Bureaucracy as Myth
The Institutionalization of Rationalized Rituals
Reading Length: 15 Minutes
Keywords: Sociology, Organizational Theory
In contemporary society there are two questions that immediately present themselves to students of organizations: (1) why is the corporation so prevalent, and (2) why do all these corporations so closely resemble each other?
The corporation is so commonplace in today’s society that we barely even second-guess the social existence of these organizations. What’s more, corporations all share similar structures: from a hierarchy of front-line manager to middle-management to executive suite to advisory board, and departmentalized into functions like marketing, sales, and finance. Roles have similar titles like vice president, similar hiring practices, and even similar offices and the concomitant office drama.
That is not to say that the firm is underanalyzed in academia. Historians write about the onset of the corporate firm, economists come up with explanations as to why the firm exists, and sociologists question the ramifications of living in an incorporated society. The firm is perhaps the most studied entity in the entirety of academia. But this was not always the case.
An economist named Ronald Coase ignited interest in the study of the firm with his seminal 1937 paper The Nature of the Firm.1 Even before 1937, Frank Knight speculated on the rationale of the firm in his legendary 1921 work Risk, Uncertainty, and Profit.
Going back even further to the 1700s, Adam Smith casted skepticism on the relatively newfangled ‘joint-stock companies’ of his day:
That a joint stock company should be able to carry on successfully any branch of foreign trade, when private adventurers can come into any sort of pen and fair competition with them, seems contrary to all experience.
Smith believed that the joint-stock companies could out-compete private individuals in only a few industries:
The only trades which it seems possible for a joint stock company to carry on successfully, without an exclusive privilege, are those, of which all the operations are capable of being reduced to what is called a routine, or to such a uniformity of method as admits of little or no variation. Of this kind is, first, the banking trade; secondly, the trade of insurance from fire, and from sea risk and capture in time of war; thirdly, the trade of making and maintaining a navigable cut or canal; and, fourthly, the similar trade of bringing water for the supply of a great city.
Smith believed that the joint-stock company was largely inferior because of what we would today call agency costs. The joint-stock owners (the shareholders) are too far removed from the technical knowledge and know-how necessary to properly run the businesses. Furthermore, the executives hired by the owners to run the company do not have aligned incentives to run it properly and will be negligent in certain aspects:
The trade of a joint stock company is always managed by a court of directors [board of advisors]. This court, indeed, is frequently subject, in many respects, to the control of a general court of proprietors. But the greater part of those proprietors seldom pretend to understand anything of the business of the company, and when the spirit of faction happens not to prevail among them, give themselves no trouble about it, but receive contentedly such half-yearly or yearly dividend as the directors think proper to make to them. This total exemption from trouble and from risk, beyond a limited sum, encourages many people to become adventurers [shareholders] in joint stock companies, who would, upon no account, hazard their fortunes in any private copartnery [a private partnership]…
The directors of such 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 copartnery 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 profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company. [emphasis added]
It is striking that Smith anticipates the sophisticated arguments theorized by Jensen and Meckling hundreds of years later in their influential book Theory of the Firm. Adam Smith, however, could not have been more wrong that joint-stock companies could not successfully compete with private individuals.2 The past few centuries of economic history has seen the domination of the corporate form.
Since Smith, economists switched from doubting corporations to trying to explain why they are so successful. Coase argued that firms are created because market transactions are too costly to simply contract out every business function. Knight argued that firms exist as a risk-bearing and risk-spreading mechanism, because the future is too uncertain. From there, theories abound to asset specificity, knowledge specificity, contractual arbitrage, team-based production, and more.3
What these economists all implicitly assume, however, is that corporations exist because they are economically efficient, and it is just a matter of explaining why they are efficient. The presupposed efficiency of corporations might strike the everyday observer as fanciful, considering the bureaucratic waste, convoluted procedures, and deadening rules that afflict virtually every firm. This presents a challenge: any theory of the firm based upon efficiency arguments must also be able to explain why firms are so often inefficient.
Sociology and the Theory of the Firm
The introduction of inefficiency rather than efficiency sets the stage for a sociological explanation rather than an economic one.4 Whereas economists search for reasons why firms are superior means of organizing and producing assets, sociologists are in no ways bound likewise and can deviate from such means. What would this look like?
