinction, although important from many points of view, need not be emphasized here. But it may be pointed out that as compared with the extensive attention given technical or physical change, organizational change has been neglected in economic studies. In the large corporation, "top management," here restricted to general executives and directors (in some instances with the participation of a large minority shareholder) carries out the social functions of innovation and adaptation with which allocation is interlocked. Management is the instrument of 23 Ibid., p. 406.

42

SOCIAL ASPECTS OF E N T E R P R I S E

these functions. Since the following chapter is devoted to the impact of change upon human relations within organizations, our point of view shifts to examine the organizational duties of executives in the corporation. The social functions of enterprise are, of course, interwoven with these specific duties of corporate management.

Chapter

IV

HUMAN RELATIONS IN CORPORATE ENTERPRISE

D

IRECTORS and general executives form the management group in the corporation. The enterprise functions to be carried out by this group have been identified as broadly conceived instruments of social utility, in the preceding discussion. Two of these, innovation (creation of change) and adaptation (adjustment to change initiated elsewhere) have so far been viewed only externally, from the standpoint of their relation and contribution to the total social structure. But the external bearings of innovation and adaptation have an internal complement no less central to our subject. Regarded from within the corporate organization, these two functions largely lose their separate identity; they are merged and translated into the single element of planned, purposive change; and it is with the large corporation as an instrument for the organization of human collaboration, in the midst of planned, purposive change, that this chapter deals. The functions of the executive, the nature of his authority, and the manner of its exercise are clearly substantive parts of the organization. Since general executives constitute the group charged with day-to-day conduct of corporate affairs, as contrasted with the intermittent activity of directors, the role of the executive is primary in dealing with organization, even though action by directors may importantly influence internal organization. Discussion of the functions of directors is therefore reserved for the following chapters. Although specialized phases of technical and operational organization policy and practice have been the subject of 43

44

SOCIAL ASPECTS OF ENTERPRISE

intense study by students of management, little systematic insight into the executive functions and discernment of their relation to organization as a system of cooperative effort existed prior to the publication in 1938 of Chester I. Barnard's book The Functions of the Executive. The clinical studies of Professor Elton Mayo and those associated with him in the Department of Industrial Research of the Harvard Graduate School of Business Administration have contributed importantly to understanding of human relations in industry. In the past few years, a number of books representing various viewpoints and dealing with diverse phases of the corporation and business leadership have been published. 1 Barnard, analyzing executive functions from a point of view stressing human relationships in organization, divides executive duties into three categories. The first is to provide what he terms the "system of communications"; the second, to promote the securing of essential efforts; and the third, to formulate and define purpose. 2 The "system of communications" consists of the establishment of the organizational services of a series of men at a series of places, that is, the assignment of duties to points (positions) in the organization structure, and paralleling this process, the selection of men qualified to discharge them. Information, report, and decision move between them in a two-directional flow. Upon the 1 John C. Baker, Directors and Their Functions. R. A. Brady, Business as a System of Power. Melvin T. Copeland and Andrew R. Towl, The Board oj Directors and Business Management. Peter Drucker, The Concept oj the Corporation. R. A. Gordon, Business Leadership in the Large Corporation. P. E. Holden, J. S. Fish, and H. L. Smith, Top Management Organization and Control. Oswald Knauth, Managerial Enterprise. Elton Mayo, The Social Problems of an Industrial Civilization. Beardsley Ruml, Tomorrow's Business. Thomas N. Whitehead, Leadership in a Free Society. 2 Barnard, Functions, p. 217.

HUMAN RELATIONS

45

selection of men fitted to the demands of each position depends the effectiveness of the communications system. Essentially, this term denotes the organization structure. Presumably the author uses it because he finds it more heavily charged with the limitations of human capacity and the sense of an exchange of information and thought, leading to understanding and action between human beings, as opposed to the more general and conventional word "organization." However that may be, Barnard, out of long executive experience, wisely observes that Men are neither good nor bad, but only good or bad in this or that position. This is why they not infrequently "change the organization," the arrangement of positions, if men suitable to fill them are not available. In fact, "executive organization" in practice cannot be divorced from "executive personnel"; and "executive personnel" is without important meaning except in conjunction with a specific arrangement of positions. 3

The securing of essential efforts embraces the application and maintenance of the methods and plans of inducements, and of the plans of deterrents, education, training, inspection, supervision, and control. The highly specialized process of making organizational decisions is, of course, involved in each of these categories, as in every phase of executive work. Group purpose is involved in the large corporation; and group, as opposed to individual, purpose, requires cooperation. The survival of any commercial system of cooperation hinges upon successful adjustment to the total external environment, that is, meeting competition, securing sufficient capital, and the like. It also depends internally upon "securing essential efforts," upon bringing into existence and satisfactorily distributing satisfactions or rewards to the members of the group. A very large portion of executive attention must be devoted to the system of communications upon which all 3 Ibid., p. 2 1 8 .

