jibskamran: October 2008

Crossing the Threshold from Founder
Management to Professional Management:
A Governance Perspective
Eric Gedajlovic, Michael H. Lubatkin and
William S. Schulze
University of Connecticut School of Business; University of Connecticut and EM Lyon School of
Business; Case Western Reserve University, Weatherhead School of Management, Cleveland
 We argue that the challenges faced by threshold firms are deeply rooted
in governance characteristics (i.e. the incentives, authority and legitimacy) which
imbue them with characteristic capabilities, disabilities and path dependencies.
Whereas Zahra and Filatotchev (2004) reason the principal problem facing threshold
firms relates to organizational learning and knowledge management, we posit
resource acquisition and utilization to be equally important. Moreover, we argue
governance theory is more able than a knowledge-based perspective to explain the
root causes of the learning and resource issues faced by threshold firms as well as the
complex set of processes involved in their effective management.
INTRODUCTION
Around the globe, over history, and across diverse social contexts, foundermanaged
firms (FMFs) have functioned as a primary engine of economic development
and growth. While FMFs often fail at a relatively young age, many of those
that survive seem to hit a juncture in their evolution at which stagnation sets in
and their resources are no longer able to support their growth opportunities. Daily
and Dalton (1992) refer to firms at this defining moment in their evolution as
‘threshold firms’. They argue that in order to obtain the resources needed to
surmount this threshold, founders must cede control to professional managers.
Journal of Management Studies 41:5 July 2004
0022-2380
© Blackwell Publishing Ltd 2004. Published by Blackwell Publishing, 9600 Garsington Road, Oxford, OX4 2DQ,
UK and 350 Main Street, Malden, MA 02148, USA.
Address for reprints: Eric Gedajlovic, University of Connecticut, School of Business; Management
Department, 2100 Hillside Road Unit 1041, Storrs, CT 06269-1041, USA (egedajlovic@
business.uconn.edu).
They also suggest that most threshold FMFs are incapable of successfully negotiating
this transition.
What is not well understood, however, is why these events occur. In a companion
paper, Zahra and Filatotchev (2004) offer an explanation based on a
knowledge-based perspective. We, on the other hand, use a variant of governance
theory drawn from Carney and Gedajlovic (2003), which defines governance, not
only in terms of incentives, as do agency theorists, but also in terms of authority
structures and norms of legitimacy. We argue that such a theory of governance
can shed important light on how knowledge and capabilities develop in FMFs. We
also discuss how governance theory provides insights regarding the evolutionary
processes by which FMFs are born, fit (or misfit) their environment, approach their
threshold, and attempt to cross over to become a Professional-Managed Firm
(PMF), as well as the path dependencies that inhibit this transformation.
Whereas Zahra and Filatotchev reason the principal problem facing threshold
firms has to do with organizational learning and knowledge management, we posit
resource acquisition and utilization to be at least as important a problem. Moreover,
we argue that governance theory is more able than a knowledge-based
perspective to explain the root causes of the learning and resource issues faced by
threshold firms as well as the complex set of processes involved in their effective
management.
We proceed by first describing how founder-management imbues FMFs with a
particular blend of incentives, authority relations, and norms of legitimacy that
makes this governance form particularly well-suited for growth and survival in
nascent and/or fragmented and heterogeneous markets. Next, we discuss how this
blend of incentives, authority and legitimacy interacts with the external environment
to affect the nature and pace of learning and capability development within
the FMF. Specifically, we reason that FMFs are more likely to be born and prosper
when the environment they face is low in munificence and complexity, but high in
dynamism. We then describe why successful FMFs tend to reach a knowledge and
resource crisis as organizational and ecological evolutionary forces propel them
into environments that become increasingly munificent, complex, and stable –
conditions that FMF governance leaves them poorly equipped to deal with. We
explain that to successfully surmount this crisis, underlying governance problems
must first be addressed and then attention must turn to the legacies of foundermanagement
that are embedded in the firm’s resources, processes, values and
culture (Christensen and Overdorf, 2000). We conclude by discussing our paper’s
theoretical and managerial implications, points of intersection with Zahra and
Filatotchev’s paper, and offer some general comments regarding the potential contribution
of governance theory to organizational analysis.