The sociologists John Meyer and Brian Rowan took the seeming irrationality and inefficiencies of the firm as the jumping off point for their 1977 paper:
…rules are often violated, decisions are often unimplemented, or if implemented have uncertain consequences, technologies are of problematic efficiency, and evaluation and inspection systems are subverted or rendered so vague as to provide little coordination.5
The pair of sociologists call this phenomena decoupling:
…formal organizations are often loosely coupled: structural elements are only loosely linked toe ach other and to activities…
In other words, there is decoupling when the rules and procedures of an organization are not followed. The activities (day-to-day work) of the employees are in contradiction with the structural elements (rules and procedures) of the firm.
If an organization is decoupled, the actual productive work takes place on an informal level:
Thus, decoupling enables organizations to maintain standardized, legitimating, formal structures while their activities vary in response to practical considerations.
The activities of employees are now in contrast to, and often in conflict with the formal rules of the organization:
The ability to coordinate things in violation of the rules—that is, to get alone with other people—is highly valued.
The idea that formal rules are actually an obstacle to productive work will be familiar to virtually anyone that has worked in a large organization. There are entire books dedicated to the art of circumventing corporate rules while still maintaining a good reputation:
While decoupling nicely highlights the ways in which firms act inefficiently, it still has not been explained why firms would decouple in the first place.
Myth and Legitimacy
We now have the problem of the firm on two levels now: (1) why is the firm so popular as a method of organization, and (2) why is the firm inefficient in so many different ways?
A solution that could answer both these questions while at the same time reconciling them would provide a novel contribution to the theory of the firm. These two questions must be reconciled because it is striking (especially to the economist) that the firm is so popular despite its inefficiencies.
A starting point to find such a solution would be to notice that in a decoupled firm, the formal procedures have become ritualized. In a ritual, it is the process itself that matters - not the outcome. Identically, we could also say the rules exist purely for ceremony’s sake. Whether we use the language of ritual or ceremony, we are now presented with a desideratum of a founding myth. There must be some original reason that these rituals were formalized into the firm; this original reason is the myth.
So why do firms institutionalize rituals that are decoupled from the productive process? Meyer and Rowan argue that these structural elements confer legitimacy upon firms. What does this look like?
Let’s imagine that you are an entrepreneur starting up a new firm. As the majority owner, you have complete discretion as to how you can set up the firm. You can choose the entity structure as LLC, LLP, or any of the many options available.6 You can choose how to departmentalize the organizational structure, for example by sales, marketing, finance, operations etc. You can choose how many levels of bureaucracy and management to incorporate, and what those titles will be. The important point is that at the outset, you can choose which, if any, rules and procedures to formalize into your firm.
As noted earlier, traditional economic theory predicts that the entrepreneur would choose structural elements that are most conducive to efficient production of assets. But this immediately implies that decoupling would not happen: if the structural elements were efficient, it would not make sense to deviate from them, so something is amiss. What else would our hypothetical entrepreneur consider when setting up the firm besides profit maximization via efficiency?
Obviously there are a number of constraints that bear upon the entrepreneur in the context of the surrounding environment. The entrepreneur may need to acquire financing from a bank or investors, will most likely need to hire employees, get approved for government permits, and procure contracts with third-party vendors. Thus there will need to be a certain degree of acceptance or harmony between the new firm and the surrounding social network of financiers, potential employees, and other firms. This degree of harmony will be called legitimacy.
Clearly if the firm is not seen as legitimate it will struggle to attract the resources it needs to be successful. As Meyer and Rowan see it, this legitimacy constraint is the pivotal consideration that leads to bureaucratic mythmaking. Why?
Isomorphism and Resources
What is the easiest way for a firm to appear legitimate? If there are already successful firms in the industry whose legitimacy is not in doubt, then a simple strategy would be to imitate these firms. If a firm has already achieved success with a certain corporate structure, then there is at least some evidence that the structure would not doom the firm to failure.
The authors put some meat on this theory by explaining:
Employees, applicants, managers, trustees, and governmental agencies are predisposed to trust the hiring practices of organizations that follow legitimated procedures—such as equal opportunity programs, or personality testing—and they are more willing to participate in or to fund such organizations. On the other hand, organizations that omit environmentally legitimated elements of structure or create unique structures lack acceptable legitimated accounts of their activities. Such organizations are more vulnerable to claims that they are negligent, irrational, or unnecessary.