46

SOCIAL ASPECTS OF ENTERPRISE

else depends in any system of cooperative effort. The problems associated with communications and satisfactions, since they are problems of human organization, are commonly magnified with increases in size. This is especially true of the large corporation that characteristically increases personnel specialization with growth in size. The maintenance of the system of communications and of satisfactions is rendered even more difficult in the midst of incessant change that alters the method and character of work, group relations, and leadership. The reasons for this selective emphasis upon organization and change are twofold. First, because the bearing of enterprise upon technological innovation and operational organization have received competent and extended study, it is appropriate to emphasize the neglected factor. To omit discussion of techniques and operations is not to deny or to minimize their importance, but because it has been extensively dealt with by others it is less necessary here. Second, perhaps owing to our very successes in material advance, that is, to the frequency of change attributable to our prepossession with technical improvement, the problems of sustained cooperation, of human relations within large commercial organizations, have risen to first place. These problems are not of recent origin nor do they spring from the growth of labor unions, although the traditional aims and practices of the latter often infinitely complicate the approach to solutions. The essence of enterprise in the internal life of the large corporation is planned, purposive change. Within the organization such change impinges upon the members by altering their group relations and ways of work and living. The sheer number of human beings involved and the maintenance of organization among them would be difficult even under conditions of fixity. To maintain cohesion and communication under conditions of never-ending change raises the com-

HUMAN RELATIONS

47

plexity of the task to altogether new dimensions, lacking any counterpart in smaller enterprises. The evidences of disintegration in our society, the tendencies to shake apart into hostile groups, are generally viewed with deep concern. These tendencies are intimately related to rapid changes in the conditions of work and living; these changes in tum are caused by material or technological innovation and the resultant systematic reordering of operations to achieve the production gains inherent in the new processes or products. The human problems entrained in this sequence are, in Mayo's phrases, the problems of an "adaptive society" as contrasted with an "established society." 4 People tend to resist change, to resent being "pushed around," the more so to the degree that noneconomic behavior is dominant and noneconomic incentives are insufficiently available. The resistance of the informal organization to planned change imposed from above becomes a principal strategic factor in the exercise of enterprise in the large corporation. In the past it has not been so viewed. Innovations in the arts and sciences of material production have been the focus of enterprise in action as well as in economic studies. Success in this sphere has been dramatic and continues so. In the subjugation of nature to human purposes, successful reduction of one obstacle leads to the selection of the next key element for attack and solution. In dealing with physical phenomena, this shifting key element is commonly termed the limiting factor. Thus, the development of the turbine was a condition of harnessing water power and converting it to electric energy. With this production success, transmission of electric power to points of use became the limiting factor and so the next object of attention. Similarly, in the evolution of corporate enterprise, the development of cooperation within the organization is the strategic factor that now needs * The Social Problems of an Industrial

Civilization.

48

SOCIAL A S P E C T S O F E N T E R P R I S E

attention. In dealing with the volitional efforts of men applied to other men, the term "strategic factor" is preferable because it denotes revision of action in relation to changes in the purposes and behavior of those affected. The point may be expressed in another way. Barnard makes a useful distinction between "effectiveness" and "efficiency": the effectiveness of cooperative effort relates to accomplishment of an objective of the system and is determined with a view to the system's requirements; efficiency relates to the satisfaction of individual motives.5 The great attention and relatively high success in effectiveness attending change in material production and the technical organization of business has not been matched in efficiency. Neglect of this human factor in change, on the one hand, coupled with rapid innovation on the other, have resulted in human collaboration becoming the strategic factor in enterprise. Indeed, failure to cope with it successfully imperils the very basis of our social and economic order. In this light, internal organization as a system of cooperation must be classed, in the large corporation, not as a mere incident of management to be fully delegated to personnel officers, but as a major function of top management. Perhaps the view developed here may be made more concrete and vivid by turning briefly to examine mass production as illustrative of a sharp and major kind of change within organization. Economists and other writers, looking at mass production, have for the most part emphasized either its effect of monotony and extreme specialization on the worker, or they have emphasized machine technology, the invention of mechanical devices, physical, chemical, and engineering advances, as its key elements. It has largely been overlooked that human organization is central to this achievement. It is doubtful whether the predominant importance of organization 5

Functions, Chap. V.

