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Understanding Management
Understanding Management
The Social Science Foundations

Paul Willman

1
3
Great Clarendon Street, Oxford, OX2 6DP,
United Kingdom
Oxford University Press is a department of the University of Oxford.
It furthers the University’s objective of excellence in research, scholarship,
and education by publishing worldwide. Oxford is a registered trade mark of
Oxford University Press in the UK and in certain other countries
# P. Willman 2014
The moral rights of the author have been asserted
First Edition published in 2014
Impression: 1
All rights reserved. No part of this publication may be reproduced, stored in
a retrieval system, or transmitted, in any form or by any means, without the
prior permission in writing of Oxford University Press, or as expressly permitted
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above should be sent to the Rights Department, Oxford University Press, at the
address above
You must not circulate this work in any other form
and you must impose this same condition on any acquirer
Published in the United States of America by Oxford University Press
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Acknowledgements

Many people have helped with the material for this book. Ray Loveridge
encouraged me to take on the course at Oxford where I first engaged with
these ideas and Ted Piepenbrock sat in on it, giving valuable feedback. Yally
Avrahampour and Brittany Jones, both MBAs, have taught the Masters course
with me at LSE where the materials were developed and helped me think
things through. Howard Gospel, Steve New, and several anonymous reviewers
for OUP have provided valuable corrections. The manuscript itself has bene-
fitted from detailed comments from Mike Power, Barbara Townley, and David
Musson. Helena Caldon did a wonderful job on the manuscript. I bear full
responsibility for the remaining defects.
Note to the reader

An objective of this book is to argue that the academic field of management,

which is conventionally divided into six sub-disciplines, has common under-
lying concerns. This argument is presented in Chapter 1 but it is also reflected
in the structure of the book. I use chapters to present the content of these sub-
disciplines and themes to explore commonalities. This explains the contents
page below.
Contents

List of Figures and Tables 9

Introduction 1

Chapter 1. The Management Field 3

Theme 1. Accounting for Capitalism 15

Chapter 2. The Firm 23

Theme 2. The Agency Problem 37

Chapter 3. Workers of the World . . . 48

Theme 3. A Short History of Collective Action 63

Chapter 4. The Search for Consummate Cooperation 73

Theme 4. A Short History of Bounded Rationality 98

Chapter 5. The Structuring of Organizations 113

Theme 5. Measuring Performance: Scorecards and League Tables 129

Chapter 6. Strategy as Competition and Cooperation 147

Theme 6. A Short History of the M Form 162

Chapter 7. Strategy as Organizational Theory 178

Theme 7. Managing Markets from Hierarchies 192

Chapter 8. The Strange Rise of Financial Economics 211

Theme 8. The Modern Corporation 225

Chapter 9. The Anthropology of Management? 237

Theme 9. Performativity—Does Life Imitate Art? 257

Chapter 10. In Search of a Better Past? 275

Appendix: A Short Guide to Texts 288

References 290
Index 309
List of Figures and Tables

Figures
C1.1 Control in hierarchies and markets. 13
C1.2 Core concerns of management. 14
T1.1 The balance sheet that changed the world. 19
C2.1 Alternative contractual forms. 32
C2.2 Employer and employee contract strategies. 35
C3.1 Long-term unionization trends; USA and UK. 51
C3.2 Disputes: The national picture. 53
C3.3 The net effect of union activity. 54
C3.4 Union and non-union voice. 57
C4.1 The manufacturing process in car production. 75
C4.2 The Hackman-Oldham model. 82
C4.3 The history of leadership studies. 92
T4.1 Prospect theory. 105
T4.2 A catalogue of decision biases (a–d). 107
T4.3 Walk on the wild side? 111
C5.1 Some members and units of the parts of the manufacturing firm. 125
C5.2 The matrix at ABB. 127
T5.1 The purposes of performance measures. 134
T5.2 Tesco ‘wheel’. 137
T5.3 GE’s ‘rank and yank’ system. 138
T5.4 Parker and Price. 142
T5.5 Financial Times Global MBA ranking 2014 (top ten). 144
C6.1 Porter’s five forces. 151
C6.2 Key industry variables. 152
C6.3 The prisoner’s dilemma. 155
C6.4 The one-shot game. 156
C6.5 The Iterated Game. 157
List of Figures and Tables

T6.1 Variance in the M form. 163

T6.2 Whitbread (1) 1992. 171
T6.3 Whitbread (2). 175
T6.4 Whitbread after divisionalization. 176
C7.1 Canon portfolio of competences. 183
C7.2 Disney—growth and diversification. 184
C7.3 Disney’s competences—1990s. 184
C7.4 Strategy as (rational?) process. 189
C7.5 The assumptions of different strategies. 190
T7.1 Spatial representation of market structure. 196
T7.2 The product life cycle. 197
T7.3 A model of process and product innovation. 198
T7.4 Wine prices and sales, UK. 201
C8.1 The capital asset pricing model. 214
C8.2 New York Stock Exchange equity turnover 1967–2002. 223
T8.1 Ratio of CEO pay to average employee pay in 2008. 231
C9.1 Mintzberg’s managerial activities. 242
C9.2 The what, where, and how of management. 243
C9.3 What the British really mean. 250
C9.4 The Goffee and Jones framework. 251
C9.5 Hofstede’s theory of cultural distance. 253
T9.1 The performativity of economics. 259
T9.2 Surplus/deficit of the UK’s private sector final salary pension. 266
T9.3 The Dimensional success model. 269
C10.1 Hamel: Principles of management. 277
C10.2 Control in hierarchies and markets. 280
C10.3 Thinking about management, management process and tools. 285

Tables
C3.1 The union wage differential in selected countries. 52
C5.1 Five Organizational Types. 122

While every effort was made to contact the copyright holders of material in this book,
in some cases we were unable to do so. If the copyright holders contact the author or
publisher, we will be pleased to rectify any omission at the earliest opportunity.

x
Introduction

This text has developed out of a core management course at Masters level
that is intended to introduce the field to students who may have little prior
knowledge of management. It is thus extensive in its coverage and integrative
in its intent. Management is a quite fragmented area of study with lots of
academic branches, but I would argue the tree is narrower at its roots, and
these roots are primarily in social science. So a key purpose of the book is
to present management theory as applied social science. This is not primarily a
book for MBA students, but aims at coverage equivalent to a conventional
MBA course; so I am keen to interpret ‘management’ broadly to embrace the
sub-disciplines of strategy, finance, accounting, marketing, organizational
behaviour, and operations management. The text tries to show how they
arose and how they relate, thus engaging the reader in a little history.
My writing is intended to be critical, in the specific sense that I hold the
view that some parts of what is called management theory stand up better
to intellectual analysis than others. The book also indicates what academics
regard as optimal or best practice in certain fields. However, two sorts of
readers may be discouraged by this text.
I have spent over twenty years in business schools and at one, attending one
of the many cocktail parties with executives that are the stuff of life there,
I was approached by an executive who, having heartily participated in the
drinks on offer, asked me ‘What should I do about my business?’ I asked him
what he did, how he saw the problems he faced, and what he had tried to do
already to resolve them, to the point where his attention span was stretched.
One of my colleagues then arrived and was accosted with the same question.
He immediately responded: ‘You should identify your core competences,
develop your strategic intent and compete for the future.’ I thought, ‘well,
there is that.’ But this book is not for those looking for that kind of answer.
LSE has a Latin motto: Rerum cognoscere causas—to understand (cognoscere)
the causes (causas) of things (rerum). Now in some traditions of social science,
academics are worried about whether one can speak of causes, and whether
Introduction

mention of social scientific ‘things’ is appropriate; in addition, many would

not use the verb ‘to understand’ in such a transitive way; many who believe
all of these things in this field study what is called ‘critical management’. If
any have made it this far, they may wish to avert their gaze now. This text
is designed to help students who will be managers understand what may and
may not work; and why. In that sense it is critical. But it is the work of a
relatively unreconstructed positivist.
The book is extensive, also in a slightly negative way. It tries to deliver a
general understanding of the elements of management, not the detailed
knowledge necessary for a specialist. So from this book you can, for example,
take away a broad understanding of what academic finance theory does and,
perhaps, why, but it is not a guide to the pricing of collateralized debt. You will
understand the main schools of strategy, but it will not tell you how to do a
value chain analysis. It focuses on styles of thought more than plans of action.
The choice and discussion of materials probably reflects a number of biases,
and influences of which I am unaware, but here are those I can acknowledge.
I was taught social theory by Anthony Giddens and W. G. Runciman at
Cambridge University and this affects the ways in which I see the early
development of management thinking out of social theory. I was taught
industrial relations and industrial sociology by Alan Fox, Rod Martin, and
John Goldthorpe at Oxford University and this gives me a particular view on
how firms work and employees respond. My first academic post was in Joan
Woodward’s department at Imperial College (sadly, she was no longer there,
but Dorothy Wedderburn was), which left me with a particular respect for
empirical studies of organization. Nearly two decades at London Business
School—including during the ‘big bang’ period of the deregulation of finan-
cial markets and several merger waves—left me with a slightly cynical view
about what modern economics can tell one either about the operation of
financial markets or, quite distinctly, the conduct of corporate strategy. The
privilege of editing the Tavistock journal, Human Relations, opened my eyes to
the rich interaction between academic activity and industrial practice; the
back catalogue is astonishing. Finally, and this is reflected in the text through-
out, being at Oxford and LSE rammed home how much social science there is,
often unacknowledged, in the academic study of management. If I picked up
half of what was on offer through all of this, I count myself lucky.

2
Chapter 1

The Management Field

Introduction

Most of the theory we teach on business and management courses emerges from
pre-existing and, in some senses, more fundamental academic disciplines. More-
over, this emergence has several broad features. First, the field has the following
characteristics: it is derivative, opportunistic, eclectic, and fragmented. Academic
and practical knowledge has been mined to deal with specific sets of problems.
Second, it has emerged over a relatively short period; most business theory dates
from the period since 1890. Third, it has almost all emerged in English, and from
English-speaking countries, but it did not all originate there. So, bluntly, we
know that we anticipate managing business growth in the early decades of the
twenty-first century, much of it in emerging markets, with a conceptual toolkit
from developed economies from twentieth century developed economies. It
would be useful to understand how much of it might work.
In many cases, the linkages of business theory to mathematics and social
science are clear from the management history literature. For example, the
lineage of organizational behaviour can be traced back through the ‘human
relations’ movement to the industrial psychology of the 1920s. Arguably,
there is a similar line of sight from Taylorism—to which human relations
was a reaction—through operations management to operational research.
Psychology was mined again to support the rise of consumer marketing in
the 1930s, as part of the development of a management discipline that did not
find enough in economists’ models of price and preference to analyse and
understand the development of markets and brands.
Economics has indeed provided a rich vein for the study of management,
though often not by the latter field adopting economic models but by turning
them around. The entire business discipline of strategy may be understood
to have originated as an attempt to advise firms on how to protect the
economic rents that efficient markets would naturally erode; strategy is
about how not to compete in an economic sense. But early twentieth-century
The Management Field

economics did not have enough to say about what went on inside the large
firms increasingly dominating Western business—how did hierarchies work,
what was driving the emergence of multi-divisional organizations and subse-
quently matrix structures? Organizational sociology initially filled the gap,
developing theories of bureaucracy and practices of organizational design,
before economists, sensing that much economic activity now took place
within firms, developed theories about market failure and hierarchy. Probably
the most successful management field and the most recent—academic
finance—can also be traced back into the work of economists such as Samuel-
son, but it required additional insights from operations research—such as the
idea of portfolio risk—and from applied mathematics—such as the use of
diffusion equations to price options—before the modern body of theory
could develop. These are merely examples, but they illustrate a common
dynamic of adapting and integrating academic insights to address business
issues and build theory.
If the previous two paragraphs have introduced ideas about how the content
of management theory emerged, the idea of opportunism as a key ingredient
of why becomes important. Much of the work of early theorists such as Fayol
and Taylor can be understood in terms of the emergence of the first modern,
large, profit-focused organizations. In turn, much of the reaction to this
emergence may be understood in terms of a concern with the impact of
such organizations on employees, and the containment of collective organ-
izations that employees developed as protection. If one needs the growth of
the firm to understand Taylorism, perhaps one needs the New Deal in the
United States (USA) to understand the human relations movement. War was
important, and not only in the stimuli that it gave to demand and productiv-
ity. Cost accounting emerged during World War I and operations research
developed massively during World War II and both were then applied, equally
massively, to post-war production, accelerated in the latter case by the increas-
ing availability of computing power. Technological developments initiated for
military purpose have often generated new product developments in both
consumer and business-to-business markets, but they have also facilitated
changes to structures and processes within firms.
From these examples, it should be clear not only that management theory
has emerged in reaction to both business developments and external events,
but also that such theory may have shaped the world it seeks to explain; for
example, a theory about the benefits of multi-divisional structures in firms
may lead to their widespread adoption. This tendency has been most notice-
able in the development of academic financial economics. The discipline of
finance, almost exclusively a post-war and Western phenomenon, can be seen
both as the precursor of and the engine for the growth of financial markets
and their increasing influence over firm governance and performance. Up to

4
 The Management Field

2008, financial economics exerted powerful pressure on life to imitate art.

