8 Power and Institutional Theory

Stijn Masschelein

Economic theory and institutional theory

Institutional theorists start from the observation that a lot of organisations have a very similar hierarchical structure (DiMaggio and Powell, 1983). There is one CEO on top, supported by an executive team. There is division of labor in different business unit based on products or geography. A lot of these similarities are further formalised in bureaucratic systems such as budgets, hiring, compensation and promotion policies, company handbooks, or job guidelines. The similarities are also expressed in norms and expectations in different professional fields. For instance, traditional professional business are more likely to expect their employees and especially their executives to wear formal business attire while business in the technology industry are more likely to accept business casual attire. The argument from institutional theory is that these practices, policies, and expectations are not necessarily the result of organisations being forced to be more efficient but the result of copying what other, similar organisations are doing.

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.

The last effect of institutions is that they set the norm and expectations of a profession or a player in the field. Professional organisations (e.g. CPA and CA) and educational institutions (e.g. universities) determine who can enter the labour market and who can not enter the market. They determine what the necessary knowledge is for entering the field but also set the expectations and ethical norms are. A potential disadvantage of such a selection mechanism is the influence of these institutions leads to limited diversity between professionals in the field.

Criticism of the institutional view

The lessons from institutional theory is that powerful organisations, groups, and individuals can have a huge impact on their environment. The power of these institutions may or may not stem from economic power but it can also come from the role this institution plays in setting an example or because the institution has a huge impact on the rules that govern economic transactions. This view has come under criticism for ignoring that organisations can make deliberate, smart decisions that are in their best interest (Abernethy and Chua, 1996). To provide a more complete picture, there is value in combining the economic insights from previous chapters with the institutional view. In my view, institutional theory is more informative when the organisation is going through change or when the environment that the organisation is operating in goes through rapid change. Under those circumstances, all the bureaucratic and social forces that resist change will be more important. The organisation will have to be aware of these operational forces to successfully adapt to the new environment. At the same time, in tumultuous circumstances where the best solutions are not clear, powerful institutions will provide examples on how to deal with change and can provide best practices. Economic theories are generally focused on what optimal management control solutions are but provide little guidance on how to get there. If we want to figure out how to implement or change management accounting systems, the institutional view will be more informative. In the next chapter, I will explain some of the more common implementation problems and solutions.


Abernethy, Margaret A, and Wai Fong Chua. 1996. “A Field Study of Control System ‘Redesign’: The Impact of Institutional Processes on Strategic Choice.” Contemporary Accounting Research 13 (2): 569–606. https://doi.org/10.1111/j.1911-3846.1996.tb00515.x.
DiMaggio, Paul J., and Walter W. Powell. 1983. “The Iron Cage Revisited: Institutional Isomorphism and Collective Rationality in Organizational Fields.” American Sociological Review 48 (2): 147–60. https://doi.org/10.2307/2095101.


  1. The impersonal writing in this paragraph is not a coincidence. The institutional theory explanation is not that these outcomes are the result of deliberate decisions by managers in the organisation but that hierarchical organisations contain a drive to protect the organisation which creates these forces towards more bureaucratisation. It is a more fleshed out argument of the common utterance that large organisations and government organisations tend to resist change.
  2. I will talk about this more when I discuss the role of cost accounting in price setting.


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