HUMAN RELATIONS

49

as the key to mass production is yet generally recognized outside the limited circle of executives of large corporations and a few professional students of management. Dramatic evidence of this pivotal importance of organization is furnished by the war record of munitions supply by large firms. In this connection, the point of prime significance is that the majority of these items had never been mass produced either by the newly converted manufacturers of automobiles, tractors, typewriters, washing machines, and the like, or by any other firm. The mass production success with planes, tanks, optical and computing sights, radar equipment, and so forth, was an achievement without past experience or precedent. Yet it was not based upon the invention of new widgets. No major innovations in machine technology were made. Essentially the achievement rested upon the process of breaking down complex parts and assemblies so as to minimize the judgment and skill required of individual workers. When simplification and standardization were impeded by the original design, purpose and use were analyzed with a view to simplified redesign. This approach made practicable the utilization of the huge unskilled labor force employed. It also involved continuous change in ways of working and in the constituents of working groups. To view each process as reducible to an aggregate of simple and unskilled operations; to coordinate and time the flow of materials and parts so that each worker, at each stage of his work, has all the needed materials at the right time; these two principles, combined with a third—standardization and interchangeability of parts—constitute the root concept of the technique of mass production. But it is primarily a technique of organizing and more effectively applying limited human capacities. This is as true when attention is focused upon the relation of man to the machine, as it is in the relation of man

50

SOCIAL ASPECTS OF ENTERPRISE

to man. Assembly-line methods are merely a species of the genus mass production. 9 But it is questionable whether our war production successes, requiring, as they did, extreme mobility and adaptability of workers to radical changes in methods and distribution of work, could have been achieved except in the presence of the overriding emotional incentives and social compulsions engendered by the national war effort. That is, it is doubtful whether the body of principles and practices generally followed by management, in the absence of such an emergency, would have succeeded in winning the acceptance by workers of so rapidly paced innovation and change. If this view is correct, it follows that organizational change will meet more resistance in peacetime. Since the effective introduction of such change is our present inquiry, we must examine the adequacy of current methods of gaining the collaboration and contribution of workers. However, inasmuch as traditional preconceptions lodged in men's minds strongly influence attitudes and methods intended to achieve these purposes, we must first turn to look at these. Fixed ideas about "economic" behavior influence not only what we do, but can cause us to misinterpret what we see. Worse, they can blind us to accurate observation by identifying interpretation with observation. Individual Versus Group Behavior The development of the social skill necessary to elicit a high order of collaboration within commercial organizations has not been facilitated by the heritage of a social philosophy and tradition bequeathed through the classical economists and their successors. The molecular view of society—that mankind is a horde of unorganized individuals actuated by self β For a discussion end interesting example of this point, see Drucker, Concept of the Corporation, pp. 30-31,182-90.

HUMAN RELATIONS

51

interest—has an ancient genealogy. The prestige of the new physical sciences early produced attempts to apply their methods to the study of men in their social relations. Such a study of society tended to treat individuals as independent units. According to A. D. Lindsay, Hobbes was the first to attempt systematically to make political theory scientific in this new sense. 7 In his theory, men are equal identical units whose natures are not affected by the relations into which they enter; their relations with one another are purely external. Social and political relations are merely means by which the individual obtains more efficiently what he desired before he entered into those relations. This molecular doctrine persisted in Locke, was revived and brought to full flowering by Bentham, and thence descended to Ricardo and J . S. Mill. This atomistic doctrine is not to be confused with religious individualism that affirms the supreme value of the individual, for the Christian belief stresses equally the teaching, " H e that findeth his life shall lose it; and he that loseth his life for my sake shall find it" (Matthew 1 0 : 3 9 ) . The individual who is of supreme worth is not an isolated atom but realizes himself in the service of the faith. And these individual and collective aspects are inseparable in the Christian religion. To Bentham, the community was a "fictitious body, composed of the individual persons who are considered as constituting as it were, its members. The interest of the community then is what?—the sum of the interests of the several members who compose it." 8 Commons observes of this: it follows that the interest of the community is only an arithmetic sum of individual interests—not an expectation of transactions be* "Individualism," Enc. Soc. Sei., VII, 676-77. 8 Works, I, 1 (Introduction to Moral« and Legislation), quoted by Commons, op. cit., p. 224.