After 2008, the basics of financial economics, and particularly the efficient
markets hypothesis which is rooted in neoclassical economics, have been
questioned, much as Taylorism was in the 1920s and Porter’s approach to
strategy in the 1990s.
This pattern of emergence and decay alone helps focus us on the central
issues that will concern this book. The first purpose of the book is to under-
stand how and why management theory emerged from the social sciences in
the West in the twentieth century. What problems were academics trying to
address, what tools did they use to build their ideas, and what impact did these
ideas have on practice? The second purpose is to demonstrate that, in part
because they mined shared seams of knowledge, there is common ground at
the conceptual level between many apparently unconversant functional dis-
ciplines. Common thematic ideas like agency, control, hierarchy, incentives
and performance measurement, rent and competition, efficiency and cost,
individual and collective action, and—perhaps most pervasively—rationality
and irrationality, glue various management disciplines together. The third
purpose of the book is to make some assessment of the resilience of this
body of thought; the key question is—which elements of it are still useful
parts of an attempt to understand and explain business behaviour? We can
quite easily point out the ethnic and cultural specificity of the origins of
management theory, but it does not follow that its usefulness is similarly
constrained. We can, however, expect it to be severely tested.
The approach is critical, but in a specific sense. I look at the origins and
development of core management theories and, since we are also concerned
with impact, I also discuss the core business practices that emerge from the
theories’ application. To take an example, I examine the growth of marketing
as a process of divorce from economic approaches to price and subject major
theories within the marketing field to critical examination. But I also examine
the central elements of a marketing plan and what the construction of a plan
can achieve. My objective is to convey not simply the strengths and weak-
nesses of the marketing approach, but also some key elements of the tools of
the trade. This is not a ‘how-to’ book, but it has little focus on purely critical
academic work that has no practical correlates.
It is also, to some extent, chronological. Much management theory develops
in reaction to the perceived weaknesses of previous theory. Indeed, some the-
ories are entirely reactive. One question we might reasonably ask is to what
extent the history of management theory is cumulative or circular. Probably, the
processes are more complicated, as some examples may illustrate. Scientific
management has limited impact in the field of leadership but is still central to
process design and performance management. Portfolio approaches to firm
structure are unfashionable in Western business firms but not in Western asset

5
The Management Field

management. Collective action is often seen as in decline among employees,

but not among consumers or users of social networks. My conception of the field
involves looking at the redeployment of key concepts in different domains.

The Field

Industrialization in Europe, particularly in Britain, prompted an intellectual

response. Political economy—the work of Adam Smith and David Ricardo—
was concerned with the factory system, technological change (the so-called
‘machinery question’), and the growth of an industrial working class (Berg,
1980). Later, in the nineteenth and early twentieth centuries, two founding
fathers of sociology—Durkheim and Weber—concerned themselves with the
division of labour, the Protestant work ethic, and the problems of bureau-
cracy. Marx, whose scope challenged any modern conventional disciplinary
boundaries, analysed the factory system, the economics of the firm, the
alienation of the working class, and the revolution that must ensue.1 From
Smith in the 1770s to Weber in the early twentieth century, intellectuals were
wrestling with the major social and economic changes prompted generally by
industrialization and specifically by the growth of the large capitalist firm.
However, this remained an intellectual response rather than a guiding
theory. When one looks at the development of ‘theory’ about management
and the firm in the early part of the twentieth century, one finds a pragmatism
and fragmentation about work on management and the firm. Engineers,
particularly military engineers, import ideas about organization and produc-
tion process. Practitioners summarize their experience into generalizations.
The newly emerging discipline of industrial psychology concerns itself with
worker productivity. Ideas about organization and management in particular
are borrowed from the main set of pre-industrial large organizations—armies,
(Christian) religious organizations, and government. Why?
A large part of the answer concerns reactions within economics, arguably
the most relevant and certainly the most developed social science at the time.
It goes missing. Whereas political economy was concerned with factories and
the machinery issue, the neoclassical revolution of the late nineteenth cen-
tury was concerned with optimization and equilibrium in markets modelled
on principles which were increasingly at odds with industrial practice. In Kay’s
(2004) terms, most economists wanted to be physicists, and so modelled firms
as production functions and markets as perfectly competitive. As J. P. Morgan
was developing the idea that all industries should be monopolies in the public

1
For a review of the work of Marx, Weber, and Durkheim, see Giddens (1971).

6
 The Management Field

interest, and trying very hard to make it happen in the USA, economists were
ignoring the fact that one major effect of industrialization was to take eco-
nomic activity out of markets and into firms. Nothing like an economic theory
of the firm arose until Coase wrote about transaction costs and the boundaries
of the firm in 1937. Even then, his work was not developed. In the 1930s, it
was more important within economics to be a macro economist like Keynes
than a micro economist like Coase.
In sociology, any elective affinity between theories about industrial society
and guidelines about how to run one was frustrated by the tendency of the
major theorists to deplore what was happening. Durkheim felt that the div-
ision of labour would generate a sense of ‘normlessness’ (anomie), a problem-
atic circumstance in which individuals shorn of the feudal certainties of a
society in which position was fixed and expectations certain would experience
something close to the more modern idea of existential doubt. Weber, not
unreasonably, became very concerned about bureaucratic organizations
becoming ‘iron cages’ for their inhabitants and charismatic leadership degen-
erating into authoritarianism. For Marx, the problem was more systemic.
Capitalism generated a working class alienated from the work process, the
work product, each other, and the fundamentals of humanity (‘species
being’). It contained the seeds of its own destruction, roughly in the sense
that it would become increasingly difficult to make a profit, and would nat-
urally fall under the weight of its own contradictions (Giddens, 1971).
There existed a substantial intellectual void. Nonetheless, in the late nine-
teenth and early twentieth centuries, a managerial curriculum developed
to train the growing numbers of those who made capitalism work. First on
the east coast of the USA, at Wharton and Harvard, then more generally,
universities developed business schools to train managers with a curriculum
designed to contain both tools and some theory. I argued above that this
curriculum had four main characteristics, some of which are enduring and
shape how we study management today. Here they are elaborated.
First, it was opportunistic. By this I mean it borrowed or shaped ideas in order
to solve some perceived business problem. Early borrowing includes using
West Point ideas about production organization and studies of stress on
World War I soldiers to frame arguments about working time in factories.
Later borrowing involves using heat diffusion equations from engineering to
price derivatives in financial markets.
Second, and partly in consequence, it was eclectic. Ideas are drawn from
just about anywhere—both inside academia and outside. The management
field is not a net exporter of intellectual capital to other disciplines. It was, and
is, voracious. Ideas come from academic disciplines such as anthropology
(organizational culture), economics (competitive advantage, but rent, really),

7
The Management Field

mathematics (portfolio theory), psychology (consumer preference), sociology

(social capital), and anywhere else you want (leadership).
Third, since it is very difficult intellectually to reconcile these materials, it
was, and is, a fragmented field. The modern MBA still resembles a baccalaureate
of uncorrelated intellectual material. Optimizing a dependent variable (e.g.
worker productivity) will generate different advice depending on whether one
addresses it from an organizational behaviour (focus on engagement and the
psychological contract) or operations management (maximize the throughput)
perspective.
Fourth, it was derivative. Put kindly, it generates intellectual capital through
second mover advantage. Several ideas that we will discuss below came into
the management field to be used and developed. Whatever else the academic
study of management may lack, it has money.
Several of the core management theorists we will discuss—Chester Barnard,
Elton Mayo, Philip Kotler, Herbert Simon, and Henry Mintzberg, for example—
are difficult academically to pigeonhole; they often have interdisciplinary train-
ing and their contributions are relevant to several disciplines. Nonetheless, the
fragmentation referred to above is not random. There are identifiable and cohe-
sive sub-disciplines within the business field. The most enduring are as follows:
 Accounting
 Operations Research and Management
 Organizational Behaviour
 Marketing
 Strategy
 Finance

These are listed, roughly, in the order in which they emerged in the modern
academic literature (or before then). The rudiments of most can be traced back
well before industrialization, at least in Europe, mostly in the documentation
of practices either in military and religious organizations or of merchants
practising trade. Double entry bookkeeping was developed in the Middle
Ages; Venetians ran assembly lines to build ships in the Arsenale in about
the same period. Cistercian monks developed models of decentralization to
counter the centralization that characterized the dominant Clunaic tradition.
St Paul marketed monotheism and the prospect of everlasting life to gentiles
in the first century (often using direct mail). Strategy was documented by
military theorists from ancient days. Portfolios and debt exposure were appar-
ently well understood by the Medici.
However, these fields acquired many of their modern characteristics, con-
cerns, and tools in the twentieth century in Western economies as responses to
or in some case triggers for developments in business practice. It is thus
significant that the twentieth century was quite a peculiar time in the West.

8
 The Management Field

Without assuming too many (I hope) pretensions as a historian, let me offer a

few observations on the ways this might have affected the management field.
 There was a lot of war between advanced industrial countries. Hobsbawm
(1994) suggests that the ‘short’ twentieth century from 1914 to 1991 was
actually one long war, hot and cold. There were a number of consequences.
First, global capital movements shrank massively compared to the nineteenth
century (Michie, 2006). If you wanted to invest abroad, putting your money
with a domestic firm with substantial international operations (like an oil
company) was a sound bet. Second, securities markets traded a lot of govern-
ment debt (wars cost a lot of money). In the twentieth century, government
debt was a risk-averse investment generating secure returns. Third, wars pump
massive amounts of money into industries that give governments the means
to fight them (e.g. aerospace, which otherwise is not economically a particu-
larly good idea). Fourth, innovations to win a war or not to fight one (com-
puting) subsequently spill out into the private sector. Fifth, and distressingly,
principles developed by firms about how to manage operations efficiently are
applied to killing people methodically (Mazower, 1998). Dupont delivered the
Manhattan Project (Weatherall, 2013).
 In part because the international labour movement of labour also shrank
compared to the nineteenth century, and in part because warring govern-
ments had to buy off their electorates to keep them fighting, governments
either built substantial welfare states that guaranteed labour security and
benefits (Western Europe) or made firms simulate welfare states by doing the
same (USA; see Davis, 2009). Stability of employment within firms, both as a
practice and an objective, developed other practices (such as pensions) that
affected both capital and labour markets. In labour markets, best practice on
remuneration, motivation, and retention was developed in a specific context.
There was a lengthy period of relatively full employment in Western coun-
tries, in which the state performed a substantial and specific role.
 The relatively smooth transition between Britain and the USA as the
dominant industrial power in the early twentieth century implied that
Anglo-Saxon thinking about how to run businesses had some primacy. The
apparent success of these two countries in the century’s subsequent conflicts
arguably reaffirmed this prejudice. After all, major wars were won by product-
ive power (Overy, 1995), and the overwhelming, if temporary, advantage
produced after World War II by possession of the atom bomb could be inter-
preted as a technological lead. Western ideas were adopted elsewhere (Lenin
was a fan of F. W. Taylor, the primary exponent of scientific management),
Japanese industrial excellence was interpreted as a more fundamental commit-
ment to American principles, and far more people from outside Europe and the
USA went to Western business schools than the reverse. A certain imperialism

9
The Management Field

about the primacy of Western management thought emerged. In the 1960s,

Clerk Kerr at the University of California developed the idea of convergence
theory—the idea that there was one path for industrialized societies such that
they would all, with differential lags, converge around one model (guess which
one). This emerged with renewed force after the Cold War in theories about the
end of history. However, at the time of writing, neither the USA nor the UK has
a balance of payments surplus; nor will have by the time you read this.
 After the end of the Cold War in 1989, both capital and labour mobility
increased substantially. The liberalization of financial markets in the 1980s
was associated with a considerable increase in the financial oversight of cor-
porate governance and practice. Labour movement under free trade arrange-
ments, such as NAFTA in North America and the expansion of the European
Union to embrace former socialist countries, similarly liberalized labour mar-
kets. Both sets of changes disturbed institutional arrangements, between banks
and corporate entities on the one hand and between employers and employees
on the other, in a direction characterized as ‘financialization’, one effect of
which has been a shift from building long-term relationships to a more short-
term, transactional approach.

Many of these twentieth-century parameters no longer hold. The theories gen-

erated to explain or influence business practice may need to be re-examined.

Life and Art

There is one final set of considerations before we begin: it concerns the

relationship between academic theory and business practice. The study of
management, as we mentioned at the outset, often bears a close relationship
to management practice. The early theorists we have discussed above were
interested less in academic articles and more in influencing such practice.
Later theorists we will discuss below were interested in both academic reputa-
tion and generating revenue through influencing practice (Abrahamson,
1996). So there has often been interplay between the study of management
and its practice, which takes a variety of forms. Let us pursue one of the
medieval religious analogies mentioned earlier. In the academic study of
management there are at least the following types:

1. Chroniclers. Those who seek to document the performance of successful

practitioners, groups of practitioners (often firms), or national industrial
systems as exemplars of ‘best practice’ to be imitated or, at least, learned
from.
2. Preachers. Those who feel in possession of an innovative or at least
effective idea that can be sold to a wider audience.

10
 The Management Field

3. Theologians. Those who are interested to develop theories that might

guide or change practice.

Each category, in different ways, is interested in the concept of performativity;

that is, broadly speaking, the idea that theory might influence management
practice (Austin, 1962; MacKenzie, 2006: 1–37). There may be another category:

4. Critics. Those who think the whole thing is an exercise in domination or

the exploitation of position. After 2008, these views have become more
influential.

So, questions then arise about academic work on management:

1. Does the theory or technique design management practice? Is there a

model that allows the prescription of managerial best practice? This is
the managerial equivalent of theology.
2. Does the account, theory, or technique arise from, and in some sense
simply summarize, what managers are already doing? This is chronicle,
and although dissemination might influence practitioners by example, it
is performative in the sense of consolidating previous insight.
3. Does the theory or technique generalize some definition of best practice?
This results from preaching, either by academics or by consultancies
involved. It may be performative in developing new managerial tools,
but it starts from the premise that current tools are defective.
4. Does the account see management as a political or anthropological
activity with no appreciable performance consequences? This is
primarily a critical activity.

