1/2 — A few limits of traditional organizations and their governance systems

The purpose of this post is to point out several flaws of traditional organizations and their governance systems. The three categories of organizations mentioned here are:

• the nation-state (public governance)
• the for-profit company (corporate governance)
• global institutions (global governance)

In contrast, the Decentralized Autonomous Organization and some of its main features will be introduced in the next post.

Governance definition

Governance may refer abstractly to all processes of governing. It is the set of processes and rules which let the stakeholders of an organization cooperate and coordinate to put the latter into motion towards its goal.

In an analogy where the puppeteer represents the stakeholders of an organization and the puppet the organization itself, governance could be seen as the strings between the puppeteer’s control bar and its puppet. The attachment of the strings varies according to the character and its purpose, and their good design is mandatory for a good performance. Governance can also be viewed as the steering wheel needed for stakeholders to pilot organizations. Without it being properly designed they shall crash at some point.

I/ Nation-state governance drawbacks

1) Age and obsolescence

Public governance systems in Western countries are hundreds of years old. They were originally designed to be implemented in a world where total population was less than a billion, globalization was very limited, the United States of America barely existed and China was governed by the Qing Dynasty. Technology wise, the telegram, as well as railway networks, weren’t even a thing. Everything was paper-based. As a result, everything went much slower in society, from communications and trade to social interactions.

In 2019 however, 200+ billions of emails are exchanged every day between people in different parts of the globe, trillions of dollars are transacted on foreign exchange markets, and movements of people and goods grew exponentially since the 1950s.

From this simple observation, we can guess there is a mismatch in the evolution of public governance methods and their environment. Indeed, while the former has been modernized incrementally, the latter has changed disruptively. Most notably, the initial environment has completely shifted in size, quantity of information and even nature (as an important part of life went from physical to digital).

2) The centralization of decision making in a large organization

Nation-state governance systems involve only small groups of individuals (ministers, president, congresspeople…) in most parts of the governing process. Nevertheless, directives end up applying to complex countries of tens of millions of individuals with a great range in the variety of their aspirations. One weakness of such centralization of decision making resides in the imperfect information (or consciousness) that the ruling entity detains on the governed object (in this case a country).

This limit relies on the ‘limited range of human consciousness. It can be summed up trivially to “you don’t know it until you live it”. It says that it is not possible for a small group of individuals evolving in a closed localization, social class, and daily environment, to be conscious of a countrywide reality and to apprehend it correctly to act on it. Simply put, governments have limited capacity to empathise with populations and their needs.

One may say that researches, surveys, polls, reports and even decentralization of decision making to regions and cities are supposed to fill this gap in the government’s consciousness. However these methods leave blind spots and gaps in the information, and delegation of power to smaller geographical units is often marginal. Hence, decisions are made centrally, on the basis of (very) imperfect information.

This difficulty in feeding consciousness with comprehensive information on the governed object is even more pronounced when populations have increasingly diverging interests or little alignment. This is the case in developed societies where the divergence in aspirations between the elite and the rest of the population is increasingly widening.

3) Short-termism, the value black hole

In the current Western tradition, political parties alternate +/-5 years mandates. In the Public Governance system, this feature presents some democratic advantage as a single ruler cannot overtake the plans of a whole nation. But it is also a huge default when it comes to achieving long term goals. Parties are incentivized to rule with a short term logic to keep winning mandates.

Taking a step back, these mandates have just been created to balance against the high concentration of power architected in our public governance systems. This is something society may want to disappear in governance systems to come, as this short-termism is incredibly harmful.

II/ Corporate governance imbalances and flaws

The capitalistic model of for-profit hierarchical organization has reached a high level of sophistication. It is embedded in a complex floor of regulations and laws. It is also deeply ingrained in our system of thought and culture.

At its heart is the partnership between an entrepreneur and capital. Over time the model has proven effective in many cases. It unlocked a marvelous creative potential and generated important value for society. However, problems and inefficiencies arise because of concentrated governing power and the rigidity of the hierarchy as an organizational model.

1) Centralization of governance and lack of general alignment

At the heart of imbalances is the hierarchical nature of this type of organization. Owners and managers are the brain. They are the controlling and creative input while the rest of stakeholders are either instrumental or passive. Employees are subordinate and instrumental. While customers and society are literally passive. Hence, by design, all the formal governance processes happen between the shareholders, the BOD, and the management.

Non-inclusive governance induces additional costs to align stakeholders. Management efforts have to be made to readjust and trivially align subordinates in addition to their initial remuneration (aggressive management, politics, bonuses…). Also, marketing and campaigning are necessary to align other more passive stakeholders such as customers so they keep using the product/service. These practices have a substantial cost.