52

SOCIAL ASPECTS OF ENTERPRISE

tween individuals as members of a going concern. . . . This concept of society was, for more than a hundred years, not a society but a population of molecules of the classical and hedonic economists, revolted against by the Marxian and Christian socialists and by modern social philosophy.9 To Jeremy Bentham the felicific calculus of pain and pleasure was the sole motive or "sanction" of conduct. 10 This passivity of the human will and the isolation of the individual embodied in the hedonic man inspired Veblen's gay ridicule of this creature, who is a lightning calculator of pleasures and pains, who oscillates like a homogeneous globule of desire of happiness under the impulse of stimuli that shift him about the area, but leave him intact. He has neither antecedent nor consequent. He is an isolated, definitive human datum, in stable equilibrium except for the impinging forces that displace him in one direction or another. . . . He is not the seat of a process of living, except in the sense that he is subject to a series of permutations enforced upon him by circumstances external and alien to him.11 Commons continues that Bentham's "moral sanction" is not that of custom, nor any of the rules of concerted action, but is the "chance" meeting of individuals in a population of molecules, with whom bargains or conversations may occur. Nor did Bentham draw back from giving pleasures and pains a physical existence. This he found in money. W. C. Mitchell quotes from an unpublished manuscript of Bentham, found in 1901 by Halevy: But the pleasure produced by the possession of money is as the quantity of money that produces it: money is therefore the measure of this pleasure. . . . The only common measure the nature of things affords is money. . . . Those who are not satisfied with the accuracy * Commons, op. cit., p. 225. ™lbid„ 1,14, n. 11 "Why is Economics not an Evolutionary Science," reprinted in The of Science in Modern Civilization and Other Essays, pp. 73-74.

Place

HUMAN RELATIONS

53

of this instrument must find out some other that shall be more accurate, or bid adieu to Politics and Morals. 1 2

Ricardo gave economic formulation to Bentham's concepts. This use took the form of assumptions that men are unrelated individuals who act in ways designed to achieve their selfinterest and that each thinks logically, to the best of his capacity, in carrying out this aim. If it is queried what meaningful bearing this examination of the 150-year-old ideas of Bentham and Ricardo has for this enlightened time in which we all know better, the reply is simple. Old intellectual baggage is hard to jettison. Vilfredo Pareto, for example, in his Manual of Political Economy ( 1 9 0 9 ) regarded society as a world of molecules acting upon each other, although ten years later, in his Treatise on Sociology he expressly repudiated his former concept of Society. For individual utility and individual wants he substituted social utility and collective wants. Benthamism, bequeathed in economic terms through Ricardo, is embodied in institutional practices and persists in management attitudes and methods even though it may formally and intellectually be eschewed in its bald and pristine expression. The modern disciples of Frederick Taylor and the practices of scientific management are by no means yet free of this legacy. Playing changes on the scale of pecuniary incentives is still the chief stock in trade of management "engineers." Sometimes these schemes take such complicated forms that the calculation of pay causes the 1 2 "Bentham's Felicific Calculus," Political Science Quarterly, XXXIII (1918), 169-70. (Quoted by Commons, op. cit., p. 233.) Mitchell points out elsewhere that "This formulation of the mental operation of an ideally perfect money-maker can be converted into a passable formulation of Bentham's hedonism by merely turning pecuniary into psychological terms. Substitute pleasure for profit and pain for loss, let the unit of sensation stand for the dollar, replace accounting by the hedonic calculus, interpret selfinterest as the maximizing of net pleasures instead of net profits, and the transformation is complete." "The Rationality of Economic Activity," Journal of Political Economy, XVIII (1910), 213.

54

SOCIAL ASPECTS OF ENTERPRISE

time interval between the period of work performance and final payment to be so great that they are self-defeating. That is, the connection between variable output and variable pay is lost to the worker. 13 Yet it is a commonplace of modern social observation that individuals tend to associate themselves into groups, often on no other basis than mere local contiguity. Among preliterate societies territorial contiguity resulted in the development of common interests although the existence of this association has been obscured by the predominance of kinship ties.14 The formation of groups and the development of mores and loyalties among such groups within large organizations is a fact of common observation and is often referred to as the "informal" organization. There is no novelty in this phenomenon in itself. But the clinical studies made by members of the Industrial Relations Department of the Harvard Business School, especially the Hawthorne experiments at the production worker level, show that within such groups logical self-interest is often blotted out by nonlogical group standards of behavior. From these Hawthorne studies, extending over a five-year period, Roethlisberger and Dickson concluded that None of the results, however, gave the slightest substantiation to the theory that the worker is primarily motivated by economic selfinterest. The evidence indicated that the efficacy of a wage incentive is so dependent on its relation to other factors that it is impossible to separate it out as a thing in itself having an independent effect. The studies provided examples of a number of situations in which the wage incentive had either lost its power to motivate or functioned differently than is frequently assumed. 15 13 For an instance of this, see Τ. N. Whitehead, Leadership in a Free Society, p. 130. " R. H. Lowie, "Social Organization," Enc. Soc. Sei., XIV, 142. 10 F. J. Roethlisberger and W. J. Dickson, Management and the Worker, p. 576. This book describee three experiments at the Hawthorne plant of the Western Electric Company, each dealing with manual workers under different conditions.