Under the first heading, I would list CEO biographies and firm histories,
including the work of Chandler; as an influence on practice, they constitute
casual empiricism but may have impact if they justify a certain approach or
tool. As examples of the second, I would quote academic discussions of the
Toyota production system (see Chapter 4) and developments in the balanced
scorecard approach to performance measurement (see Theme 5). As examples
of the third, in finance theory, the Black–Scholes theorem, the Modigliani–
Miller hypothesis, and the capital asset pricing model stand out and, in
strategy, the work of Michael Porter on the sources of competitive advantage.
If we are considering the ways in which management writing might influ-
ence management practice, then at least two considerations become relevant.
First, if any of the categories listed above has an influence, is the performativ-
ity positive (i.e. it can be seen in some way to have enhanced practice in the
way predicted) or negative (i.e. it seems to generate outcomes that run contrary
to the theory)? This assumes we can think of management writing as having

11
The Management Field

some impact (either positive or negative). Or second, is it simply irrelevant (i.e.

it represents fashion, and maybe influences the rhetoric, but makes no differ-
ence)? There are complications with this. To give an example, in many large
firms in the mid-twentieth century it was seen to be a good idea to give
employees occupational pensions in which, in exchange for mutual contri-
butions by employer and employee, employees would be guaranteed a per-
centage of their final salary indefinitely. This was advocated by many
management writers, but you would be fired for suggesting it at the time of
writing.
The final idea to introduce at this point is the idea of fashion, or at least
herding. Many management practices diffuse across firms and sectors. For
example, the multi-divisional organization that I will discuss in Theme 5
became very common in a variety of sectors and countries. In economics,
authors such as Williamson would argue that it became common because it
was efficient. In economics, any common institutional form must be pre-
sumed to have efficiency properties, otherwise one needs a comprehensive
market imperfection explanation for its survival. However, there are also
arguments that it diffused because of fashion and the influence of certain
consultancy firms selling solutions to accountability problems (McKenna,
2006). It may be that, as many sociologists argue, legitimacy—the general
acceptance that a business practice is in some sense good—precedes efficiency
because the latter follows from the former through the effects that legitimacy
has on the cost of various forms of capital. Efficiency is a very under-contested
concept (Fligstein, 1990).
The management field shows the circumstances of its birth. One of the
many transformations effected by industrialization was the growth of the
large firm, which in turn influenced the growth of management as an activity.
Developments in political economy and sociology that addressed the large-
scale social changes also had implications for the study of organizations, but
efficiency concerns often led to the application of engineering principles or
simply the adoption of pre-industrial practices from military or religious
organizations.
The modern large firm was not, generally, designed and built by academics.
It emerged to accommodate rather particular circumstances, in a specific
historical context, before anyone thought to develop a theory about it.

The Structure and Content of the Book

Given these considerations, particularly the fragmentation of the field, it is

necessary to provide some logic for the presentation of the material in the
book. The first structuring device is chronology. We deal with the key elements

12
 The Management Field

Labour
market

The firm
Product
market

Capital
market

Figure C1.1. Control in hierarchies and markets.

of academic business thought, roughly in birth order. The book is structured

into chapters that deal with the core elements of an approach or sub-field and
offer critique by reviewing the literature they generate.
Figure C1.1 draws loosely on the work of Fligstein (1990). I am suggesting
that the body of academic work we call management can be understood in
terms of an attempt to solve problems presented initially by the growth of the
firm and subsequently by attempts to manage the three main markets in
which the firm operates; labour, product, and capital markets respectively.
This does some—but I would argue not too much—violence to the history of
management thought, and is the core organizing principle for the chapters.
We deal with management of hierarchy first, and the field of finance last.
Themes sit between most of the chapters. They deal either with core con-
cepts that are central to a number of disciplines (for example, bounded ration-
ality), or with practices that prompt integrative thinking (for example,
performance measurement). The themes are the glue that holds the book
together, preventing it replicating fully the patchwork fragmentation of the
field, and they are also the location of many of the practical examples on offer.
So, to use a term common to the field, the book has a matrix structure.
Unifying both chapters and themes are a set of core concerns. I will argue
that there is a set of core concerns common to all of the six disciplines listed
on page 8. I offer ten in Figure C1.2. Three characteristics of these concerns are
as follows. First, they are topics around which there has been considerable
academic theorizing; there are literatures, in several academic disciplines, to
address. Second, they each concern several management disciplines. Third,
they relate directly to problems faced by practising managers. They thus
facilitate the examination of the relationship between theory and practice,
which is a core concern of this book.

13
The Management Field

Concern Chapter Theme

Market, hierarchy, and network 2,5,7 3,5,7
Coordination and control 2,5,9 1,6
Contract 3,4 2,3
Individual and collective action 3,6 3,4
Rationality and irrationality 8,9 3,4,8
Incentive and performance 3,4,9 5,8
Price and profit 6,7,8 7,8
Efficiency and cost 2,8 1,9
Agency 2,5 2,5
Competitive advantage 4,6,7 6,8

Figure C1.2. Core concerns of management.

Any list of such a set must, given the nature of the field, be arbitrary, and
there may be many more to add, but the list is intended to be a necessary road
map to the book rather than a sufficient and exhaustive list of relevant
concepts. The figure also relates the concerns to the content of the chapters
and themes, indicating where these concerns are primarily addressed within
the book.

Conclusion

This chapter has attempted primarily to present the logic for the book which is
derived from an examination of the properties of the management field.
I have characterized the field as derivative, opportunistic, eclectic, and frag-
mented but also argued that an understanding of the chronology of its devel-
opment and the underlying concerns being addressed will help to view it as a
whole. A further characteristic—to which we will return in the conclusion—is
its stability, which is both a strength and a weakness. However, we begin the
journey to that conclusion by trying to understand something of the legacy
upon which the field rests.

14
Theme 1

Accounting for Capitalism

Introduction

The first theme deals with legacies. Here I look at the pre-industrial practices
and teaching that influenced modern management practice. There is survivor
bias in the account; I focus on the best-documented practices and try to show
how they influenced subsequent work. The best-documented case is account-
ing, which is probably as old as history, but in its recognizably modern form
can be dated back to the Italian Renaissance. Indeed, there was a popular
argument in the nineteenth century that developments in accounting, par-
ticularly double entry bookkeeping, caused capitalism to develop (it’s not so
popular now).
At the core of this is the idea of rational calculation. I am going to suggest
loosely that rationality is the sieve through which survivor bias works; by this
I mean that nineteenth-century searchers for rational approaches to the man-
agement of industrial concerns looked for rational examples from the past.
Now this might be a specific version of a very contested engineering notion of
rationality (see Shenhav, 1999), but it will serve our purposes for the moment.
Selecting the Italian Renaissance is also a contingency, but just as one could
hear most of the best music ever written in early nineteenth-century Vienna,
you could learn a lot about management in sixteenth-century Venice.

Merchants of Venice1

If a nineteenth-century British business owner had left the heart of the Indus-
trial Revolution and pitched up in mid-sixteenth-century Venice, what might
he have seen or heard in conversation that would be familiar business practice?
The Venice of the time had been effectively a republic for several centuries,

1
This section is indebted to Crowley (2011).
Accounting for Capitalism

dominated by a few families who selected both the Doge (leader) and who
formed the Council; essentially an oligarchy. It had an extensive mercantile
empire which required substantial military expenditure to secure it, and it had a
strong sense of community identity, defined by its island status. A bit like
home, then.
A history of sporadic merchant adventuring, where individuals pooled
money into partnerships for long-distance trade, had given way to a more
state-sponsored kind of profit making, in which individuals could invest to
make money, but on terms defined to give the state a cut and further the
Imperial interest. Rather like the British East India Company familiar to our
visitor, but more controlling.
Engaging in conversation on the Rialto (no bridge yet), an individual would
have heard that business financing could be supplied by banks—in Venice but
particularly in Florence. These banks, such as the Medici or Gritti, were trust-
based family networks that could finance trade and investment throughout
Europe. In fact, they could engage in relatively sophisticated futures contract-
ing in which they would price and fund risky ventures, provided they got their
pound of flesh (if Shakespeare is to be believed—see Chapter 8).
These banks also dealt in politics in two ways. First, they ran their little city
states, a bit like J. P. Morgan did in the nineteenth century; second, they dealt
in sovereign debt. This could be risky. A couple of hundred years before, one
bank, the Ricciardi, had gone down in a liquidity crunch when, in 1294,
Edward I of England didn’t get the loan he wanted and seized everything;
but when the Frescobaldi went in afterwards, they made money for years. A bit
like the Rothschilds in our businessman’s own era.
Looking more closely at business practice, he would have found much to
reassure him, in particular in the biggest factory in town, which had been
there for hundreds of years. Venice knew about fighting wars at sea to generate
and protect trade. In this factory, the Arsenale, they built assembly lines.

[Venice] could standardize designs and build up stores of spare parts, making it
possible to complete even major refits in a fraction of the time . . . the designs
themselves, as well as the techniques, could be revolutionized . . . One of the
secrets of Venice’s rise to power was that she never saw the twin necessities of
defence and commerce as altogether separate . . . the nobles were merchants and
the merchants noble . . . .
(Norwich, 1977: 85).

The Venetians knew how to maximize throughput and reduce production

times; standardization of inputs, process, and product was an important
component. Alignment of defence and commercial interests was another.
You could send out the ships to fight and then use them to carry the spoils
home; smart capacity management.

16
 Accounting for Capitalism

The Arsenale was at the centre of a tightly managed multinational operation.

It depended on documentation.

Its principles were continuous oversight and collective responsibility. No officer was
to act alone . . . All decisions, transactions, commercial agreements, wills, decrees and
judgements were set down in literally millions of entries, like an infinite merchant’s
ledger, which formed the historic memory of the state. Everyone was accountable.
Everything was written down.
(Crowley, 2011: 242)

Penalties for failure were severe; terminal, in fact. The terminology would have
been different, but for our nineteenth-century visitor, this would look like a
bureaucracy with a death penalty. A bit like the British Navy.
The city was also home to innovative international organizations like the
recently founded Jesuits (1540), who had chosen Venice as a place to start
because of its arm’s-length regulation by the Papacy; no Inquisition, relatively
free markets in ideas. The Jesuits were developing an interesting approach
to global expansion in new markets such as Asia, Canada, and South America,
in which a basically geographical structure of organization was overlaid by
‘product’ areas such as education and conversion. Our nineteenth-century Brit
could have called this a matrix if he had known what that was.
Jesuits also knew about accounting. They had resources, international
reach, and an objective; saving souls. But:

A strictly economic analysis of the nature and role of accounting as an instrument

for allocating, monitoring, and administering resources within the hierarchical
structure of the Society of Jesus would leave undiscovered important aspects of the
practices deployed by the Order to manage, organize, and account for its multifa-
ceted activities.
(Quattrone, 2004)

How does one optimize the allocation of resources to maximize the saving of
souls? The first thing one needs is a management accounting system to tell
you where the resources come from and go to. The second thing, more
controversial perhaps, is you have to put a value on a soul. At the margin,
one might have to choose which soul to save or to justify the return on
investment. Should the resource go to Canada or China; in which location
will you get more souls for the unit of investment? As a counter-reformation
organization, Jesuits could target Protestants in Europe, or even existing Cath-
olics who might lapse (on the grounds that customer retention is often easier
than customer acquisition). Are all souls of the same value? Who is the
investor and who is the audience for these accounting statements? All ques-
tions with which our nineteenth-century businessman would be familiar,
albeit in a slightly different form. In the nineteenth century, railways in the

17
Accounting for Capitalism

Americas used similar practices to identify costs and provide balance sheets to
absentee creditors in Europe (King, 2006: 8).
And one of the two books on sale that were all the rage was very interesting
on these topics. The first, The Prince, on leadership and strategy by a Florentine,
Niccolò Machiavelli, was interesting, but more about politics than business; our
Victorian businessman’s grandchildren would become more interested in lead-
ership and strategy. But the second, by Luca Pacioli, describing the Venetian
method, was about double entry bookkeeping. Home from home.
If our time traveller had stuck around for fifty years in order to see the bridge at
the Rialto, he could have seen something like an audit. From the 1580s onwards,
the Arsenale was the subject of continuous monitoring and improvement, and
clear elements of the modern firm emerge. The trigger was an arms race. Venice
had participated in the destruction of the Ottoman navy in 1571, and was
shocked when they rebuilt it within 18 months; this had to be matched.
There is a huge debate about the extent of implementation of reform,2 but
the reports discuss:
 The introduction of salaried managers.
 The imposition of labour discipline, including attendance and job
descriptions.
 Identification of costs, including standard costs (‘man months per ship’).
 Measurement of inventory and work in progress with a target of 100
ships in reserve.
 Resistance by employees to these changes.

Two things about this are of huge significance, over and above these specific
innovations. First, bookkeeping becomes management accounting; it moves
from underpinning inspection and control to a tool for understanding, man-
aging, and changing operations (Zambon and Zan, 2007: 121). Second, this is
accounting without economics or markets. The Arsenale was a public sector
monopoly and the driver for the managerial reforms was war and discipline.
This may seem a bit far-fetched, not least the time travel, but it does serve to
remind that many of the problems business owners were trying to solve after
the Industrial Revolution had been met and solved before, since they are
essentially problems in the management of large organizations. I have no
idea whether Venice is the best example, but it is a good one. In the sixteenth
century, these large organizations were predominantly state and church, but
the Arsenale and Jesuit examples show you can have effective business

2
Venice is a history industry since it houses 65 km of records. That the Venetians measured
everything and wrote it down tells you something. This section relies on Zan (2004) and Zambon
and Zan (2007).

18
 Accounting for Capitalism

practices in production management and accounting within hierarchies and

without markets. I will elaborate the significance of this in coming chapters.
Note for the moment that the accounts that were being produced in six-
teenth-century Venice were as much legal, juridical documents as economic
ones (Power, 2010); they did not seek to make an economic valuation of the
organization concerned. They sought to account for transactions and to dem-
onstrate the trustworthiness of the transactor. There is no concern about
whether running the Arsenale is the best use of the state’s assets, only about
how to optimize its performance. No consultant is around to suggest diversi-
fication into a football club on the basis of increased shareholder value. We
will pick this up again. For the moment, let us turn to accounting; it is
intrinsically interesting (really), and has some very general implications.

The Balance Sheet that Changed the World

In order to understand why people such as Goethe could get worked up about
it, it is important to be clear about what double entry bookkeeping (DEB) is,
but more importantly, what it lets you do. It records all transactions, twice.
Transactions appear as debits under the account of the seller and credits under
the account of a purchaser. It generates a picture of stocks and flows, as shown
very simply in Figure T1.1.
From this information one can do a number of things (Carruthers and
Espeland, 1991; Robertson and Funnell, 2012).

1. In partnerships, joint ventures, and later in joint stock companies, one

can keep track of each investor’s share in the capital and revenues of the
firm. This enabled the socialization of capital by answering the question:
given what I have put in, what is my fair share of the revenues? Investors
could collaborate to contribute against a formula on returns.
2. That question works for one-shot ventures, but what about permanent
firms where the capital needs to keep working, such as the subsequently

Credits Debits
Revenue Expenses
Income and
(sales)
expenses1

Liabilities Assets
Assets and • Creditors • Fixed
liabilities2 • Loans • Current
• Equity
1= Flows; 2= Stocks

Figure T1.1. The balance sheet that changed the world.