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GOVERNANCE AND THE PRE-THRESHOLD
FOUNDER-MANAGED FIRM
Alchian and Demsetz (1972), Jensen and Meckling (1976) and Fama and Jensen
(1983) each contributed seminal insights that put the economic incentives of FMFs
under the microscope. That these agency theorists chose to ground their theory
on the case of the FMF suggests the quintessential character of this governance
form. However, their analysis of firm governance, which reduces relationships
within firms to simple dyadic principal-agent relationships between economically
rational and motivated actors, offers an arid and superficial portrayal of the FMF.
And, while this reduction may be theoretically elegant and parsimonious, it
seriously underspecifies what organizations and their actors are about. Although
incentives may play a role in defining and motivating self-interested behaviour, not
all conduct can be properly characterized as such (Becker, 1981; Kahneman and
Tversky, 1979). Moreover, a singular focus on incentives ignores important
sociopolitical factors that affect the probability that particular individuals, or
groups of individuals will engage in self-interested pursuits (Granovetter, 1985;
Lubatkin et al., 2004). Such limitations raise serious concerns regarding the usefulness
of agency theory and its conceptualization of corporate governance for
management theory and practice.
In this section, we propose that a more fully specified treatment of FMF governance
and its influence on organizational learning and capability development
requires a consideration of not only incentives, but also the character of authority
relationships and norms of legitimacy that prevail in FMFs (Carney and
Gedajlovic, 2003).
Applying this governance view, our initial argument is that because authority
in FMFs is largely conditioned by the coupling of ownership and control in the
hands of the founder, it tends to be highly centralized and vested in that
person. The founder, therefore, has the largely unchallenged discretion to
share (or not share) authority with family members and a few trusted associates.
Moreover, the strategic, organizational and resource allocation decisions of
owner-managers in FMFs have the inherent legitimacy afforded the owners
of private property. In contrast, authority in firms managed by professional,
salaried managers is generally widely diffused across a managerial hierarchy
and is vested in the position, or function, not the individual. Managers in such
PMFs hold fiduciary powers ‘in trust’ and must justify decisions in terms of
their impact on the welfare of others. In the remainder of this section, we
describe how the system of incentives, authority relations and norms of
legitimacy inherent to FMF governance provides these firms with advantages
and disadvantages that are manifest in characteristic capabilities and
disabilities.
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FMF Governance and Capabilities
Founders are individuals who demonstrate the alertness, character and temperament
needed to exploit a discovered opportunity (Kirzner, 1985). Founders are also
the source of at least some of the firm’s initial equity capital, typically provide
labour and technical expertise, and hold the decision rights afforded top managers.
The coupling of ownership and control grants founders the classic property rights
of usus (the right to use one’s property as one sees fit), abusus (the right to alter,
modify, or destroy one’s property) and usus fructus (the right to the profit generated
by the asset). Because of the concentration of these rights in the hands of the
founder, authority in FMFs tends to be highly centralized and vested in that person.
The founder, therefore, has the largely unchallenged discretion to share (or not
share) authority with family members and trusted associates. Moreover, the
strategic, organizational and resource allocation decisions of owner-managers in
FMFs have the inherent legitimacy afforded the owners of private property. In
contrast, authority in PMFs is generally widely diffused across a managerial hierarchy
and vested in the position, or function, not the individual. In this regard,
managers in PMFs hold fiduciary powers ‘in trust’ and must justify their decisions
in terms of their impact on the welfare of others.
