Review of 'Why Managers Matter'

Why coordination within the firm is important and how it can be achieved.

Austrian economists Peter Klein and Nicolai Foss wrote 'Why Managers Matter' as a defense of traditional managerial hierarchy from the 'bossless narrative' that calls for flatter organizations with fewer managers or without managers altogether.

They don't present this book as a libertarian analysis. And some of their arguments seem closer to conservative principles rather than libertarian ones ('As Jared Diamond put it: “Large populations can’t function without leaders who make the decisions, executives who carry out the decisions, and bureaucrats who administer the decisions and laws.”' 'That the Church is a conventional example of hierarchy should give us pause: the world’s oldest surviving organization, and therefore a very successful one in terms of longevity, is also very hierarchical.') 

Still, it's an insightful read about the relationship between free-market economics, the theory of the firm, and organizational theory.

What follows is less of a book review and more of my reflections ignited by the book. 

I will first summarize the main points. And then I will pose some questions which were not fully addressed in the book.

Here are the main points raised in the book

1. Production of goods and services requires coordination and cooperation

'Coordination means figuring out what should be done, by whom, when, how, and in what quantities... cooperation is about getting them to do it, even when doing so is not in everyone’s self-interest. Cooperation typically requires incentives because what is good for each of us individually may not be what is best for the group.'

2. Often market coordination is too costly (transaction costs)

'the invisible hand does not do its job costlessly. Trading can be difficult. You need to know the offerings. You have to bargain with vendors or entrepreneurs. Contracts must be made and enforced. Disputes arise. It is difficult to know the quality of many products and services.’

3. To reduce transaction costs activities are brought into companies

'The Nobel laureate Ronald Coase argued that the division of labor is often best exploited inside firms because managerial coordination can reduce the “transaction costs” of putting all these pieces together'

'conflicts between firms and outside parties (customers, suppliers, competitors, community members) are usually resolved by courts, while conflicts inside the firm are settled by the firm itself, with the board or top executives serving as a sort of supreme court.’ 

4. Unlike the market, companies are intentional. Therefore they require different, intentional direction (visible hand) to achieve coordination and cooperation 

'In markets, people are free to transact with each other; prices regulate who buys and uses the goods, services, and inputs in the economy; resources tend to flow toward the places where they are valued the highest; and entrepreneurs test new ideas and projects against the profit-and-loss test of market competition. The market isn’t a thing, or a place, or an organism, but a process'

'Companies, by contrast, are established by specific people at specific times and places for specific purposes… companies are based on (some measure of) direction and planning' 

5. A hierarchy that mandates who has authority over whom is needed to achieve coordination within companies

'Management is essential for coordinating people, resources, and tasks'

'A hierarchy is simply an arrangement in which someone holds authority over others’

'authority as the right to choose an action for another person, out of the set of that person’s possible actions’

‘Even highly competent employees are sometimes motivated to pursue their own interests rather than the company’s (what the academic literature calls a “principal-agent problem”).’

6. What works well for markets cannot work for companies

‘the fundamental misconception at the root of the bossless company narrative: that companies are essentially the same as markets. By overemphasizing flat structures, decentralization, and autonomy, the narrative suggests that all the great features of the market—exchange, competition, survival of the fitter, and so on—can be re-created inside the firm. But the forces at work inside organizations are different from those at work in markets. Pretending they are the same leads to trouble.’

These points lead to some questions

1. If not fully, can some features of the free market be partially re-created inside a firm? If so, to what degree a hierarchy will be an obstacle to that?

If markets and companies are fundamentally different does it mean no market features can be recreated in firms? Probably, not. Some free-market-leaning authors claim that we can use in companies what we learn from how markets operate. Here's, for example, Charles Koch in 'The Science of Success':

'I came to realize that there were laws that govern human well-being... It seemed to me that these laws are fundamental not only to the well-being of societies but also to the miniature societies of organizations.' 

Let's take, for example, a Hayekian concept of 'dispersed knowledge.' Hayek used it to emphasize that no central planner can collect all the data needed for economic coordination. Instead, the market process makes use of this knowledge dispersed through all the market participants. Wouldn’t the same be valid for ‘central planning’ within a firm? And if so could it be that the hierarchy may introduce some rigidity that makes it harder to tap into the dispersed knowledge within a company?