19
Accounting for Capitalism

founded Dutch and English East India companies? For this you need to
measure profits in order to pay dividends and DEB allows the distinction
between profits and initial capital to be made (Bryer, 2000).
3. For long-term ventures, investors want to make comparisons between
different destinations for their investment and DEB allows for a
standardized measure of return on capital employed (Bryer, 1993). So
DEB enables an answer to the question: is this the best place to put my
money? This was important both for Venetian trading ventures and for
the railways with which our nineteenth-century time traveller would
have been more familiar.

These are so-called ‘technical’ issues. There are also what are termed, in this
literature, ‘rhetorical’ ones that essentially had to do with legitimacy.

4. Medieval businesses had a respectability problem. In a society where

religion dominated many spheres of activity, and where religion
disapproved of usury (i.e. lending money at interest), DEB could show
that profits from trade were other than interest payments. Pacioli was in
part trying to show the legitimacy of mercantile trade (Carruthers and
Espeland, 1991).
5. For the individual merchant operating in trust-based networks, the record
of transactions was a record of trustworthiness. It allowed accountability
to trading partners and investors. Once this form of accounting was
accepted, if one did not have a complete transaction record, then that
said something. ‘Showing the books’ was a trust issue.

Back to Venice . . .

Even kings and princes could not have aspired to the trust and credit enjoyed by a
good merchant. Reciprocal trust and good faith in their dealings were the ethical
elements which distinguished (them).
(Tucci, 1973: 367).

Merchants did not have power in the ways that princes might. They relied on
their record of behaviour in what—in the small island nation of Venice—was
quite a tight network.
Pacioli almost certainly documented rather than invented DEB; he seems to
have been codifying merchant practice, but he was a university ‘cleric’ and his
work certainly prompted its dissemination (Hoskin and Macve, 1994). Of
interest to our story is that DEB did not take over the world immediately, or
even soon. It seems to have taken a long time to diffuse, and the Dutch and
English companies mentioned above, which were operating from the next
century, did not seem to use it regularly or systematically (Robertson and
Funnell, 2012). Quite why this happened is beyond the scope of this book,

20
 Accounting for Capitalism

but it is of interest to find early social theorists arguing for DEB’s influence.
It turns out that their arguments are based a little more on styles of thought
than direct bookkeeping evidence.
Both Weber and Sombart stress the importance of rational calculation in the
rise of capitalism in the seventeenth century. Capitalists needed to calculate
income and profit and, for Weber, they did so by using ‘the methods of
modern bookkeeping and the striking of a balance’.3 Sombart took this
further by arguing that you could not have capitalism without DEB; ‘one
could not imagine what capitalism would be without DEB; the two phenom-
ena are connected as intimately as form and content.’ This is now an unfash-
ionable argument—as indeed are most single-factor explanations of social
phenomena—and in the accounting history field it is debunked (Hoskin and
Macve, 1994). But it does indicate how important the idea of rational calcu-
lation, and the accounting technology in which it was embedded, was to
observers of the huge transformation of business taking place in the nine-
teenth century. In the absence of the voluminous information we now have
from accounting historians, Weber and Sombart could not have estimated the
limited use of DEB, particularly in the Industrial Revolution in Britain that
triggered those elsewhere. But for them it was more the idea, or theory, of DEB
that mattered. There are deep roots to the problem of the relationship between
theory and practice in the management field and I will return to this in my
final theme, again using accounting as the example.

Conclusion

The main purpose of this theme has been to flesh out the assertion that large
parts of the management armoury were available prior to the Industrial Revo-
lution since they are generic issues to do with managing large organizations.
They emerge to deal with common problems such as coordination and control
and in turn they raise other problems, such as agency and accountability.
Accounting data in our Venice example is useful for investors looking for a
return on capital, for managers looking at efficiency and productivity in
the operations they manage, and for governments looking for sources of tax;
these remain the main audiences for accounting data. But there is an account-
ability as well as an accounting issue. Investors can use accounting data to
monitor the performance of managers, particularly where the actions of man-
agers are not directly observable. It is probably not an accident that most
of our examples of pre-industrial accounting—maritime Venice, Jesuits, the

3
Weber and Sombart both cited in Robertson and Funnell, 2012; by the latter term, Weber
means ‘creating a balance sheet’.

21
Accounting for Capitalism

East India Company, for example—come from operations characterized by

action at distance, where investors sink non-transferable assets into ventures
controlled by their agents. Exactly the same problem faced subsequent UK
investors in American railroads, which were to prove so important in the late
nineteenth century to the development of both US business and global
finance. By contrast, it seems that owner-managed factories in the British
Industrial Revolution, where agents were often directly observable, were
slower to use it; there were, after all, substantial set-up and operations costs
(see Theme 9).
A secondary purpose of this theme has been to open up discussion of the
relationship between theory and practice. Few would support Sombart’s argu-
ment about theory causing practice, but there is arguably less doubt that the
two interact, often in complex ways. To take Pacioli’s example, was he an
innovator or a chronicler of Italian merchant practice: or maybe just an
apologist for the merchant class? And why did his product, DEB, conquer
the world 400 years later? Put another way, what held up the diffusion of
practice longer than the diffusion of knowledge?
These questions will concern me throughout. I turn initially to the growth
of the firm, and to the emergence of modern management thought about it in
the nineteenth and early twentieth centuries. Lest you wonder why I am
suggesting time travel for the second time in this theme, let me close it with
a quote from Hamel, whose main concern is management in the twenty-first
century. Addressing a practitioner audience, he argues:

. . . your company is being managed right now by a coterie of long-departed

theorists and practitioners who invented the rules and conventions of ‘modern’
management back in the early years of the twentieth century. They are the polter-
geists who inhabit the musty machinery of management.
(Hamel, 2007: ix)

But it’s much more than a ghost story.

22
Chapter 2

The Firm

Introduction

The corporate form is a rather late arrival on the scene. Before the nineteenth
century, only a handful of corporate-type entities existed and these were
largely extensions of state power. Companies such as the Hudson Bay Com-
pany or the Dutch East India Company were important agents of empire. They
were granted exclusive rights by governments to trade and conduct business
in certain markets or products. So, for example, the Hudson Bay Company was
established by two French adventurers who were granted exclusive rights to
fur trapping in large areas of Canada by the British government in 1670
(having first been turned down by their own government). It was a truly
international venture; the Frenchmen gained a Royal Charter in Britain with
the encouragement of Boston merchants.
The company built forts, extended the speaking of English, founded cities,
and established distribution channels; and it still exists in Canada as a chain of
department stores. It had thirty-two investors who shared risks and returns.
The Dutch East India Company, founded earlier, in 1602, funded long-
distance trading in any items between Europe and the Far East. Investors,
primarily in Amsterdam, would pool funds to support risky trips which,
if successful, provided huge returns. In the course of this, it prompted the
development of the Amsterdam securities market in which spot and future
contracts, call and put options, and hedging and short selling were all possible
(Michie, 2006: 27). The number of investors was very large indeed. These
entities have some important characteristics for the future analysis of
the firm. Initial investors control supply-side risk (by securing monopoly)
before sharing investor risk, they get government to provide the muscle, and
they diversify away some operational risk by embracing a range of uncorrel-
ated activities. These features were all to become important for the develop-
ment of the twentieth-century divisionalized business. Indeed, there is some
The Firm

evidence that at least one of these monopoly operations, the British East India
Company, was divisionalized (see Theme 6).

The Brits

However, it would be too easy to draw a simple line of descent from these
seventeenth-century organizations to modern versions. The Industrial Revo-
lution took off in Britain in the early nineteenth century and, as Michie notes,
in the period before 1850, ‘The British Economy remained mostly untouched
by joint stock enterprise’ (Michie, 2006: 69). Enterprises were either entrepre-
neurially owned, as in manufacturing, or owned by local inhabitants, as in
utilities and canals, and funded by retained profit or bank loans. Pollard (1965:
250) has argued persuasively that there was neither management (as a salaried,
non-owning class) or management ‘technology’ in the first Industrial Revolu-
tion in England. The key developments in both took place in the USA
and, as Chandler has famously argued, they rested on the application of
military organizational principles—specifically West Point—to production.
The Springfield Armoury was the Arsenale of its day (Chandler, 1977: 72–5);
a military factory which became an example in civilian life.
Railways changed everything, requiring large-scale initial finance but able to
set this against the prospect of steady low-risk returns from natural monopoly.
This provided investors with an attractive alternative to government debt. The
USA itself was different in the nineteenth century, in part because there was
no government debt to trade until the civil war in the 1860s and later in
the century, when very large organizations were generated by merger waves,
the joint stock form became the norm for big business. However, well into the
twentieth century, in many large corporations in the USA, such as Ford, Coca-
Cola, and Dupont, family ownership and control remained in place.
A crucial early development that did emerge in England occurred in the
textile industry: the growth of the factory. As well as the massive impact on
output, it is significant for the development of management as an activity.
Historically, cloth had been produced domestically (i.e. in the home), usually
by workers who had other concerns (farming), using simple equipment and
raw materials provided by an entrepreneur, who was also the purchaser of the
finished product. This was a flexible and relatively low capital cost operation,
but it left the entrepreneur with little control over production volumes.
As David Landes, the key historian on the Industrial Revolution, noted:

. . . the domestic weaver or craftsman was a master of his time, starting and stopping
when he desired. And while the employer could raise the piece rates with a view to
encouraging output, he usually found that this actually reduced output.
(Landes, 1969: 59).

24
 The Firm

This backward-sloping labour supply curve arose because the workers tended
to have a subsistence income target, not a utility maximizing one. Cutting the
rates did no good either; it led either to the worker quitting or stealing some of
the raw material in compensation (Salaman, 1981: 27). In short, incentives
alone did not work. What the entrepreneur needed was control of labour time,
and for that, he needed to make sure that workers had work discipline and the
absence of alternative income sources. The answer: the factory, in which
workers were monitored (or managed). This was problematic because it was
not, generally, a process workers welcomed. Thompson (1968), refers to the
‘making’ of the English working class, and he does not characterize it as a
voluntary activity.
This development is highly significant. The modern economic theory of the
firm relies heavily on the ideas of monitoring, incentives, and hierarchy.
Historians have debated the relative importance of these contractual-versus-
technological arguments for the growth of the firm; once the factory existed, it
became possible to apply steam power and technological innovations in
equipment to the raising of output, but the factory came first.
Economic structure aside, there is no doubt that the scale of firms increased.
Prais (1976) quotes figures for the USA and UK which indicate that by the late
1920s the 100 largest firms in both countries accounted for approximately a
quarter of all output. It was to rise to over one-third by 1960. A vast amount of
economic activity was moving from markets into firms. With this, a vast
amount of employment came to be located in large, bureaucratic enterprises
under formalized employment contracts. Let us look at the story in slightly
more detail, and chronologically.
As Cassis (2007: 175) puts it, ‘big business in the third quarter of the
nineteenth century primarily meant the railroad companies’. They became
exemplars in two ways. The first I have noted. They are almost the prototyp-
ical joint stock enterprise; they needed lots of investors. The second concerns
models of employment and management. They were the first modern organ-
izations to develop ‘extensive hierarchies of managerial and white collar staff ’
(Gospel, 2007: 427). They engaged in systematic recruitment, and set up
promotional hierarchies and pay scales. Assuming lifetime, or at least long-
term, employment, they introduced welfare arrangements such as housing,
health care, and pensions. In the UK at least, they liked to recruit employees
with a military or police background, or relatives of those already employed;
this led to a readier acceptance of the employment relationship as an author-
ity relationship, necessary for control of a dispersed workforce.
By the start of the next century, as Cassis notes, in a variety of sectors:

‘The large enterprise of the turn of the twentieth century . . . appears as a centralized
and vertically integrated firm, with its own distribution and purchasing facilities,

25
The Firm

whose various functions, including marketing, were entrusted to a hierarchy of

salaried managers, and which tended to cluster around sectors where economies
of scale and scope could be achieved through mass production.’
(Cassis, 2007: 178).

This was more true of the USA than many parts of Europe.
The impact of World War I was crucial. First, these mass production
industries—food, chemicals, oil, engineering—became central to the war
effort, and expanded considerably; as we show in Theme 9, this had massive
consequences for the development of accounting. There was little product
market competition. After the war there were further merger waves in these
sectors (Chandler, 1962), particularly in Germany (Cassis, 2007: 181). Big
business became bigger. Second, there was a massive change to the labour
market; labour markets were tight (i.e. labour was scarce) and labour was
crucial to the fighting of industrialized war. In Europe, a significant proportion
of the male labour force was, first, in the army, then dead. Unions became
strong and employers had to bargain. Global securities markets collapsed.
There was a mass of government debt to compete with equity investment.
Governments wanted to control the securities markets in which this debt was
traded and capital markets correspondingly contracted. UK investors sold
massive amounts of overseas securities and the London stock market became
more localized. US investors had a very good war, and US markets, particularly
New York, grew massively. As Michie puts it:

. . . the global securities market was reduced to a series of compartmentalized

marketplaces only loosely linked to each other rather than the fully integrated
system that was in full flow before 1914.
(Michie, 2006: 204).

After the war, in the 1920s and 1930s, government involvement in business,
particularly in European labour and capital markets, continued. The USA
made two clear declarations of its intent to isolate itself from the rest of the
world, in both cases defeating its own president. President Woodrow Wilson
wanted a League of Nations to help secure peace. He did not want prohibition.
He did not get much of the first, but he did get the second: Congress won on
both. Arguably, the Wall Street Crash in 1929 cemented introversion.
Readers may at this point wonder why they have been treated to such a
selective and potted history. My intent has been to characterize some key
historical developments and current circumstances surrounding the period of
the birth of modern management theory. As Witzel puts it:

Most of the disciplines of management . . . developed in their modern codified

form during the period from about 1900–1930.
(Witzel, 2002: 179).