Moreover, non-inclusive governance introduces duplicity of goals in the organization. While the whole of stakeholders share a common interest around an always more valuable product/service, the small group possessing governance power has an internal goal of handing back value to shareholders. Therefore, within the same company exists an ongoing fight between two competing objectives.

When the minority goal has great influence, it leads to short term thinking. The long term purpose of the company becomes secondary. Obviously, the pursuit of shareholder wealth maximization creates much less wealth in the long run. No surprise then, that the most valuable companies are the Amazon or Apple type, where the general goal is protected by the founder.

Finally, non-inclusive governance and hierarchy excludes the pursuit of goals which would harm the interests of the governing group of stakeholders. Many potential use cases may not be realized because they do not fit this governance setting.

2) Barriers to accessing governance

There are two ways of accessing governance in a hierarchical organization. Buying a seat at the top as a shareholder or climbing the pyramid.

Buying a seat as a shareholder is difficult.

The best companies in the world end up being traded on public markets that are legally “public” but not in practice. Less than 1/5th of the US population directly owns stock. Moreover, we can expect shareholding of global US stocks to be much lower outside the US. Overall there are high barriers for some stakeholder groups to participate in Stockmarkets such as available capital, investment costs, education, and legal geography.

Therefore, the Stockmarket setting is the first barrier preventing outside stakeholders to take part in corporate governance. Leaving ownership and control to a few. At a time where companies have never been this deep in people’s lives and therefore so influent and valuable, the risk of one group having control has never been costlier.

Climbing the pyramid

In hierarchical organizations, roles are centrally assigned to resources. In some cases, this rigid and arbitrary design fails to realize a lot of potentials. This is especially true with Human Resources where employees are assigned titles with rather rigid functions. Climbing the pyramid often means jumping from titles to titles. It can also mean being an early employee, a founder, or a hired executive who are minority cases.

3) Other inefficiencies corporate governance fails to address: personal bias and moral hazard

Examples of personal bias and moral hazard are numerous in recent corporate history:

• Enron & Arthur Andersen
• BP Horizon Water
• 2008 subprime crisis: AIG, Lehman Brothers…
• HSBC money laundering activities
• Facebook Cambridge Analytica
• Volkswagen toxic emissions
• and many others…

Unfortunate events may have financial consequences impacting society. Some others have a dramatic impact on the environment. Overall those cases of mismanagement show that some companies have become too important in people’s lives and for society as a whole to be handled by current governance systems.

Those are the result of too much power in the hands of biased individuals, and corporate governance as well as hierarchical organizations failure to keep everyone aligned and accountable. A few attempts like Corporate Social Responsibility (CSR), i.e. companies implementing self-control over potential hams they may cause, has remained useless over the years.

III/ Issues with global governance

Global governance is the discipline that focuses on the creation, enforcement, and change of global patterns of activity in the anarchic society of states. The network of global institutions is supposedly in place to manage the globalization process. Those would cooperate for cross-sectoral issues and engage in a conversation with civil society as the organ of directives to refer to (Pisani-Ferry, 2018).

A paper by Jean Pisani-Ferry (October 2018) gives a pretty good overview of the difficulties faced by this network of global governance institutions:

• The shifting world order and political basis on which it was initially created
• The emergence nationalism to correct the bad effects of globalization
• Obsolescence in the face of rapid change (age)
• Existing gaps in the network of institutions around several problematics such as tax rules for example
• Obsolescence in the face of complexity and ever-growing interdependencies

A taste of failure

The last WTO negotiations (Doha round) started in 2001 and could never reach consensus. Numerous agreements on climate (Kyoto Protocol, Copenhagen conference, Paris COP21) were vague, ratified but not implemented or not ratified at all. Moreover, many other debates around the environment and competition were pushed back recently. Finally global economic institutions like the IMF loose grip in the face of protectionism and nationalism.

These facts question the legitimacy of an already weak mechanism for global cooperation and action. Pointing at huge limits in this governance system.

Limits of global governance organizations

• Inability to generate consensus in a plural world order
• Lack of enforcement capabilities which relied on a world order with the US at the top
• Lack of flexibility interoperability between institutions because of the slow bureaucratic processes

Overcoming the limits of traditional organizations

In the next blog post of this series will be introduced the decentralized autonomous organization (DAO). This new type of organization, network-based, is by nature a tool for cooperation rather than subordination. Resource allocation is fluid and not arbitrary. It has interesting properties for aligning stakeholders around a single long term goal, distributing governance among them in an efficient and balanced way. It also has the potential to overcome some shortcomings of traditional networks as stakeholders do not need to trust other parties. Finally, these tools keep being flexible while rules are enforced systematically.

Sources:

• https://en.wikipedia.org/wiki/Marionette
• Investigating Policy Processes: The Governance Analytical Framework (GAF) — Hufty 2011
• Governance a very short introduction — Mark Bevir
• Should we give up on global governance? — Jean Pisani-Ferry 2018