55

HUMAN RELATIONS

A similar conclusion, based upon long executive experience, is reached by B a r n a r d : The unaided power of material incentives, when the minimum necessities are satisfied, in my opinion is exceedingly limited as to most men, depending almost entirely for its development upon persuasion. Notwithstanding the great emphasis upon material incentives in modern times and especially in current affairs, there is no doubt in my mind that, unaided by other motives, they constitute weak incentives beyond the level of the bare physiological necessities. 18 M a y o summarizes the final phase of one series of experiments at Hawthorne, called the Bank W i r i n g

Observation

R o o m studies, as follows: Payment was made to workers in terms of a group incentive plan; but this plan completely failed of effect. Work was done in accord with the group's conception of a day's work; this was exceeded by only one individual who was cordially disliked. Nor was output in accord with the capacity of individuals as predicted by certain tests. The lowest producer in the room ranked first in intelligence and third in dexterity; the highest producer in the room was seventh in dexterity and lowest in intelligence. 17 H e goes on to point out that these observations a r e not unique;

"exactly

the

same

phenomenon

Mathewson in his extensive industrial

is recorded

studies. 1 8

by

Golden and

Ruttenberg discuss the situation at length and claim that unionism offers remedies for t h i s — a c c o r d i n g to their state16 Functions, p. 143. Barnard continues: "To many this view will not be readily acceptable. The emphasis upon material rewards has been a natural result of the success of technological developments relative to other incentives; it is the material things which have been progressively easier to produce and therefore to offer. Hence there has been a forced cultivation of the love of material things among those above the level of subsistence. Since existing incentives seem always inadequate to the degree of cooperation and of social integration theoretically possible and ideally desirable, the success of the sciences and arts of material production would have been partly ineffective, and in turn would have been partly impossible, without inculcating the desire of the material." 1 7 Mayo, op. cit., p. 42. 1 8 B. Mathewson, Restriction of Output among Unorganized Workers.

56

SOCIAL ASPECTS OF ENTERPRISE

ment—inevitable condition of 'unorganized' industry." 1 9 And Mayo concludes: It is at least evident that the economists' presupposition of individual self-preservation as motive and logic as instrument is not characteristic of the industrial facts ordinarily encountered. The desire to stand well with one's fellows, the so-called human instinct of association, easily outweighs the merely individual interest and the logical reasoning upon which so many spurious principles of management are based. 20 The studies of other members of the Industrial Relations Department associated with Mayo at Harvard, as well as his own studies, support his conclusions concerning social grouping in industry. Having cited four cases, as typical of many, he asserts: It is my belief that in every instance of which we have first-hand knowledge there is clear evidence that the usual ideas and practices in industry are based on a general misconception of the nature of the problem and consequently on misconception also of the nature of effective remedy. . . . In industry and in other human situations the administrator is dealing with well-knit human groups and not with a horde of individuals. Whenever it is characteristic, as in the California of 1943, that by reason of external circumstances these groups have little opportunity to form, the immediate symptom is labor turnover, absenteeism, and the like. Man's desire to be continuously associated in work with his fellows is a strong, if not the strongest, human characteristic. Any disregard of it by management or any ill-advised attempt to defeat this human impulse leads instantly to some form of defeat for management itself. 21 In the Relay Assembly Test Room experiments at Hawthorne every effort was first made to secure the active collaboration of the workers. Then the conditions of work were changed one at a time; rest periods of different number and different length, shorter working day, shorter working week, 19