26
 The Firm

He argues that strategy came later. Finance came later still. But he is right about
theories of organization, labour management, operations, and marketing.
Wharton opened its doors in 1898. Harvard Business School started in 1919.
At the risk of being too historically materialist in my interpretation of ideas, let
me offer the following observations. I argued in Chapter 1 that management
theory opportunistically develops in response to perceived managerial prob-
lems; let me now be much more specific. Where labour is scarce and product
markets buoyant, labour becomes a critical resource to manage, and one needs
theories about both individual and collective labour management, including
incentives, control, motivation, and conflict management. Where firms have
become very large and centralized and managerial hierarchies elaborate, one
needs theories about organizational coordination. Where businesses have
become very capital intensive and integrated, one needs theories about produc-
tion optimization.
On the other hand, where capital markets are inefficient, over-regulated, and
compartmentalized, you don’t immediately need a discipline of finance based
on the idea of an efficient market. And where large firms dominate protected
home markets in oligopolistic competition, you don’t need strategy to tell you
about differentiation. And they did not develop then. They come much later.

Market Failure and Management: The Curious Case

of the Dog in the Night

Meanwhile, in 1937, an LSE graduate named Ronald Coase asked why, if

markets were efficient, so many people were employed in firms rather than
simply contracting with each other in markets (Coase, 1937). It was an inter-
esting question to ask at roughly the same time as two other academics, Berle
and Means, were discussing the separation of ownership and control in the
large firms that were dominating the USA and most other developed econ-
omies, arguing that shareholders in such firms had ownership, but managers
had control. Coase spends the first part of the article justifying the mere asking
of the question in terms of how it relates to the Marshallian (neoclassical)
ideas of margin and substitution in economics. It led eventually both to an
economic theory of the firm and to the Nobel Prize in Economics in 1991. But,
at the time, an interesting thing happened: absolutely nothing.
Coase argued that firms exist because of market—or, more specifically, price
mechanism—failure in the presence of transaction costs.

. . . the fact that it costs something to enter into . . . transactions means that firms will
emerge to organize what would otherwise be market transactions whenever their
costs were less than the costs of carrying out the transactions through the market.
(Coase, 1988: 7).

27
The Firm

Certain types of transactions in markets entail considerable costs of price

discovery, negotiation, and enforcement. For such transactions, Coase argued,
it may be more efficient for what he terms an ‘entrepreneur’ to use ‘authority’
to direct resources to their most efficient ends. The boundary of the firm is set
where the costs of organizing a transaction within the firm equal the costs of
carrying it out through the market. Within this boundary, the firm makes
products or services; beyond it, it buys or sells them.
The revolutionary idea was the notion of a transaction cost. Much later, Coase
argued that without transaction costs firms would not exist, but nor would
markets (1988: 6–8). Economists were primarily interested in markets, but they
focused mainly on prices, and when they discussed market structure, they
referred to the number of firms, and products, rather than the ‘social institutions
that facilitate exchange’ (Coase, 1988: 8) and thus defined transaction costs.
In economics, indifference spread like wildfire in response. Recently Morri-
son and Wilhelm noted (apparently without irony) that ‘Coase was ahead of
his time. His work spawned a related literature from the late 1960s’ (Morrison
and Wilhelm, 2007: 51—my emphasis).
This is only a sensible remark if applied solely to mainstream academic
economics. In the 1930s, huge enterprises such as US Steel, Dupont, Standard
Oil, General Electric, and AT&T dominated industrial sectors. They also strad-
dled sectors, developing multi-divisional structures to manage diversified
product ranges. Vertical integration was also extremely advanced. As Davis
notes about a single Ford factory:

The (River) Rouge was an entire industrial economy in two square miles, bringing
iron ore, coal, rubber, and sand in one end and sending cars out the other. In the
1930s over 100,000 people worked at the Rouge in the most vertically integrated
factory the world had ever seen, with its own fire department, police force and
hospital.
(Davis, 2009: ix).

The reason why Berle and Means (1932) were concerned about ownership and
control was that some of these very large firms (like Ford) were controlled by
their owners but, in many others where shareholding was more dispersed, the
many managers who were employed to run the businesses had substantial
freedom of action; the modern corporation was a threat to property rights, and
the specific threat lay in the behaviour of managers. I have much more to say
about this in the next theme.
Coase had pointed the way to an explanation of why so much economic
activity took place outside markets, but it was many years before this insight
was pursued: I will explain how below. But what the market failure approach
did not do was to offer a route to the study of the firm’s internal operations.
The stylized ‘entrepreneur’ allocates resources using ‘authority’ to maximize

28
 The Firm

‘efficiency’ and sets the boundary of the firm where market and hierarchy
transaction costs equate; none of these concepts is defined, and they really do
not tell you much about what went on in River Rouge. Coase was not really
concerned with why some ‘entrepreneurs’ might be better than others. As a
result, Coase made little impact—at the time—on the study of management
either. However, in the longer term, the impact was substantial.
Several features of the Coase argument are replicated in much economic
theorizing about organizations down to the present day. First, in the pursuit of
a theory of the firm, organizations are considered simple alternatives to mar-
kets; that is the pursuit of efficiency by other means. There are two problems
with this; first, firms may pursue multiple objectives of which efficiency is one,
and since these objectives may be in conflict, efficiency may not be the prime
objective in the short term. Moreover, there is no obvious reason why markets
could not emerge from organizational failure, rather than vice versa. In fact,
much later—with the growth of outsourcing—they did, and one needed to
explain why a ‘make’ decision turned into a ‘buy’ decision, with the corollary
that firm size tended to shrink (Pfeffer, 1997). Transaction cost arguments can
provide a perfectly reasonable explanation for this shrinkage, but Coase did
not pursue it.
Second, as Penrose (1959) was to note many years later, markets do not
make anything; they exchange but do not produce—firms do both, and are
thus much more than merely alternatives to markets. She makes the percep-
tive observation that there is a difference between a theory of the firm and the
economics of the firm. Much later, Bromiley (2005: 13) makes a parallel point
about the difference between explaining why firms exist versus explaining
what they do. For business strategy,

The existence of firms stands more as a constraint on theorizing than an interest-

ing problem; a theory that predicts firms should not exist is clearly deficient.

To use a metaphor; on the one hand, economists tended to see the world as a sea
of markets with the occasional island (the firm). Those who have studied man-
agement tend to see the world as a desert of firms with the occasional market
oasis. In the early twentieth century, if one is to believe Coase, there must have
been an awful lot of market failure in the USA, given the dominance of large firms.
The second feature which has endured in economics is the representation of
the firm in terms of one or more stylized actors; for Coase it is the ‘entrepre-
neur’, for later economists it is the ‘principal’ and ‘agent’. This simplification
enables formal modelling but is not receptive to ideas about organizational
diversity or complexity; firms are timeless and geographically unembedded.
The third feature is that intra-organization relationships are treated in a very
unproblematic way. Coase’s ‘entrepreneur’ exercises authority and those she
hires obey. For Jensen and Meckling (1976), who were to codify ‘agency

29
The Firm

theory’ much later, monitoring ensures compliance and incentives provide

motivation; other approaches to the study of management treat monitoring
and incentives as costly and problematic, but in economics they are simply
causal. Fourth, and related, rationality is an assumption not a variable. Actors
within firms are built the same way as actors within markets, so that if one
replicates the competitive conditions of markets within firms, the same
behaviours will emerge. By extension, if an organizational feature is empiric-
ally common, logically it must be efficient, since inefficient organizations will
disappear over time. Organizational diversity should disappear too.
This has had consequences for the relationship between economic theories
of the firm and empirical studies of what managers do, such as those discussed
in Chapter 9. Specifically, as both Pfeffer (1997: 46) and Donaldson (1995)
note, the economic approach sees hierarchy design in terms of the prime need
to control managers with self-interested goals and employees who are effort-
averse. These assumptions about individuals within firms lead to the argu-
ment that hierarchies have control and coordination costs, rather than
focusing on the positive impact managers might have on firm performance. In
fact, as we shall see, were one to design an organization according to economic
principles, it would probably be inoperable, primarily because of the reaction of
employees to such organizational controls. However, before I turn to this, we
need to look at the development of economic ideas about hierarchy. Coase
looked at market failure, but what about the dynamics of hierarchy?

Transaction Cost Economics

Oliver Williamson’s early work concerned managerial decision-making; he

found that managerial discretion often undermined efficiency (Williamson,
1963). Much later, he would articulate the problems of the ‘propensity to
manage’ in two forms. It exists:

1. instrumentally—managers pretend they can manage complexity, when

they cannot, and;
2. strategically—managers pursue their own sub-goals (Williamson, 1985).

However, rather than turning to markets as the answer, he focused on the

internal operations of the firm. The two aspects of ‘propensity’ rest on two
assumptions about individual behaviour that are core to the entire project.
Individuals are boundedly rational; that is they have limited capabilities to
deal with information complexity and information uncertainty. Specifically,
and crucially, they cannot write complete contracts. Second, individuals are
opportunistic, in that they pursue ‘self-interest-seeking with guile’ (Williamson,
1985: 47); this is an extension of the conventional economic assumption about

30
 The Firm

the pursuit of self-interest, which may roughly be summarized as the idea that,
since one cannot discover in advance who is trustworthy, organizations need to
be designed to cope with a pandemic of dishonesty.
The third leg of this structure is the idea of asset specificity. The central issue
is the existence of human or physical assets which are locked into a particular
exchange relationship, that is they have lower values elsewhere. This might be
ex ante; for example, in the oil industry, you have to build a pipeline from a
market to an existing oilfield and you are creating (in effect) bilateral monop-
oly. Or it might be ex post; for example, you have worked in the same firm for
many years developing firm-specific skills; you cannot find a ready market for
such skills and the firm may find it difficult to replace you. The three legs come
together, as Bromiley notes: ‘ . . . efficient operation may require investments
that have little value outside that operation, but the parties cannot trust one
another, nor can they write the perfect contract . . . bringing both parties to the
transaction into the same company (internalisation) may be more efficient
than doing the transaction in the market’ (Bromiley, 2005: 97).
Put another way, firms arise where boundedly rational individuals exchange
very specific assets with counter-parties who need to be watched. As with
Coase, transaction costs in markets and hierarchies are important and Wil-
liamson borrows Arrow’s (1974) definition as follows:
 Ex ante costs: the costs of drafting, negotiating, and safeguarding an
agreement.
 Ex post costs: misalignment, haggling costs, the costs of running and
referring to governance structures, ‘bonding’ costs.

But contractual governance costs can be optimized in either markets or hier-

archies: ‘transactions, which differ in their attributes, are aligned with gov-
ernance structures, which differ in their costs and competences’ (Williamson,
1995: 27), so that transaction costs are minimized.
The influence of transaction costs economics has been substantial perhaps
because of its scope, but also because of the nature of its assumptions. Asset
specificity alone does not give you the firm; opportunism is key. Since oppor-
tunism is a very strong form of the self-interest assumption, it has attracted
substantial criticism; it is a very negative view of human propensities
(Ghoshal and Moran, 1996), it may well be ethnocentric (Dore, 1983), and it
is not empirically grounded (Simon, 1991). However, it gives you not only a
theory of firm formation—firms arise from the original sin1 of opportunism—

1
I owe this expression to Arthur Francis (1983).

31
The Firm

but also an approach to the optimization of firm structure; for example,

Williamson explains the growth of the multi-divisional firm in terms of
efficiency—it economizes on the transaction costs of capital markets and min-
imizes the managerial activity that detracts from shareholder value (1985: 288).
I will discuss multi-divisional structures in depth in Theme 6. Here, how-
ever, the focus is on the approach to hierarchy. Williamson develops an
approach to the employment contract which is of generic interest to the
relationships between owners, managers, and labour I discussed at the outset.
Employment contracts are often characterized in economics as incomplete.
They also have asymmetric authority (the employer issues instruction), asym-
metric information (sometimes in favour of the employee), asset specificity
(the skills and equipment used are often not transferable), and they are often
of long duration. They are, empirically, the building blocks of hierarchy, since
monitoring and incentives are central to them. Williamson’s approach can be
illustrated by reference to Figure C2.1.
Williamson (1975: 69) discusses three contractual possibilities for employ-
ment contracts. Under spot contracting the parties contract at time 1 (T1) that
when event 1 (E1) occurs, the exchange of money for effort (X1) will occur. If
this occurs once, the spot contract form is efficient. However, if the game is
repeated, two problems emerge. First, the transaction costs are high, both ex
ante and ex post; you have to bargain with the same counter-party each time.
Second, opportunism—by both parties—is likely. Under contingent claims
contracting, the parties at T1 try to write a comprehensive contract covering
all events and their related effort bargains. This fails the bounded rationality

Spot contracts
T1………… E1……… X1

T2………… E2……… X2

T3………… E3……… X3

Contingent claims
T1………… E1……… X1

E2……… X2

E3……… X3

Authority relation
T1…………

E1………… ....……… E3

X1………………

Figure C2.1. Alternative contractual forms.

(Source: Derived from Williamson, 1975)

32
 The Firm

test in many circumstances, particularly where the number of discrete events

is high; it becomes very difficult to imagine and cover all future contingencies.
The third option is adapted from Simon (who was Williamson’s PhD super-
visor). In this approach the parties agree to an authority relationship. The
employee, in exchange for a single comprehensive effort bargain, agrees to
allow the employer the authority to make state-of-the-world definitions across
a range of events (Willman, 1982). The problem here is how to define the
acceptable range of events. However, an authority relationship economizes on
transaction costs and does allow some form of monitoring.
Let me make this concrete with examples. A casually employed gardener or
window cleaner has a series of spot contracts with the households that employ
him or her. A contingent contract to cover repairs to a domestic appliance says
what will and will not be covered by the engineer under a specified set of
circumstances. My employment contract is an authority relationship because
it says I will do whatever is asked of me by my head of department within a
mutually understood (?) range of academic activities. These contracts have
very different transaction cost properties and fit different contingencies.
Where the future is highly unpredictable and the task can be specified, spot
contracts may be the easiest option for both parties. Where we can effectively
make a list of tasks and embed them in a job description, that is where the
future is predictable, a contingent claims contract might work well, but
unclassifiable events may be ignored. An authority relation is, in Williamson’s
view, more robust in the face of uncertainty.
The great step forward from Coase to Williamson is that the latter is theor-
izing the dynamics of the operation of hierarchy rather than simply explain-
ing how market failure might bring it about. Hierarchies arise because of
transaction costs in markets, but hierarchies themselves may differ in terms
of their transaction costs’ properties depending on the choice and mix of
contractual forms. Williamson does not, however, use this insight as a plat-
form for analysing differences between firms. Since he is concerned primarily
with the efficiency properties of hierarchies, and inefficient hierarchies must
disappear in the face of competition from more efficient forms, he is con-
cerned to identify the most efficient hierarchical form.
What Williamson came up with as the optimal form relies very heavily on
Doeringer and Piore’s (1971) idea of an ‘enterprise market’; this is essentially
an authority relationship with a set of clear rules. He emphasizes several
elements; internal promotion ladders to encourage on-the-job training and
cooperation, pay rates attached to jobs within these ladders—rather than
individual performance—ascending with position on the hierarchy, moderate
rather than intensive metering, and job security bolstered by a grievance or
arbitration procedure to resolve disputes. This might be regarded as a hybrid
form—an authority relationship with many contingencies spelt out. It was

33
The Firm

widespread in the USA at the time Williamson wrote (1975), and as we saw it
has a history going back at least as far as the nineteenth-century practices of
rail firms.
Williamson is in effect describing the institutional structure of managerial
capitalism—what Davis has referred to as ‘corporate feudalism’—in which
long-term attachments between firms and employees, bolstered by firm-spe-
cific benefits and privileges such as pensions, profit sharing, and long-term
employment, characterized not only the fabric of managerial work but,
increasingly with the advent of labour unions and particularly in the USA,
that of all permanent employees. This was widespread practice (in the USA, if
not elsewhere) so it must, if you are an economist, have efficiency properties
to be unearthed. Unfortunately, it was disappearing almost as Williamson
wrote (Davis, 2009: 195–200); I shall have much more to say about this in
Theme 8.
For Williamson, a key part of the efficiency gains that come from this
considerable investment in hierarchy comes from its impact on the behav-
iours of those in the hierarchy. His distinction between ‘consummate’ and
‘perfunctory’ cooperation outlines, but does not perform, a theory of value
creation by managers.