If a firm is more likely to be accepted if it follows a certain structure, then it is obvious they will accrue more advantages:
At the same time, these myths present organizations with great opportunities for expansion. Affixing the right labels to activities can change them into valuable services and mobilize the commitments of internal participants and external constituents.
What exactly does it mean if the ‘commitments of internal participants and external constituents’ are mobilized?
The incorporation of structures with high ceremonial value, such as those reflecting the latest expert thinking or those with the most prestige, makes the credit position of an organization more favorable. Loans, donations, or investments are more easily obtained
Put simply, firms imitate formal rules and procedures because it will help them obtain resources. We now have a solution that answers both problems previously posed: (1) entrepreneurs set up firms to establish legitimacy, and (2) firms become decoupled because the formal procedures exist for legitimacy’s sake, not for the productive process.
Meyer and Rowan summarize:
Thus, organizational success depends on factors other than efficient coordination and control of productive activities. Independent of their productive efficiency, organizations which exist in highly elaborated institutional environments and succeed in be coming isomorphic with these environments gain the legitimacy and resources needed to survive. [emphasis added]
What does it mean if a firm becomes isomorphic? Isomorphism is the tendency for firms to resemble their environments. If firms face similar environments, then firms will end up looking similar. In this case, the legitimacy-granting feature of bureaucratic myths explains why firms isomorphically adapt.
Carrying on the Myth
Why do firms not drop the pretense of formal procedures after gaining legitimacy and success? If contextual constraints persist, then we would not expect this to happen. Large firms must stay legitimate in the eyes of shareholders, debtholders, politicians, and other important stakeholders. Therefore the myths must be upheld.
Institutionalized organizations must not only conform to myths but must also maintain the appearance that the myths actually work.
How can the myths be upheld if they are obviously inefficient? One strategy is to ceremonialize inspections and audits so that they still happen, but always ineffectually:
Institutionalized organizations protect their formal structures from evaluation on the basis of technical performance: inspection, evaluation, and control of activities are minimized, and coordination, interdependence, and mutual adjustments among structural units are handled informally.
Integration is avoided, program implementation is neglected, and inspec tion and evaluation are ceremonialized.
In this light, it is not surprising that firms are so bad at carrying out their own formal procedures. In fact, that is the point. If formal procedures were properly carried out, the decoupled structure would be exposed and the myth ruined.
Furthermore, the lens of legitimacy explains why firms are often so confoundingly inefficient:
…expensive technologies, which bring prestige to hospitals and business firms, may be simply excessive costs from the point of view of immediate production. Similarly, highly professionalized consultants who bring external blessings on an organization are often difficult to justify in terms of improved productivity, yet may be very important in maintaining internal and external legitimacy.
We now have a theory that explains:
why firms are so common
why firms resemble each-other so closely
why firms are so obviously inefficient
But there is one issue left. If firms are indeed ignoring technical efficiency for the benefit of legitimacy, economists would argue that this presents an opportunity for entrepreneurs to ignore or find a why around these legitimacy constraints to outperform legacy firms. In other words, there is a tradeoff between internal coordination (of productive assets) and legitimacy. Shouldn’t we expect firms to try to innovate and discover new, more efficient formal procedures?
Innovation and Bureaucracy
Returning to the argument of contextual isomorphism, firms will imitate other firms that are already successful in their industry. But what if they are in a brand new industry and there are no other firms to copy? According to the theory, we should expect that entrepreneurs are more willing to innovate in this specific context.
Considering the case of Silicon Valley, this is exactly what we expect. New technology firms are seemingly much more willing to deviate from bureaucratic myths than firms in traditional industries. It is not uncommon to hear about a startup with a ‘flat’ hierarchy (no middle-management), and many technology firms were experimenting with remote work years before the COVID pandemic.
To highlight one example, the online shoe-selling firm Zappos is famous for its innovative organizational structure. In their words they practice ‘holacracy’ instead of hierarchy.7
To take another example, Google gained notoriety for flouting the traditional rules of bureaucracy. Most dramatically, reporting managers are not allowed to make hiring or promotion decisions.8 Less dramatically, they eschewed the standard department name of Human Relations/Resources and call it ‘People Operations’.