C. S. Golden and H. J. Ruttenberg, The Dynamics of Industrial Democracy.

20 Op. cit., pp. 42-43. 21 Ibid., pp. 110-11.

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and food and beverage in the morning break were introduced. A t each step in the program the workers were consulted concerning proposed changes. The upshot of the experiment was that increments of production could not be related point for point to the experimental changes introduced. A major change, extraneous to these purposive changes, was taking place and this was chiefly responsible for the steadily increased output of the group. What had happened was that the experimenters, in seeking to hold the situation humanly steady by getting the cooperation of the workers, had inadvertently, and amusingly, caused these six individuals to become a team which gave itself so unreservedly to cooperation in the experiment that output continued to rise even during later experimental periods which duplicated the original least favorable conditions of work. 22 T o develop such working teams and to gain their participation in the broader spheres of organization purposes is a m a j o r and largely unsolved task of management. The key must be sought in bringing the larger purposes of the organization into meaningful bearing upon their daily round. Unless this is achieved, group loyalties may degenerate into vexatious cliques. But the translation of local loyalties to organization loyalty is commonly not to be accomplished in a single step. Whitehead maintains that in spite of endless talk about the value of "esprit de c o r p s , " " m o r a l e " a n d the like, many executives become visibly uneasy when this sentiment begins to build up in the only w a y possible to it. W h a t is asked of the worker is a vivid loyalty to some high abstraction variously referred to as " C o m p a n y p o l i c y , " " T h e firm," or even " T h e principles f o r w h i c h we stand." But loyalty is a social sentiment and it is built on routine collaboration, starting with quite small groups within the structure, and gradually spreading outward as these groups begin t o integrate among themselves. T h e progress of loyalty is f r o m small to larger associa22

Roethlisberger and Dickson, op. cit., Part I.

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tions; this is the story of American federalization; it represents the historical growth of most large companies, and it is the story of integration in any wide associations of human beings. 2 3

In the same paper Whitehead summarizes four conclusions: 1. Group integration depends on routine relations among people developed over a period of time. 2. A group will resist any outside threat to its own integrity by withdrawing into a self-made shell, and so ceasing to collaborate effectively with the larger society around it. 3. Change to be acceptable to a group must come from within, and must proceed as the visible need of its present activities. 4. N o society or large organization is averse to change provided the initiative for that change takes place at the relevant level—at that level where the daily activities have shown the need. Under these conditions change will present itself not as an interruption, but as the natural flow of social living. 2 4

Clearly these conclusions suggest that leadership must shape the methods of introducing change in such ways as to minimize conflict with existing attitudes and sentiments of those affected by the innovations. Rude collisions with the set ways of life are not calculated to elicit from members of the organization their maximum contribution to the enterprise and are likely to be reflected unfavorably in the income statement. Moreover it has been shown that the deep-seated proneness of humanity to resist change is by no means always best overcome by increasing the material rewards. Even where this is feasible and appropriate it is commonly necessary to buttress it by other types of incentives and by persuasion. 25 Obviously it is a major task of management to explore, devise, and apply appropriate incentives in addition to material ones, to secure and maintain the maximum contribution 23 Whitehead, "Leadership Within Industrial Organizations," Harvard Business Review, XIV (Winter, 1936), p. 164. See also Barnard, to the same effect, Functions, p. 104. 24 Leadership f fithin Industrial Organizations, p. 170. 25 See Barnard, Functions, p. 143, and Whitehead, Leadership in a Free Society, p. 131.

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of the organization to the enterprise goals. Such incentives are to be found in improved opportunities for social compatability, distinction, prestige, personal power, and pride of workmanship. A detailed discussion of noneconomic incentives and the procedures of their application is inappropriate here. The specific plans and steps necessary to apply such incentives will inevitably differ widely from industry to industry and from firm to firm. It is sufficient here to indicate that the engrossment of executive attention with these "noneconomic" desires is a condition of effective human collaboration.26 An exclusive reliance upon material incentives to provide maximum motivation may or may not prove immediately unfavorable to the enterprise. But we have seen that such reliance is likely to fail to elicit the best teamwork within the enterprise; by magnifying one element in the gamut of human desires, it ignores and leaves dormant others, the development and satisfaction of which are necessary to an integrated society. Management aware of and responsive to its role in the community will increasingly emphasize the appropriateness of incentive and accent less strongly the material rewards. 27 These responsibilities of extending group loyalties to organization loyalties, of maintaining balance and adequacy of incentives, and of softening the social shock incident to technological change are heavy executive burdens. Indeed they call for such a high order of ingenuity in developing noneconomic incentives and of social skill in the communication 26

For a discussion of these see P. H. Douglas, "Non-Commercial Incentives," in The Trend of Economics. 27 The same view is expressed by Τ. N. Whitehead: "Poverty of social activity cannot be cured by great elaboration of the economic motive. The solution is to enrich the human collaborations and to arrange the organization of the work to give a sufficient opportunity for initiative and self-expression at all levels; and then to back up an adequate situation with a wage system which seems fitting and moderately motivating, and which is above all simple." Leadership in a Free Society, p. 131.