Consummate cooperation is an affirmative job attitude—to include the use

of judgment, filling gaps, and taking initiative . . . Perfunctory cooperation, by
contrast, involves job performance of a minimally acceptable sort . . . where . . .
incumbents . . . need merely to maintain a slight margin over the best-available
inexperienced candidate.
(Williamson 1975: 27)

All other things equal, a firm in which managers generate consummate cooper-
ation will out-compete one in which they do not. Understanding this difference
has provided the motivation for the development of theories about both man-
agement and labour performance based on findings from different disciplines,
which I examine in the next two chapters. They all challenge Williamson’s
assumption that such cooperation stems from contractual design alone.
Let us pursue this by looking at the idea that the different parties might
have, in the short term at least, different preferences for the form of contract.
Figure C2.2 illustrates the issues using a simple game theoretic framework of
the sort that we will explore in more depth in Chapter 6. Two parties—
employer and employee—are seeking to agree which contract to use under
two conditions: offensive and defensive. Both parties adopt offensive strat-
egies when they feel their bargaining power is high and defensive when they
feel it is not. Offensively, the employer will wish to establish an authority
relationship to throw contractual risk on to the employee and the employee
will wish for spot contracting to maximize the opportunities for opportunism.

34
 The Firm

SPOT/AUTHORITY
Offensive Defensive

Authority Contingent
Offensive
Spot contracts Spot contracts
EMPLOYEE
STRATEGY Contingent
Authority
Defensive
Contingent Contingent

Figure C2.2. Employer and employee contract strategies.

(Source: Willman, 1986: 97)

Defensively, both parties will wish to control counter-party risk with a com-
plex contingent claims contract.
The simple example shows that contractual consensus is only unproblem-
atic when both are on the defensive. Offensive strategies lead the employer to
seek to impose authority and the employee to seek to bargain. It also indicates
why contractual choice may not be homogeneous or stable and why consum-
mate cooperation might be elusive.

Conclusion

In this short chapter, I have tried, first, to describe in brief the emergence of
the large firm and, second, to outline the first main attempt to develop a
theory of it. This theory has a number of features that are significant for the
chapters that follow.
First, it emerges as essentially a negative explanation about market failure;
firms are implicitly second-best structures that arise when markets fail.
A hierarchy is essentially a set of incomplete contracts bound together in an
authority structure, but the existence of authority is an assumption not a
finding. Logically, one optimizes the performance of a firm hierarchy by
making sure it runs as close to being a market as possible. Within firms,
managers potentially engage in problematic behaviours because the structures
bring out the worst in them—opportunism. Coase is the precursor of a range
of anti-managerial theories of organization.
Second, the theory is not empirically based. Not only is it surprising that
economics developed a theory of the firm long after firms came to dominate
industries (and then ignored it), it is surprising that the theory was not
informed by any extensive observation of industry structure or firm behaviour.

35
The Firm

Empirical examination of the internal operation of the firm has remained

unfashionable within economics and, as we shall see, it does not infect the
modern field of organizational economics very much either.
Third, because the transaction costs approach remained marginal to eco-
nomics for thirty years, and economics remained relatively uninterested in the
firm, a space was created into which business disciplines such as marketing,
organizational behaviour, and strategy moved. Academic economics becomes
much more involved with the study of managerial behaviour with the growth
of the economics of strategy and organization and, less directly, of financial
economics from the 1960s. One interesting consequence of this is that we can
look at the central themes of the management field from the varieties of
perspective available from different disciplines.
I turn to the first. Our railway example is a useful way in. Investors in railways
wanted clear accounting measures to ensure that managers whom they could
not directly monitor were acting on their behalf. Managers of railways wanted
institutional arrangements to secure a labour force they could not see most of
the time who would keep the trains running. They both faced agency problems.

36
Theme 2

The Agency Problem

Introduction: Pins and Managers

The following might be one of the most famous quotes about the division of
labour. It is from Adam Smith and concerns pin making.

A workman not educated to this business, nor acquainted with the use of the
machinery employed in it, could scarce, perhaps, with his utmost industry, make
one pin in a day, and certainly could not make twenty.
One man draws out the wire, another straights it, a third cuts it, a fourth points
it, a fifth grinds it at the top for receiving the head; to make the head requires two
or three distinct operations; to put it on is a peculiar business, to whiten the pins is
another; it is even a trade by itself to put them into the paper; and the important
business of making a pin is, in this manner, divided into about eighteen distinct
operations, which, in some factories, are all performed by distinct hands, though
in others the same man will sometimes perform two or three of them.
I have seen a small manufactory of this kind where ten men only were
employed, and where some of them consequently performed two or three distinct
operations . . . they could, when they exerted themselves, make among them about
twelve pounds of pins in a day. There are in a pound upwards of four thousand
pins of a middling size. Those ten persons, therefore, could make among them
upwards of forty-eight thousand pins in a day.
(Smith, 1776, Wealth of Nations: Book 1)

Smith goes on to remark that working this way might not be in the
best interests of the individuals involved; specialization might make them
‘stupid and ignorant’. He foresees (or maybe observes) a central problem about
the management of factory labour that would concern many practitioners
later on, particularly after task fragmentation was raised to an art form by
F. W. Taylor and his followers: how do you ensure they ‘exert’ themselves? But
there is a very interesting omission from this example . . .
Who manages this? Do the non-educated workmen come together in the
generation of spontaneous order similar to that characteristic of the invisible
The Agency Problem

hand of the market mechanism? Or does there need to be a coordinating

mechanism that manages production speed and quality at each work station,
buffer stocks between each activity, and the job design choices that determine
whether men do ‘two or three distinct operations’? Does this coordinating
mechanism operate by authority or consent? Does it impart the expertise
needed by the uneducated? If production moves from one pin per day to
48,000, who gets the benefit? When the unit cost of pin production falls,
who sets the internal transfer prices of part-finished goods and final product
price? How are individual workers rewarded when there is such interdepend-
ency of tasks? Why should workmen as the ‘small manufactory’ he saw ‘exert
themselves’?
These are only some of the basic questions about the management of
a production process. Although much more interested in the practicalities of
production than many subsequent economists, Smith assumed that efficient
organization emerges in both hierarchies and markets. He assumed that
resources would be naturally allocated to their most profitable use, and
that less-efficient divisions of labour would yield to more efficient ones. As
I will demonstrate below, the originator of the term ‘invisible hand’—about
the operations of the market—had no theory of what much later Chandler
would term the ‘visible hand’ of management in the generation of value and
profit. In fact, like many subsequent economists, Smith had ideas about the
problematic nature of managerial agency.
Adam Smith, again, on the firm.

The directors of . . . companies, however, being the managers rather of other

people’s money than of their own, it cannot well be expected that they should
watch over it with the same anxious vigilance with which the partners in a private
company frequently watch over their own. Like the stewards of a rich man, they
are apt to consider attention to small matters as not for their master’s honour, and
very easily give themselves a dispensation from having it. Negligence and profu-
sion, therefore, must always prevail, more or less, in the management of the
affairs of such a company.
(Smith, 1776).

This is one of the earlier statements of what much later came to be known
as the agency problem (Jensen and Meckling,1976). It goes to the heart of what
management is about: how to delegate and coordinate tasks in an efficient and
effective manner. Once large industrial organizations emerged in which the
number of activities and of employees was so great that they could not be
monitored directly by a proprietor or even a family of proprietors, hierarchies
of delegated authority emerged in which salaried managers managed (mostly)
wage-earning employees. In these hierarchies, two major problems emerged in
the following historical order, concerning coordination and control.

38
 The Agency Problem

The first, which was evident in Smith’s lifetime but peaked in the nine-
teenth and early twentieth centuries, concerned the need to create, manage,
and develop an industrial labour force compliant enough to operate an effi-
cient division of labour in the large manufacturing or service organization.
There is much debate amongst economic historians about whether and when
the Industrial Revolution improved the living standards of wage-earning
employees in the West, but there is ample historical evidence that issues of
compliance, attendance, productivity, and collective withdrawal of effort
affected a number of industries in a number of countries. Thus, one finds
that many early management writers concern themselves with the ‘labour
problem’ and with the practices firms should adopt to resolve it.
The second, which is the one Smith directly addresses above, stems from
something first characterized by Berle and Means in the USA (1932) as the
separation of ownership and control. They argued that the development of
large firms had led to the emergence of a class of professional managers whose
independence of action and practical control of large businesses was sup-
ported by limited effective property rights for shareholders, particularly
small ones, and limited oversight by capital markets. So, those who owned
businesses in a property rights sense did not control what happened within
them. Aims might be pursued that served the interests of salaried managers,
preserving their job security and bolstering their earnings.
These can be presented fairly simply, but in practice the issues involved and
the implications for theories about management are a bit more tricky. In the
early twentieth century, international mobility of both labour and capital was
more limited than in periods before or since (Gospel, 2007; Michie, 2006).
Firms in many Western countries could not easily find substitute skilled
workforces if their current ones sought more share in corporate rents, nor
could they easily relocate productive activities to low-wage economies; and
investors did not have an operative global market for capital and money,
particularly after the Wall Street Crash. Constellations of corporate stake-
holders in the USA at the time when Berle and Means were writing embraced
organized labour and government in ways they do less today, and excluded
consumer and investor interests more. So the context of the first set of agency
issues was the employment contract, and that of the second was the financial
market. I shall look at each in turn, stressing the conceptual similarity but not
continuity.

Optimizing Production?

The nineteenth and early twentieth centuries in Europe and the USA were,
arguably, characterized by two features relevant to the design and conduct of

39
 Another Random Document on
Scribd Without Any Related Topics
felicitations of the United States Government. But Mr. Marcy never
forgave the instrument of his blunder, and one of his last official acts
was to beg of President Pierce, as a personal favour, the dismissal of
Minister Wheeler, a request which the dying administration was weak
enough to grant.

We now behold Walker at the zenith of his fame, the lawful ruler of a
country whose position and resources made it a prize worth the
ambition of all Europe and America to possess. Besides a powerful
native party, he had an army of his countrymen at his back
numbering over a thousand men, a line of steamers under his
control—for the California agents of the Transit Company were his
friends as long as their interests and his were the same—and a
strong party in the United States in sympathy with his cherished
project for the extension of slavery. The tradition vouched for by
Crowe in his "Gospel in Central America," as current among the
Indians of Nicaragua—"that a grey-eyed man would come from the
far North to overturn the Spanish domination and regenerate the
native race"—seemed likely to be confirmed, in part, at least.

The ceremony of inaugurating the new President was performed

with great pomp at the capital on the 12th of July. The acting
provisional director, Don Firmin Ferrer, administered the oath of
office, Walker kneeling to make the solemn affirmation. The
President-elect was dressed in his customary civilian costume of
decorous black, in manner and attire a striking contrast to the gaily
decked natives who flocked to the ceremony. The inauguration was
celebrated on a large staging erected in the plaza, which was
festooned with the flags of Nicaragua, the United States, France,
and the unborn republic of Cuba. The text of the oath which Ferrer
administered, with a highly eulogistic address, was as follows:

"You solemnly promise and swear to govern the free Republic of

Nicaragua, and sustain its independent and territorial integrity with
all your power, and to execute justice according to the principles of
republicanism and religion."

"I promise and swear."

"You promise and swear, whenever it may be in your power, to

maintain the law of God, the true profession of the Evangelists, and
the religion of the Crucifixion."

"I promise and swear."

"In the name of God and the sainted Evangelists, you swear to
comply with these obligations and to make it your constant guard to
fulfil all that is herein promised."

"I swear."

"And for this the succession is committed to you firmly, by these

presents, by authority of the Secretary of the Government charged
with the general despatches."

At the end of this ceremony Walker delivered an inaugural address

of the usual character pertaining to such prosaic compositions. The
President was not without hopes of establishing friendly relations
with the Great Powers, and among his first acts was the sending of
ministers to England and France. The envoys either never reached
the fields of their missions or failed to receive official recognition, as
the Blue-books of those governments make no mention of diplomatic
intercourse between the filibuster cabinet and their own. The nations
of Europe, in their blind jealousy of American influence, would not,
or could not, understand that the aims of Walker were, if successful,
likely to prove an unsurmountable obstacle to the very American
expansion which they feared. To build up a strong confederacy of
slave states, which should antagonize the powerful free states of the
North, was the prime, if not the sole, object which won for Walker
the sympathy and aid of the Southern States. By opposing and
frustrating this scheme, Great Britain unwittingly lent herself to the
service of the party of union in the United States, thereby weakening
the cause which she afterwards favoured, of Southern secession.

