John Kay: “For the past fifty years or so, the economic theory of the firm has been based on the paradigmatic model of corporate activity which perceives the firm as a nexus of contracts, its boundaries defined by the relative transaction costs of market-based and hierarchical organisation. Issues of both corporate governance and corporate management are seen as principal-agent problems, to be resolved by the establishment of appropriate incentives. This approach has had considerable influence on corporate behaviour and on public policy. Business has placed ever-greater emphasis on ‘shareholder value’ and incentive-based schemes of executive remuneration have become widespread.
In this paper, I describe the origins, development and effect of the ‘markets and hierarchies’ approach. I argue that this reductionist account fails at a political level, giving no coherent account of the legitimacy of such corporate activity – that is, no answer to the question ‘what gives them the right to do that?’ – and additionally that the model bears little relation to the reality of successful corporations. I describe an alternative tradition in the understanding of business, owing more to organisation theory, corporate strategy and business history, which treats the concept of corporate personality as more than a legal doctrine. In this view, corporations are social organisations: their competitive advantage is based on distinctive capabilities which are the product of their history, their internal architecture and organisational design, and the relationships with employers, customers, suppliers and commentators at large which arise from them. This is not just a more plausible account of what firms actually do: by