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of ideas and feelings to others as to suggest the necessity of large corporations generally raising their personnel officers to a position directly advisory to the chief executive. In short, to see that such officers are fully equivalent in ability and influence to the executive vice-president or vice-president in charge of operations. Rule-Making Up to this point we have been occupied chiefly in examining the conditions needed to elicit the maximum contribution of members of the organization. But contribution without coordination and control is calculated to produce confusion and anarchy. Authority and rules are as necessary to confer order and predictability in the internal corporate structure as in the larger society of which it is a part. These aspects of corporate organization must now be considered. Although business is merely one rule-maker among many, it is so importantly a rule-maker that a well-known business leader and student of business has made this fact the basic point of view of a book devoted to problems of modern business. 28 Other examples of rule-makers are the church, the state, the family, and the trade-union, to name only a few. The nature of the rules developed by each powerfully influences the character of the behavior as well as the kind and measure of the social satisfactions enjoyed by a community. Not merely because it absorbs the greater part of the disposable time of its personnel, but more importantly owing to the character of the aspirations it implants and the satis28 "This is a book about business as an instrument of authority and power, as a source of direction and decision. It looks at business as one rule-maker among many rule-makers, providing in part the pattern of organization and activity in which each human life takes form. Rules and rule-makers are necessary to order, and therefore, to human freedom. Business as a rule-maker accordingly stands high in responsibility among human institutions, as a source of goods and services, to be sure, but also as a source of order and of freedom." Beardsley Rum], Tomorrow's Business, p. 1.

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factions it offers, the rules made by business exert a pervasive influence. As a rule-maker each of these institutions develops a code to which the loyalty of the individual is tied. Additionally each individual has his own code, which may be an eclectic melange drawn from the institutional codes about him. Differences in goals and disparities in adaptability and social maturity result in conflict among the codes. The code of the business organization must receive the loyalty of the personnel if effectiveness is to be maintained. Yet individuals as "business personnel" carry with them appurtenances in the form of their institutional and individual codes and their attached loyalties. When conflict arises between the code of the organization and his appurtenant codes, the loyalty of the individual is torn between them and the organization suffers. Such conflicts may take varied forms. They may develop from simple ethical collisions, as when organization policy requires the retirement, for age, of a popular and useful member of the organization while still in full vigor. In such an instance, personal loyalties and ethical standards of groups and individuals often diverge from the objectives and policy of the organization. Another and potent source of conflicts lies in the not infrequent opposition of economic as distinguished from technological values. Every condition may be present and fulfilled dictating to the technician a change in method, process, or product, yet the economic position of the enterprise or the present and anticipated state of the market may lead to a decision overruling his recommendations. The effect of this upon the engineer is frequently a sense of frustration and divided loyalty between his technical code and the economic code of the organization. Again, opposition may frequently arise between the size and individual constituents of groups as determined, on the one hand, by natural or social groupings and, on the other, as dictated by the requirements of

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organization objectives in making changes. Here also group loyalties conflict with organization purposes. Doubtless other examples will occur to the reader. It is a major executive task to minimize the opportunities for these conflicts of codes and to resolve them when they occur without damage to the moral responsibility of personnel. The perception of this caused Barnard to write: "The higher the grade (of executive position) the more complex the moralities involved, and the more necessary higher abilities to discharge the responsibilities, that is, to resolve the moral conflicts implicit in the positions." 29 By "moral conflicts implicit in the positions" Barnard, of course, means those internal conflicts that converge upon the executive by his occupancy of a position at the center of communications, control, and authority in the organization. It is not a conflict between the executive's own appurtenant codes and his duties that he has in mind (although to be sure this may occur) but that the singularity of the executive position is such that conflicts between individuals, and conflicts between individuals and the organization itself, come to him for resolution. It is a delicate and exacting art to deal with these conflicts, that is, to adjust and settle them without impairing the validity of the organization code or weakening the moral responsibility of affected personnel. Business as a rule-maker also has a quasi-political status in the sense that it is a private government, the rules (laws) of which are controlling and finally authoritative for those within its sphere. To be sure, as long as alternative suitable employment can be found, one set of obnoxious rules (laws) may be escaped by finding employment with another organization. Yet obviously this is an empty privilege, availing nothing, unless diversity of rules exists among organizations. No observer of business would question the existence of » Functions, p. 276.