The shrewd English observer, Laurence Oliphant, writing, in 1860,

his personal recollections of "Patriots and Filibusters," shows the
mistake into which his Government fell, as he frankly says, through
"no mere considerations of morality," but through a mistaken notion
of self-interest. Walker never intended that Central America should
become a part of the Union. Like Aaron Burr, he wished to keep all
the fruits of conquest for his personal glory and aggrandisement; but
he was sincere in representing to his countrymen that the effects of
establishing a powerful slave empire south of the United States
would be of incalculable advantage to the pro-slavery party at home.

[1]
Goicouria was a devoted Cuban patriot, who was
executed many years afterwards by the Spaniards at
Havana.
 CHAPTER XII

Administration of President Walker — The Allies advance towards

Granada — Naval victory — Review of the filibuster army —
Filibusters and their allies — Assault on Masaya — Civil
government — The Slavery decree — Antiquated logic.

W ALKER wisely gave the most important places in the cabinet to

his native adherents. His faithful friends, Don Firmin Ferrer and
Mateo Pineda, were appointed respectively Ministers of Foreign
Affairs and of War. Don Manuel Carascossa received the Treasury
portfolio, and that of Hacienda was given to the Cuban, Don
Domingo Goicouria. Hundreds of recruits continued to pour in from
California and the Atlantic states. In the Northern departments the
Allies also received strong reinforcements, and by the 1st of July
they had undisturbed possession of Leon, whence they soon spread
over the country, annoying the foraging parties sent out of Granada
to collect cattle in the district of Chontales. A detachment of cavalry
which Walker sent against them was repulsed near the river
Tipitapa, and one of the leaders, Byron Cole, was slain. Cole was the
early friend of Walker, and the negotiator of the contract under
which the filibusters had come to Nicaragua. Belloso, reinforced by a
strong body under command of General Martinez, was now
emboldened to advance to Masaya, which he fortified and made the
base of operation against Granada, fifteen miles distant.

Xatruch, Jerez, and Zavala were acting with the enemies of their
country. Rivas was of little importance among his dubious friends.
Salazar, who had been so prominent in inciting the invasion, was
captured on the coast of Nicaragua by Lieutenant Fayssoux, and
carried a prisoner to Granada, where he was tried for treason, found
guilty, and executed.

Fayssoux, the only commander in the navy of the ephemeral

republic, was a splendid specimen of the sailor-filibuster. A native of
Louisiana, he had seen service in Cuba with Lopez and Pickett.
Walker, having confiscated the schooner San Jose for carrying a false
register, had her fitted out with some guns and placed her under the
command of Fayssoux. Her first exploit was an engagement with the
Costa Rican brig, Once de Abril, carrying thrice the armament and
six times the crew of the Granada, as the San Jose was now
christened. The Costa Rican was blown out of the water after a two-
hours' fight, and the Granada remained mistress of the Pacific
waters until a heavier antagonist came upon the scene.

The position of the Allies at Masaya was well chosen. It is an eagle's

nest, hung high a thousand feet, on the crest of a volcanic upheaval.
Half-way down its sides lies the Lake of Masaya, imprisoned within
its walls of adamant. To the south lies the lava desert, well named
"the Hell of Masaya," barring the road from Granada.

Belloso from his eyrie was wont to swoop down on detached parties
of foraging filibusters, or to strike with quick and deadly blow the
solitary hamlets whose people might be suspected of a leaning
towards the liberal cause. Walker did not need control of the
northern districts, and would have been content to leave Masaya and
its barren crags in undisturbed possession of Belloso's rough riders,
but for the daily waspish annoyance to his foragers and the loss of
prestige in the eyes of the conquered Leonese. Characteristically he
chose the bold plan of attacking the enemy in his stronghold,
regardless of the enormous odds against him. At the head of only
eight hundred men he rode out of Granada, on the morning of
October 11th, and took the high road for Masaya.

There was a gallant review of the little army, proud in the bravery of
new uniforms and waving banners, and under the eyes of wives,
sisters, and sweethearts, of whom not a few had followed the flag
down to the seat of war. For the filibusters had "come to stay," they
boasted. What further ambition they dreamed may not be known;
but something was hinted in the device upon the flag of the First
Rifle battalion, the corps of one-legged Colonel Sanders, a grim and
hard-fighting old colonel withal. It bore, in place of the old-time five
volcanoes and pious legend, the filibuster's five-pointed red star, and
the motto, in sword-cut Saxon, "Five or None"—a hint to the allied
states of new and stronger alliance yet to be.

The march was leisurely and uninterrupted. By ten o'clock at night

they halted near the suburbs of Masaya, threw out pickets, and went
into camp. It was a glorious tropical night. The early evening had
been misty, but night fell without the laggard twilight of temperate
zones, and the full moon shone in all her splendour upon a scene
worthy the pencil of Salvator Rosa. Before the filibusters' bivouac lay
the Lake of Masaya, reflecting the watch-fires of the town. In the
distance rose the towering cone of Mount Masaya, clouded in dense
volumes of smoke, and grandly indifferent to the puny preparations
of the insects about to bring their mimic thunders into play on the
morrow. The filibusters lay in groups around their fires, the very
flower and perfection of that lost race called the "49-ers." They
smoked their pipes tranquilly; they took an occasional sip of
aguardiente—but it was a temperate potation, for the General was at
hand, and woe betide the luckless wretch who unfitted himself for
duty in that dread presence on the eve of battle. They talked of the
past much, of the present little, and of the future not at all, save in
connection with mining prospects. For it was a religious belief with
those queer adventurers that in coming to Nicaragua they had been
governed by a marvellous inspiration of good sense. It was to them
a question of practical business, they believed; and if its pursuit
involved a little incidental fighting, why, that was to be reckoned
among the taxes to fortune. Hence they had not wasted their hours
in Nicaragua, but had diligently, as their duties would allow, visited
every rivulet and hill, and talked knowingly of "indications," and
"colour," and other technical lore. Regarding themselves as
industrious, if rather enterprising, men of business, they would have
resented any intimation of romance or recklessness in their present
occupation.

They spoke in a short, terse way which it was the despair of their
allies to understand. Ollendorf had furnished the Spanish student
with no equivalent for the wondrous vocabulary of California. The
Nicaraguan, who uses not over one-fifth of the words in his glorious
Castilian inheritance, was at the verbal mercy of the man who
possessed a whole mine of phrases unknown to the lexicographers,
and who pitied with a fine scorn the ignorant wretch, native or
foreign, who knew not the patois of the mining camp. He even
improved upon the language of the country, when he condescended
to use it, changing such household words as "nigua" or "jigua," into
the more expressive "jigger," nor omitting to prefix it with the Anglo-
Saxon shibboleth known to all mankind—the watchword which,
hundreds of years ago, gave to English soldiers in foreign towns the
charming sobriquet of the "Goddams." The prefix was not inapt, for
the "jigger" is the most pestiferous parasite of all his race, and a
living thorn in the flesh of his victim. Spanish verbs, like "buscar,"
"pasear," &c., masqueraded with English terminals and marvellous
compound tenses, a wonder of philology. Nor did the sonorous
native names come forth unrefined from the furnace of California
speech. "Don Jose de Machuca y Mendoza" was a style
nomenclature altogether too lofty for democratic tongues, which
found it easier and much more sociable to pronounce "Greaser Joe."
Whatever was to come of the incongruous alliance, for the present
there was a touch of nature, a community of courage, which made
the parties kin in thought and action. The native, whether friend or
foe, was no coward. In endurance he was the peer of his northern
rival, though he lacked the physical strength and wild hardihood of
the pioneer. The bivouac before Masaya was but one of a score of
such.

The enemy, who had kept up a desultory firing through the night,
appeared in force at daybreak a few hundred yards away. Walker
began the engagement by a general advance on the town under
cover of a well-directed fire from his battery of howitzers. In a short
time the First Rifles had driven the enemy out of the main plaza,
which was immediately occupied by the whole force of the
assailants. The position was excellent as far as it went, but the
enemy still held two other plazas and the intervening houses, and to
dislodge them would have entailed a heavier loss of life than could
be afforded. The artillery was accordingly brought up, and sappers
were detailed to cut passages through the adobe house walls. Slowly
but steadily the work proceeded, the besieging lines converging
towards the enemy's stronghold. The day was thus consumed in
engineering, with an occasional skirmish in the narrow streets.

While the combatants lay on their arms that night awaiting the
morrow which was to see the city in the possession of the invaders,
what was happening in Granada? Zavala and eight hundred swarthy
Serviles, making a forced march from Diriomio, had entered the
Jalteva at noon of the 12th. A scant garrison of a hundred and fifty
men, mostly invalids, was all that remained to oppose them; and
Zavala, feeling sure of an easy victory, divided his forces so as to
surround the little band. The latter were distributed in the church,
armoury, and hospital, whither also repaired all the civilians who
could, having little confidence in the security of their neutral
position. General Fry, commanding the garrison, hastily prepared for
a desperate resistance. He had two or three field pieces, which were
placed to best advantage and managed by Captain Swingle, an
ingenious experimenter, with an enterprising eye to church bells and
such raw material.
Zavala found himself, to his great astonishment, repulsed at every
point after several hours' hard fighting. In his rage, he wreaked
vengeance on the neutral residents who had trusted to the
peacefulness of their character or the protection of their government
rather than to the rifles of the filibuster garrison. The American
minister's house was assaulted, though unsuccessfully. Three of his
countrymen, a merchant and a couple of missionaries, were
murdered in cold blood. Padre Rossiter, the army chaplain, knew his
countrymen, and boldly took up a musket in defence of his life, as
did also Judge Basye of the Supreme Court. Honest Padre Vijil took a
middle course by discreetly flying to the swamp until the storm was
over. Nor did the civilizing mission of the worthy editor of El
Nicaraguense prevent him from seeking liberty under the sword. He
went back to his desk, the wiser for a broken thigh.

So for twenty-one long hours the siege lasted, while recruits flocked
to the side of the assailants, and the little garrison struggled bravely
against the fearful odds. To the threats and the promises, alike of
the enemy they returned but defiances and the cry, "Americans
never surrender!" Renegade Harper, acting as interpreter, assured
them that Walker had been annihilated at Masaya, and that Belloso,
with four thousand men, was on the road to Granada. No quarter
was the penalty if they delayed longer to surrender. But they did
delay. The hospital patients limped to the windows and rested their
rifles there. The women and children stood by to supply them with
cartridges. At night a courier was despatched in hot haste to
Masaya. Eluding the enemy's pickets, he made his way along the
road, only to meet the advance guard of Walker's returning forces.
The news of Zavala's movement had already reached Masaya,
putting the loyalty of an ambitious soldier to as severe a test as well
might be. To abandon his assured victory for the safety of a hundred
or two non-combatants was something of a sacrifice, but Walker did
not hesitate a moment. The sacred ties of comradeship were strong
in the hearts of those wild men, who, almost without awaiting the
word of command, took up the march for Granada.

In a few hours they arrived in the Jalteva, where they were

confronted and for a time repulsed by a strong battery placed to bar
the way, and well handled by the enemy. The advance guard fell
back, as well they might, for the position was skilfully chosen for the
defence of a narrow roadway. In the moment of confusion Walker
rode up, and pointing to the Lone Star flag which still floated over
the church, called for volunteers to succour their beleaguered
comrades. The response was a cheer and a fierce charge, led by the
commander in person, before which the enemy was scattered like
chaff. Following up this advantage, the Americans moved upon the
plaza before the church, where stood Zavala and his forces, now
themselves on the defensive. But the intrepid resistance of the
garrison, followed by the capture of the battery, had utterly
demoralized the Serviles, who scarcely struck a blow in their own
defence. In mad panic they fled through the city, only to be met in
the suburbs by a detachment placed to intercept them.

Barely half of Zavala's army escaped capture or death. Masaya had

not been taken, but Walker had achieved a greater victory and
inflicted a heavy loss upon the allies. Four hundred of them had
fallen in the battle of Masaya, and an equally large number was
supposed to have perished before Granada. Walker's loss was less
than a hundred killed and wounded in both engagements.
Lieutenant-colonel Lainé, a young Cuban aid of the general, was
made prisoner at Masaya and shot by his captors, who refused an
exchange. Walker was so incensed at this, that, in reprisal, he had
two of his prisoners, a colonel and a captain, shot next day, and sent
word to Belloso that a heavier reckoning would follow any future
acts of atrocity.

With those engagements active hostilities ended for a time. The

enemy grew more wary in his movements.
Civil government had not been neglected during the prosecution of
military enterprises. An elaborate revision of the constitution and
laws of the country was perfected; changes of a most serious nature
being introduced. Walker reviews with complacency the laws of his
government, especially those affecting the rights of property and the
more vital right of liberty. Whether we look with approval or blame
upon his course up to this point, it is impossible to excuse acts which
in his eyes were not only just but even praiseworthy. A law was
passed making "all documents connected with public affairs equally
valuable, whether written in Spanish or in English." The American
residents who knew both languages could here find an opportunity
of outwitting the natives with the purpose, which Walker commends,
of having the "ownership of the lands of the state fall into the hands
of those speaking English." To further the same end, the military
scrip of the republic was made receivable for Government lands sold
under forfeit. Still further to aid the same purpose, he passed a law
requiring a registry of all deeds; a thing heretofore unknown in the
country, as "it gave an advantage to those familiar with the habit of
registry." The Spaniards of California have had reason to regret that
familiarity in their American neighbours. There is no pretence in all
these acts of any higher or worthier purpose than that avowed by
their author, viz., the practical confiscation of the lands of the
Government for the benefit of his adherents. Finally, on the 22nd of
September, "the President of the Republic of Nicaragua, in virtue of
the power in him vested," decreed that "Inasmuch as the act of the
Constituent Assembly, decreed on the 30th of April, 1838, provides
that the Federal decrees given previous to that date shall remain in
force, unless contrary to the provisions of that Act; and inasmuch as
many of the decrees heretofore given are unsuited to the present
condition of the country, and are repugnant to its welfare and
prosperity as well as to its territorial integrity; therefore:—

"Article I. All acts and decrees of the Federal Constituent Assembly,

as well as of the Federal Congress are declared null and void.
"Article II. Nothing herein contained shall affect rights heretofore
vested under the acts and decrees hereby repealed."