A consequence of this concentration of power is that founders have the ability,
and the incentive, to pursue options that they perceive as ‘first best’ in terms of
their personal (subjective) utility. This helps explain why FMFs tend to strongly
reflect the expertise and personality of their founder (Miller et al., 1982), which
itself is the product of a multitude of background (informal) institutional influences,
including their upbringing, education, social contacts, cultural heritage and
work experience. In this regard, the nascent FMF is very much an incarnation of
its founder and has the essential character of a ‘tool’, or ‘goal-attainment’ device
for the advancement of the founder’s particular goals (Selznick, 1957). The result
is that the decisions reached and the strategies pursued by FMFs are often highly
idiosyncratic.
Idiosyncratic strategies and their strong reliance on their founder for critical
resources make FMFs highly prone to failure. On the other hand, such idiosyncrasy
may spark the discovery of truly de novo opportunities and frame-breaking
innovations. Moreover, the wide discretion afforded the founder facilitates dealmaking
and promotes the organizational agility necessary to exploit unrecognized
niches and address unmet market needs. Said differently, the governance structure
of nascent FMFs can facilitate their identification and pursuit of entrepreneurial
opportunities (Shane and Venkataraman, 2000).
A second source of FMF advantage stems from the fact that its governance
structure provides strong incentives for efficiency and parsimony (Brickley and
Dark, 1987). In contrast to public corporations, which use widespread shareholding
to diversify risk and raise capital, founders are generally unwilling, or at least
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highly reluctant to reduce their control (i.e., their ownership stake) in the firm.
This constraint makes them highly reliant on retained earnings and organic growth
for capital investment (Carney and Gedajlovic, 2002a). Founders thus have strong
incentives to maintain efficiency in their operations and be parsimonious in their
use of capital.
A third source of advantage is rooted in the veil of secrecy that FMF governance
provides. While founders of nascent FMFs must bear the consequences of their
actions, they rarely need to justify, or expose their decisions to the scrutiny of others,
nor need they disclose the terms and conditions of the deals they make with business
partners and suppliers and buyers of resources. This veil can be a benefit in
circumstances where the terms of exchange are potentially controversial, such as
when deals need to be cut with gatekeepers in emerging markets, or when decisions
are made to shed and/or re-deploy firm resources from an existing activity to newer,
and perhaps less legitimate economic pursuits. These properties also allow the FMF
to operate effectively in environments where property rights and formal contacts
are difficult to specify or enforce (Khanna and Palepu, 1997).
Viewed collectively, these three sources of advantage point to a relationship
between governance (i.e., incentives, authority structure and norms of legitimacy)
within FMFs, and the development of interstitial capabilities – the ability to generate
rents by filling market and institutional niches left unrecognized and/or unexploited
by other forms of business enterprise. Such interstitial capabilities can take
a variety of forms. For instance, as described above, FMFs are effective at perceiving
market opportunities others miss, and entering into relational contracts,
for which firms conditioned by other forms of governance are ill suited. Their tendency
towards parsimony and their personal character also allows FMFs to operate
profitably in market niches and institutional contexts that are inhospitable to other
types of firms.
FMF Governance and Disabilities
While the governance structure of FMFs may engender advantages that make
them capable of entering and competing in marketplaces in ways that widely-held
PMFs may find difficult, these advantages come bundled with offsetting and sometimes
toxic disabilities that tend to accumulate over time. We say this for five
reasons. First, the nascent FMF is overly dependent on its founder, which makes
it highly prone to failure and can cause key stakeholders to discount the firm’s
legitimacy. Aldrich and Fiol (1994), for example, note that nascent ventures may
lack both cognitive or sociopolitical legitimacy needed to secure cooperative ties
with key stakeholders in the firm’s factor (e.g., capable employees and resources),
product (e.g., distribution channels), or capital markets. Legitimacy deficits, it
follows, can engender resource deficits in FMFs and result in the types of strategic
learning difficulties described by Zahra and Filatotchev (2004).
