8 Power and Institutional Theory

Economic theory and institutional theory

In the previous chapters (transaction cost economics, specific knowledge, agency theory, and promotions and subjective performance evaluation), I have implicitly assumed that organisations either deliberately choose formal systems and develop norms that work best for their specific circumstances or that they are forced to adopt those norms because they feel pressure from capital markets. Banks, shareholders, venture capitalists and other capital providers ask a price (interest, dividend, buy-backs) for their investment. If the capital market believes that the firm is not sufficiently adapted to its competitive environment, they will ask a higher price for investments to cover the risk that the firm decreases in value or goes out of business. The capital market can even decide to withdraw its investments from the firm. If a company does not adapt to its competitive environment it will get a signal from the capital market that something has to change. As a result, firms in the same competitive environment will be similar to each other.

However, institutional theorists argue that this is not enough to explain all the similarities between organisations (DiMaggio and Powell, 1983). In times of uncertainty and unpredictability, humans and organisations have a tendency to look for stability and structure. Stability in this sense simply means that the organisation survives in a similar form as it was before. Thus, the need for stability leads to the introduction of a formal hierarchy with levels of decision making and clear role descriptions for every individual and business unit. This formal hierarchy will only remain stable if making changes to the hierarchy needs to be approved by the hierarchy through bureaucratic rules that determine how the role descriptions and levels of decision making can be changed. These bureaucratic rules will also determine what the appropriate lines of communications are in the organisation so that all decisions receive the correct approval. In this view, accounting and control systems are the means by which organisations maintain stability and the survival of the organisation. ^[1]

As a result of this process permanent structures arise which can be organisations (for-profit and not for-profit, financial and product markets), communication channels (consultants and universities), and governance systems (government and private regulation). If these permanent structures become important and stable enough they are sometimes called institutions and as we will see in the next section, they can have the power to shape their environment and other organisations.

Institutions shape the environment

In the economic theories I have discussed before, organisations always respond to their environment. They will adapt to price changes in markets, changes in customer demand, or changes in technology. Institutional theory argues that some institutions do not have to respond to the environment by adaptation but that they can change the environment themselves. A specific example is that some firms do not have to accept the market price, but can set the price for their own products ^[2].

Institutions can become influential in three different ways. Some institutions take decisions that influence a large number of other organisations. If Google changes its search algorithm, this has an impact on all organisations and individuals who use their website to generate an income. If Microsoft Windows changes its operating system both hardware and software developers for Windows have to make changes to their product. Similarly, governmental decisions on environmental regulation have an impact on the whole economy of a country. This is not to say that it is either good or bad that one institution has such an influence but it is hardly disputable that in a lot of fields one institution can set the direction for the whole field. If this is the case, the dependent organisations  have to conform to the powerful institution. Economic efficiency will only be a secondary consideration because survival primarily depends on the powerful institution.

Another role of institutions is to set the example of what the best course of action is. For instance, the Balanced Scorecard is a performance management tool that combines financial and non-financial measures initiated by Harvard scholars (an institution). One factor in the popularity of the balanced scorecard compared to earlier and similar performance measurement tools such as the French Tableau de bord is Harvard’s fame. Firms will be more willing to adopt a new strategic performance measurement system if it is backed by a well known institution. Similarly, over the last couple of decades, government agencies have started to see business practices as examples on how to run government agencies. This movement towards new public management has many causes which I will not delve into here. What is important for us is that government agencies have felt pressure to adopt tools and organisational structures from for-profit companies. Obviously, this will lead to a greater similarity in the how government agencies and business units in the private sector are managed. In general, by copying examples set by prestigious or influential institutions, organisations will look more similar to each other even without the pressure from the capital market.

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