2. If companies cannot rely on market coordination it's crucial to know what exactly a company is. What is that granular entity that requires a ‘visible’ hand instead of an invisible hand?

Unfortunately I didn't find a clear explanation of what the company is. The authors themselves admit that the 'boundaries of the company can... be a bit fuzzy.' Then logically it follows that it's a bit fuzzy where we can allow market coordination and spontaneous order and where we require managerial authority and hierarchy.

Take for example, Uber which the authors mention several times. Uber coordinates taxi drivers without managerial authority over them. There is no Uber manager telling the drivers 'what should be done, by whom, when, how, and in what quantities.' Of course, there is a legal distinction between contractors and permanent employees. But from an economic point of view both these groups provide their labor to the company. So at least partially market can coordinate the labor of self-interested taxi drivers without hiearchy. 

3. What is essential about managers for coordination within a company?

It's hard to disagree that coordination and cooperation are needed to produce something. But it doesn't mean that responsibility for coordination must lie solely with one person. We all know exceptions. The simplest one: the coordination doesn’t stop when managers go on vacation

I didn’t find a persuasive argument for why peers cannot coordinate. Managers are also self-interested and prone to the principal-agent problem. So what is exactly about them that makes them better at coordinating group efforts?

One of the responsibilities of managers that the authors emphasise is monitoring:

'manager as a monitor—someone who makes sure that the right effort is expended at the right time in the right amount, that schedules are followed, and that work takes place according to the rules.'

But why a manager would be best placed to monitor others? In many cases, they won’t have the capacity to monitor everybody all the time. Also they may lack the technical expertise to assess how everybody is doing.

Authors tentatively posit that 'sometimes peer organization and peer monitoring beats supervision by middle managers.' The question then is what are the conditions that prevent that from happening consistently and sustainably?

In another place, it’s implied that only managers can react to what is happening in the environment.

'companies need managers who can recognize and act upon changes in their environments as well as manage the processes, structures, key performance indicators (KPIs), and rewards that incentivize employees to respond to these changes.'

What is so profoundly different about non-managers that they can't recognize the changes in their environment? Doesn't everyone, in a way, manage a certain scope of work, process a certain amount of information, and make certain decisions? 

In some way, it feels like a chicken and egg problem. Why managers are good at management stuff? Because only they are allowed to do it. Why are others not allowed to do it? Because they are not good at it.

4. What kind of hierarchy is needed to enable coordination and cooperation? 

Here's what Frederic Laloux writes in 'Reinventing Organizations,' one of the 'bossless narrative' books:

'Because there is no hierarchy of bosses over subordinates, space becomes available for other natural and spontaneous hierarchies to spring up—fluid hierarchies of recognition, influence, and skill'

It's not a call to eradicate hierarchy whatsoever. It's rather a call to allow a different kind of hierarchy to rise. That hierarchy will be more spontaneous (akin to how hierarchies spontaneously come about in a voluntary market). The difference is not about whether there should be a hierarchy or not. It's about what kind of hierarchy: formal or informal, top-down or bottom-up, spontaneous or fiat.

Unfortunately, I didn’t see authors addressing spontaneous hierarchies in detail. Only indirectly they refer to them negatively while discussing Valve, the video game company:

'what the sociologist Robert Michels called “the Iron Law of Oligarchy.” If there are no formal bosses, informal ones will emerge. Natural leaders arise to fill the gaps left by formal leadership structures.'

' informal structure may fill the void left by the absence of formal structure.'

This seems to be the reason why they think negatively about informal hierarchies:

‘Without well-defined roles and responsibilities, it is hard to coordinate people and tasks quickly and smoothly. Without formal rules and procedures, everything gets politicized and decision-making becomes messy and prone to conflict.‘

Traditional formal hierarchies may indeed be quicker. But politics and messy decision-making they surely do have.

Conclusion

What is great about this book? The authors provide a lot of interesting insight into organizational theory. They emphasize that cooperation and coordination are not free. 

What is the most efficient way of coordinating? According to the authors, it's a formal hierarchy with managers having authority over who does what. To them, formal managers and fiat authority are superior to peer coordination and spontaneous hierarchy.

With many good things about the book, it doesn't give fair treatment to the 'bossless narrative.' They do not address fluent and spontaneous hierarchies. And they deemphasize peer coordination and accountability.

I hope that the next edition will have more extensive quotations from the other side and more cases to explore.