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diversity in organizational rules. But management generally, as a rule-maker, has certain tendencies that collide with basic concepts of the dignity and integrity of human personality as these are somewhat imperfectly expressed in our democratic governmental institutions and practices. An experienced executive points out that these tendencies are commonly "excesses in the very traits which are most desired in private executive management." 30 These traits of human behavior are so intangible and subjective that they can be influenced chiefly by public opinion and the slow processes of a maturing civilization. There is little that management itself can do to abate such excesses other than to understand the nature of executive authority and to take to heart the ancient admonition, "know thyself." Executive authority is so intimately related to order, to effective communication, and especially to maintaining the adherence of groups or informal organizations to the formal organization, that it requires our attention, however briefly. Executive

Authority

Barnard has told his difficulties in finding among the learned an explanation of authority consistent with his own firsthand experience of authority in action within commercial organizations. 31 He offers as an approximate definition: A u t h o r i t y is t h e character of a c o m m u n i c a t i o n ( o r d e r ) in a f o r m a l o r g a n i z a t i o n b y virtue of w h i c h it i s accepted by a c o n t r i b u t o r to or " m e m b e r " of t h e o r g a n i z a t i o n a s g o v e r n i n g the action he c o n t r i b u t e s . . . under this definition the d e c i s i o n as to whether an o r d e r h a s 30 "Initiative becomes arrogance; resourcefulness, cunning; efficiency, greed; tenacity, obstinacy; and willingness to take authority and responsibility, pride and lust for power."—"Yet they cannot be rooted out without destroying the motives and energies which draw from private business its superb contribution to the public welfare. These traits, like any other powerful and dangerous force, must be stimulated, used, and held in check." RumI, op, cit., p. 52. Ruml adds that it is the role of government to restrain them. 31 Functions, Preface,

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authority or not lies with the persons to whom it is addressed, and does not reside in "persons of authority" or those who issue these orders. 32

Such a view gives formal expression to the admonitions of Mary P. Follett and Ordway Tead that it is "power with people, not power over people," that counts. It is consonant with the sociological view of law as receiving its ultimate sanction from the consent and acceptance of the formal and informal organizations comprising the juridical community. Should it be queried how it is possible to secure enduring cooperation, such as experience has shown, if the determination of authority lies with the individual, Barnard's answer is that authority in the aggregate arises from all the contributors to a cooperative system. Also that there is a "zone of indifference," which is explained in this way: if all practicable orders are arranged in order of acceptability, there are some that will clearly not be obeyed; there is another borderline group either barely acceptable or barely unacceptable; and a third group acceptable without question. The last group is within the zone of indifference. Within this zone, orders will be accepted as lying within the range in a general way anticipated upon joining the organization; most orders fall within this zone. For example, any young man joining a large industrial organization having many plants and offices widely scattered through the United States, would ordinarily expect transfer among these and accept an order to that effect. If the company started a branch in India and ordered him to go there, he might refuse because that assignment was unanticipated and therefore outside his "zone of indifference." Moreover, there is an active personal interest among most of the contributors in maintaining the authority of all orders which to them are within this zone of indifference. The main32 Ibid., p. 163.

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tenance of this interest in acceptance rests largely with the informal organizations. This is commonly expressed in such phrases as "feeling in the ranks," "organization opinion," or "group attitudes." The zone of indifference is also enlarged and this informal pressure toward acceptance reinforced, as to each individual, by the extent to which the inducements and satisfactions exceed the burdens and sacrifices of adhering to the organization. It is, of course, axiomatic that orders which cannot or will not be obeyed, must be avoided. The history and the fictional literature of war are filled with stories of the tragedy or pathos of unskilled officers who had not learned this. The authority of position is clearly distinguished from the authority of leadership. Authority of position arises from the presumption that a communication originating from recognized sources of organization information—a communication center—is better informed than individual sources. Such authority is to a considerable degree independent of the personal abilities of the holder of the position. His advice may be acceptable and controlling merely owing to the advantage of position. The authority of leadership, however, stems from the respect commanded by superior personal ability, knowledge, and understanding. When the authorities of leadership and position are united, a confidence is born causing members of the organization to grant authority and accept orders far outside the usual zone of indifference. 33 Clearly this view pretty well extinguishes the Olympian lightnings traditionally associated with authority. Barnard has summarized his view epigrammatically: "Cooperation, 33 /6i