The principal decree which this was intended to repeal was an Act of
the Federal Constituent Assembly of the 17th of April, 1824,
abolishing slavery and indemnifying the slave-owners in the then
confederated states of Central America.

Thus the institution of slavery, without any restriction, was

reimposed on Nicaragua. Walker, so far from denying that this was
the object of the decree, expressly avows it, saying, "By this Act
must the Walker administration be judged. If the slavery decree, as
it has been called, was unwise, Cabañas and Jerez were right when
they sought to use the Americans for the mere purpose of raising
one native faction and depressing another. Without such labour as
the new decree gave, the Americans could have played no other part
in Central America than that of the Pretorian guard at Rome or of
the Janizaries in the East, and for such degrading service as this
they were ill suited by the habits and traditions of their race." He
admits that annexation to the United States was no part of the
programme of the American adventurers in Nicaragua, knowing that
it could not be constitutionally effected after the passage of a slavery
law.

To-day it seems strange to read such arguments as Walker used to

defend the institution of slavery. But by the lurid light of his
sentences we can see something of the bitter conflict which then
raged between the friends and the enemies of slavery. His contempt
for the Abolitionist party speaks in every line, whilst his defence of
the now obsolete system of unspeakable wrong seems as puerile as
the solemnly sincere essays of a Mather on the evils of witchcraft.
He admires the "wisdom and excellence of the Divine economy in
the creation of the black race," and the providence of letting Africa
lie idle until the discovery of America gave a chance of utilizing the
raw material of slavery. No self-appointed theological dragoman to
the court of Heaven ever showed more readiness in interpreting the
sentiments of Providence than he does when he piously asks, "And
is it not thus that one race secures for itself liberty with order, while
it bestows on the other comfort and Christianity?"

Did the author of such views look at his subject through a moral
single-convex lens which presented every object inverted? Was he
colour-blind to right and wrong, or did he wilfully and deliberately
present the side which he knew to be ignoble and the opposite of
true? He was perfectly sincere. Walker was no worse, and no better,
than nine-tenths of his fellow citizens in the Southern States, who
honestly believed in the divine right of slave-holding, and testified to
their conviction by the willing sacrifice of their blood and treasure. A
wrong defeated, dead and buried, is a wrong which becomes visible
to the blindest eyes. Whether we, who pass prompt sentence on it,
might perceive its enormity so plainly, had the "leaded dice of war"
turned up differently, is a speculation as idle as any other on the
might-have-beens of history.

The severe punishment inflicted on the allies at Masaya and Granada

had the effect of keeping them for a time in check. A few days after
those engagements, Walker received a most valuable ally in the
person of General Charles Frederic Henningsen, an able officer, who
had seen service and achieved distinction in many lands.
 CHAPTER XIII

Henningsen — Early service with Zumalacarregui — Campaigning with

the Prophet of the Caucasus — Joins Kossuth — Arrival in
America — Omotepe — A gallant defence — Watters carries the
barricades.

H ENNINGSEN was born in Belgium, son of a Scandinavian officer

in the British service and his wife, an Irish lady. At the age of
nineteen he left his home to take service under Don Carlos, in 1834.
He was assigned to duty on the staff of the sturdy old partisan,
Zumalacarregui, from whose rough school of war he graduated with
the rank of colonel and an honour of nobility, the only rewards left in
the power of the Bourbon to bestow.

In one engagement he captured single-handed three cavalrymen

and their horses, and was the first man to enter Villa Real, after
chasing the enemy three leagues. For this he was offered the choice
of a commission as first lieutenant in the general's body guard or the
cross of St. Ferdinand. He chose the cross.

The Order of Isabella the Catholic was subsequently conferred on

him, with promotion, for his gallantry before Madrid, but a wound
received in the foot, which caused him much suffering and refused
to heal, compelled him to ask for sick leave. As he was with difficulty
wending his way homeward he was pursued by the enemy and
abandoned by his guide. After hiding for three days he was captured
and imprisoned with three other foreigners. Feigning an illness which
afterwards became real, he was removed to a hospital. The English
doctor in attendance knew only of the prisoner's feint and admired
the natural way in which the shivering fits were counterfeited. In
vain the patient, who was really ill, protested that he was so, until
after a time the truth of his assertion became apparent, for typhus
fever had declared itself and the doctor was, too late, convinced of
it. For twenty-one days Henningsen's life was despaired of, during
which time his friends interceded for him. His release was demanded
by the British Government, but General Espartero sternly refused it,
saying his life was forfeited, for he had both with his sword and pen
proved himself a dangerous foe. At the reiterated request of Lord
Palmerston, backed by the Duke of Wellington and others, Espartero,
however, was compelled to yield, as the withdrawal of the foreign
legion was threatened if he persisted in his refusal.

Henningsen, on his return to England, published a couple of volumes

of personal recollections, which still hold a place in literature. His
story was told in a simple and direct style, which showed marked
literary ability. But the world was then too full of doing, for an active
mind to content itself with thinking or saying. Schamyl the Prophet
had unfurled his sacred banner, lit the fires of revolution on the
Caucasus, and thrown the gage of battle to the mighty Czar himself.
His cause was just enough, his case was desperate enough, to enlist
the sympathies of the young knight-errant, who soon found himself
battling beside wild mountaineers in Caucasian snows, and
completing the education begun on the vine-clad hills of Spain. That
campaign over, he improved his leisure in writing two or three books
on Russian life, which increased his literary reputation without
inducing him to take up a life of letters. The restraints of civilisation
were too irksome, and he fled to the wilds of Asia Minor, where the
news of Hungary's revolt against Austrian and Russian despotism
found him. He arrived on the scene of action too late to take part in
anything but the sorrowful ending. Gorgey's treason, if such indeed
it were, had turned the scale against the patriots. Henningsen
submitted a plan of operations to Kossuth, who decided that it was
now too late for offensive action. All that remained was to offer his
sword to the forlorn hope. The offer was gladly accepted. He joined
Bem in the last ditch at Komorn, aiding not a little in the stout
defence of that place.

When the pitiful collapse came, Henningsen was one of the

chieftains who were outlawed and had a price set upon their heads.
He narrowly escaped capture and its inevitable consequence, death.
Once he was saved by the tact of a lady, a relative of Kossuth, who,
when the police were searching for a likeness of the fugitive, allowed
them to find a portrait of some stranger, upon which she had hastily
written the words, "From your friend, C. F. Henningsen." Being
questioned, she averred that the likeness was not Henningsen's, but
with so much apparent confusion as to make them disbelieve her.
Copies of it were accordingly printed and distributed with the hue
and cry, to the manifest benefit of the fugitive. Again, upon the very
border of Turkey, he was chased so closely by a party of Haynau's
bloodhound troops that capture seemed inevitable, and he had
prepared a dose of poison, which he always carried with him, to be
swallowed at the moment of arrest. His Caucasian experience had
taught him that mercy was not to be expected of Cossack victors.
More fortunate than many of his comrades, he managed to elude his
foes and escape across the boundary, to join Kossuth. With him he
crossed the Atlantic, never to return. In the United States he shared
the social and political distinction of his leader.

Henningsen at this period was thirty years old, tall and strikingly
handsome, with the polish and breeding of a man of the world and a
scholar. In Washington he met and loved a Southern belle, at the
time when Southern society ruled in the national capital. The lady,
who was a widow, was a niece of Senator Berrien of Georgia. She
returned his affection, and they were married after a brief courtship.

It was a critical period in American politics. It was the reign of King

Pierce the Irresolute, to be followed shortly by that of King
Buchanan the Unready. Henningsen by his matrimonial alliance was
thrown into the society of those who favoured slavery, wherein he
imbibed opinions in harmony with the upholders of that institution.
The adherents of slavery felt that in the political field they were
fighting a losing battle. The more farsighted saw that the success of
their cause could be promoted only by "extending the area of
freedom," as they phrased it. Thus the filibusters acquired new
importance in the eyes of friend and of foe at home.

Henningsen's wife, with the spirit of a Roman matron, acquiesced

heroically when her knight volunteered to go forth and do battle for
a cause which would have won his sympathy for its very danger
alone. His reputation as a soldier was well established. He had
introduced the Miniê rifle into the United States service, and was an
authority upon his speciality, the use of artillery. Nor did he come
empty-handed to Nicaragua; but brought with him military stores,
arms, and ammunition, to the value of thirty thousand dollars, the
contribution of himself and his wife, besides an equally liberal
offering from George Law and other sympathizers with the cause.
Walker immediately placed him on active service, with the rank of
brigadier-general.

Henningsen had scarcely assumed his command before he was sent

to clear the Transit road of marauding bands of Costa Ricans, a large
body of whom had landed at San Juan del Sur, under General Cañas.
Henningsen scattered them promptly, and admitted a force of
recruits from California, who had arrived on the steamer Cortes. The
reappearance of the Costa Ricans on the Transit was too dangerous
a menace to the communication with the United States, however;
and Walker saw that to preserve his base of supplies, and at the
same time to garrison the large city of Granada, was a task too
serious for his slender forces. But as he did not wish to let the latter
important stronghold fall into hostile hands, with the moral and
material benefits accruing from the possession of the seat of
government, he resolved to destroy the city. Previous to evacuating
Granada he made another attack on Masaya, in order that the
enemy might remain on the defensive and not suspect his intended
movement of retreat southward. A trifling engagement took place, in
which the artillery was well handled. On the 19th of November the
sick and wounded were transported in the lake steamer to the island
of Omotepe, where they were placed in charge of Colonel Fry and a
corps of medical attendants.

This island is one of the healthiest places in the country, being a

volcanic upheaval, with a mountain towering from its centre to a
height of five thousand feet. A few families of native Indian
fishermen, rude and savage, are its only inhabitants, and their frail
huts dot the margin of the lake. In the interior a dense jungle bars
the road to the mountain top. The rank growth of the tropics hides
the ruined monuments of a civilization which preceded Conquistador
and Aztec. The traveller who cuts his way through the rank
vegetation finds himself, here and there, in the presence of quaintly
sculptured, hideous idols overturned. In remoter nooks, whither his
Indian guide cares not to lead him, he would see the gods whom the
Christians threw down, reinstated on their pedestals; and the good
folk of Granada say in whispers, that thither, at stated times, flock
silent, dusky worshippers, to offer up unholy rites and pray for the
return of the gods of their fathers, who fed on human victims, and
spoke to their people in the awful accents of the volcano. Little knew
or recked the bold filibusters, quarantined beneath the frowning
peak of Omotepe, of the alleged idolatrous practices or the evil
repute in which the islanders were held by their mainland neighbors.
They nursed their wounds with scant patience, recovered, and
sought a chance to get new ones, or died and were forgotten, as
though their passports to the realm of Death had been viséd by the
most legitimate of all lawful war-makers.

Walker, having entrusted to Henningsen the duty of destroying

Granada, set out for Rivas. Upon his departure, many of the men
and some of the officers, feeling that the severe restraints of
discipline were withdrawn, plunged into a wild debauch.
Henningsen, with the aid of such as were in decent condition, began
the work of firing the town. As the smoke of the burning houses
arose in the air the enemy's pickets saw and reported it to General
Belloso, who rightly surmised the cause and ordered an immediate
attack. The miserable debauchees awoke from their stupor to find
that they had aroused a formidable foe. Five thousand furious
Serviles were pouring into the city, and had already secured a strong
strategic point in the church of the Guadaloupe, whence their
sharpshooters were keeping in play the useful men whom
Henningsen could gather about him.

Under a fierce fire Henningsen continued the work of destruction

until almost the entire town was reduced to ashes. His position,
encumbered as he was with sick and wounded, was so perilous that
he determined to capture the Guadaloupe church at any cost, as
that important position commanded the passage to the lake. That
end was not attained without the loss of many valuable lives and
two days of hard fighting. Finally, on the 27th of November, the
church was carried by assault, and all the American force, with their
supplies, ammunition, and non-combatants, were safely transferred
to the new quarters. A guard of thirty men, detailed to protect the
wharf on the lake, three miles away, had been betrayed and
captured two days before. Henningsen, in order to secure
communication with the lake, began throwing up a line of
earthworks along the whole distance, the enemy contesting every
inch of the road. To keep the latter in check, Captain Swingle and his
howitzers were employed night and day. When ammunition ran short
the ingenious gunner made balls from scraps of iron piled in a mould
of clay and soldered together with lead.

As soon as they had effected communication with some adobe huts

half way to the lake, Henningsen removed the sick and wounded to
the more healthful land near the water. It was none too soon, for
over a hundred men had perished from the ravages of cholera and
typhus in the crowded quarters of the Guadaloupe. Lieutenant
Sumpter with seventy men was left to garrison the church.
Meanwhile the enemy had not been idle; they had thrown up
earthworks between the lake and Henningsen's defences, and
gathered a strong force to prevent the advance of relief from that
direction.

For three weeks the unequal fight lasted, until of the four hundred
men who had remained to burn Granada, less than one hundred and
fifty answered to the roll-call on the 13th of December. To Zavala's
demand for their surrender Henningsen sent back word that he
would parley only at the cannon's mouth. Their position,
nevertheless, was so critical that many of the men talked openly of
forsaking their helpless comrades and cutting their way to the lake.
Finding that the first sign of such a proceeding would be greeted
with a volley of grape, for Henningsen had learned from his chief the
way to deal with insubordination, a few of the malcontents deserted
to the enemy. The rest imitated the heroic fortitude of their officers,
and all shared together their sorry rations of mule and horse meat
as long as they lasted. That was not long; they had reached the limit
of their supplies on the 12th of December, and Henningsen sent a
message to Walker begging immediate relief. A native boy of the
Sandwich Islands, who had come to Nicaragua on the Vesta, and
who was known in the army as "Kanaka John," volunteered to carry
the note. It was given to him sealed and enclosed in a bottle. The
boy made his way unperceived through the enemy's lines, and
reached the water in time to see the lake steamer, La Virgen, lying
beyond the line of surf, with lights shrouded and not a sign of life on
board. The amphibious Kanaka swam out and boarded the steamer,
where he found Walker and three or four hundred new recruits from
the States.

Colonel John Watters, with a hundred and sixty men, was at once
ordered to relieve the beleaguered force under Henningsen. Watters
on landing was met by a stout resistance from a large body of Allies
guarding the wharf and adjacent earthworks; but the Californians
rushed upon the barricade with a yell and carried it by storm.
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