It could be argued that the stakeholders of Silicon Valley startups, venture capital firms instead of traditional banks and hedge fund shareholders, are much more tolerant of structural innovation. Therefore the legitimacy-granting benefit of bureaucratic mythmaking is greatly reduced. Additionally, early adopter consumers are by nature more tolerant of experimentation and innovation, while the labor pool of potential employees is also more risk-seeking.
Following this line of thought, it could be argued that as startup firms mature they will be under increasing pressure to adopt bureaucratic myths as their set of stakeholders changes from venture capital firms and early adopters to the traditional set of Wall Street stakeholders. The ridesharing company Uber suffered from problems of legitimacy as they went public and underwent a serious reworking of their structural elements to adjust.9
This suggests a progressive dynamic of maturity and legitimacy. As companies become larger, the importance of legitimacy actually increases because there is less tolerance for deviation and more risk to the downside. It is not surprising then, that the executives of large companies are referred to as ‘figureheads’ that merely represent the face of the company to outsiders rather than being intimately involved in the production of goods.
The idea here is that the more highly institutionalized the environment, the more time and energy organizational elites devote to managing their organization's public image and status and the less they devote to coordination and to managing particular boundary-spanning relationships. Further, the argument is that in such contexts managers devote more time to articulating internal structures and relationships at an abstract or ritual level, in contrast to managing particular relationships among activities and interdependencies.
Conclusion
Although the authors are sociologists, it is important to stress that this is not a theory of irrationality. Entrepreneurs are not working against their own interests by following these myths. They are maximizing their chances of survival by conferring legitimacy on their firms, even if they have to decouple the productive processes from the formal procedures.
Where the theory deviates from traditional economic orthodoxy is not in the assumption of rationality, but in the idea that entrepreneurs and managers are making decisions divorced from the efficiency of the productive process.
In this sense, Meyer and Rowan present a powerful argument that contributes to the theory of the firm in an original way. They do not buttress their argument with any empirical data, but they do point towards some potential experiments that could be conducted:
Experimentally, one could study the size of the loans banks would be willing to provide organizations which vary only in (1) the degree of environ mental institutionalization, and (2) the degree to which the organization structurally incorporates environmental institution.
Experimentally, the time and energy allocations proposed by managers presented with differently described environments could be studied. Do managers, presented with the description of an elaborately institutionalized environment, propose to spend more energy maintaining ritual isomorphism and less on monitoring internal conformity? Do they tend to become in attentive to evaluation? Do they elaborate doctrines of professionalism and good faith?
To my knowledge these experiments have never been carried out, which may explain why so many are still mystified and frustrated by the the institutionalization of rationalized rituals that pervade bureaucratic organizations.
It took a number of decades, however, for scholars to reflect and build upon the paper; it was not immediately influential.
Some scholars defend Smith, arguing that his argument held true for the 18th century and was economically sound. See, for example: Fleckner, 2016, ‘Adam Smith on the Joint Stock Company’ or Anderson & Tollison, 1982, ‘Adam Smith’s Analysis of Joint-Stock Companies’.
For a critical collection of theories of the firm, see Foss’s 2000 book The Theory of the Firm Critical Perspectives on Business and Management, although it is out of print.
Max Weber, the father of socialism, was fascinated by the firm and bureaucracy. Both were a regular topic of his studies throughout his career. See for example, ‘Weber's Last Theory of the Modern Business Enterprise’ by Søren Jagd, 2002. Frank Knight, mentioned at the beginning of the article, was heavily inspired by Weber.
John W. Meyer, Brian Rowan, ‘Institutionalized Organizations: Formal Structure as Myth and Ceremony’, 1977.
The IRS lists 7 broad business structures to choose from, although some states include more. https://www.sba.gov/business-guide/launch-your-business/choose-business-structure
https://www.zappos.com/about/how-we-work
Note that Zappos is actually headquartered out of Las Vegas, Nevada - not Silicon Valley. However, Zappos has been owned by Amazon since 2009.
For more on Google’s unique culture, see the book Work Rules!
https://topicinsights.com/leadership-management/how-uber-tainted-leadership-compromised-its-ipo/#:~:text=In%20recent%20years%20and%20under,departure%20of%20some%20of%20the
The former CEO and founder also faced complaints of sexual harassment, so the argument is not as simple or clean.