Corporate Structure, Darwinism and Random Selection

The corporate world exhibits a wide variety of structures.  Co-operatives and partnerships have been around for a long time and have some well known examples.  The Co-op, for example, was founded in Rochdale as long ago as 1844 and now is represented worldwide.  Goldman Sachs was a partnership for most of its existence.  There are more exotic forms of the corporate beast, such as companies limited by guarantee, industrial and provident societies, friendly societies and, recently made possible by legislation in the UK, community interest companies.

But by far the dominant form of corporate organisation is that of the joint stock company with limited liability.  In other words, companies ultimately controlled by shareholders.  These can range from one person bands to the world’s largest firms such as Google.

Although the concept had been around for a long time, the shareholder company came into dominance in the corporate world in the late 19th century.  It remains by far the single most important form of corporate structure, even if we count the frequencies of the various structures on a simple head count rather than by value or turnover.

Companies run by managers on behalf of shareholders are coming in for increasing criticism.  In the financial crisis, the value of the equity of many banks collapsed and shareholders were sometimes left with nothing at all.   But in the process, the managers had enriched themselves.  The issue of the pay of senior executives in such companies remains a very live and sensitive political issue.

Is it time to call a day on this form of organisation, and if so how is it to be done?

A lot depends on why we think this particular structure came to exercise such dominance in what we might think of as the ecology of corporate organisation.   Many different forms of organisation compete to be adopted by entrepreneurs setting up in business.  But it is the shareholder company which is by far the most frequent choice.

If we do a simple plot of the relative frequencies with which the different types of structure are observed – even on a simple head count – we observe a highly skewed outcome.  Huge numbers of shareholder based companies, a lot of partnerships, but far fewer than the number of the ‘market leader’, some co-ops, then fewer and fewer until we get down to recent innovations such as the community interest company, with very few examples.

Pure Darwinism would lead us to believe that the shareholder company is dominant because it is better suited to the environment, to the ecology of corporate structure.  It is somehow fitter than its rivals.  Selection by fitness, however, does not by itself account for the relative frequencies with which we observe the different corporate forms.

A quite different theory also comes from biology, to account for the frequencies with which different species are observed in any given ecology.  Stephen Hubbell, based at the University of California at Los Angeles, came up with the so-called ‘neutral’ theory, which generates results which conform to the outcome which we observe empirically in ecological systems.  A few species have lots of members, most species have very few.  Exactly what we see with corporate forms.

A plausible hypothesis is that, in any given system, rare species are rare because, for whatever reason, they have not adapted well to their environment. Similarly, abundant species must have particular attributes which enable them to flourish. But the word ‘neutral’ in this context means that no species has any special qualities or characteristics which make it more or less suitable to operate in its given environment. Their relative success or failure is ‘neutral’ to their attributes. In other words, how a species behaves, what it can and cannot do, is irrelevant to whether or not at any point in time its numbers are small or large. The outcomes which we observe are the result of purely random processes.

It is a disturbing theory, which appears to defy common sense.  But common sense tells us that it is the Sun which goes round the Earth and not vice versa.  We see the Sun move, but we seem to stay still.  It has the great strength that it fits the facts.  Yes, evolution takes place, but the eventual outcome and the eventual ‘winner’ are determined much more at random than by inherent fitness.

The policy implications of this are important.  If we think the neutral theory applies in any serious way to corporate structures, the way to remove the dominance of the shareholder company is to allow more innovation, to allow different forms to come forward, one of which will eventually replace the dominant species.

By Paul Ormerod

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