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Second, these resource and learning problems are exacerbated by the fact that
FMF equity shares are privately held. Private ownership not only makes capital
more costly (due to liquidity and other risks of investment), but also isolates the
FMF from the monitoring and disciplinary influence that external capital markets
provide. This increases the odds that the founder may make decisions that
inadvertently compromise the firm’s long-term viability. Private ownership also
promotes risk avoidance, because founders tend to have most of their wealth
invested in the firm and so bear the full financial burden of failed investments.
Third, the governance structure of FMFs makes their founders vulnerable to
self-control problems. These problems, which Thaler and Shefrin (1981) call
‘agency problems with oneself,’ are especially potent in FMFs because founders
have the authority and legitimacy to pursue options they perceive to be ‘first best’
in terms of their subjective utility. The problem, of course, is that absent the need
to justify their decisions in terms of their impact on the welfare of others, founders
may occasionally do as they wish as opposed to doing what they should. The risk
that the founder may make strategic decisions that promote their personal utility
at the expense of others exposes both existing and potential stakeholders to risks
of expropriation (Morck, 1996), or to what Perrow (1986) calls ‘owner opportunism’.
As suggested by Adams’ (1963) equity theory, Barnard’s (1938) theory of
inducements-contributions and Rousseau’s (1995) notion of psychological contracts,
such actions may lead key stakeholders (e.g., employees, suppliers, financiers)
to avoid making relationship-specific investments in resources and processes and
can lead them to withhold required capital, effort and valued information.
Such dynamics may result in FMFs being faced with serious resource constraints
and can constitute a formidable impediment to broad-based organizational
learning.
Fourth, private ownership and the threat of self-control problems may combine
to make it difficult for the FMF to match the terms of employment offered by
other types of firms. Founders tend to be possessive of their property rights and
thus are hesitant or unwilling to dilute their control of the firm to outsiders. Consequently,
they are less able and likely to use stock and stock options as compensation,
a factor that limits the FMF’s ability to compete in certain labour markets
(Morck, 1996). FMFs may thus have difficulty hiring and retaining high quality
employees and managers, which can result in a significant human resource deficit
(Carney, 1998).
Finally, to the extent that founders value the veil of secrecy that their governance
provides, it makes FMF’s poorly suited to raise external capital through
public equity markets. To participate in these markets, firms are required to disclose
important financial and strategic aspects of their business, including the rationale
for large-scale investments and the expected impact that these investments
will have on shareholder wealth. These disclosures place the firm under the
scrutiny of money managers, outside investors, and rivals.
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FMF GOVERNANCE AND ENVIRONMENTAL FIT
Up to this point, we have discussed FMF capabilities and disabilities without considering
the role played by the firm’s competitive environment; that is, the exogenous
set of influences, embodying the separate dimensions of munificence,
complexity and dynamism (Dess and Beard, 1984). In this section, we argue that
whether FMF governance results in a net competitive advantage is contingent
upon the attributes of the firm’s competitive environment. Specifically, we reason
that by virtue of their unique form of governance, FMFs are more likely to be
born, grow, and thrive when the environment they face is characterized by low
levels of munificence and complexity, but by high levels of dynamism.
Munificence refers to the degree of resource abundance and the richness of
investment opportunities in the firm’s environment, and therefore, its capacity to
support growth and profitability (Miller and Friesen, 1984). We reason that due to
its distinct blend of incentives, authority and legitimacy, the FMF organizational
form is well suited for scarce environments. In this regard, the FMFs ability to
operate effectively with a lean administration and to engage in informal contracting
increases the probability that these firms will be able to operate profitably in
small or highly fragmented markets, and in harsh, resource scarce and pricecompetitive
markets like OEM manufacturing (Hobday, 2000) that professionally
managed firms (PMFs) are likely to deem too unattractive to enter.
The rules of the competitive game, however, change in more munificent environments.
The high expected internal rates of return associated with projects in
these environments are likely to provide PMFs with the economic incentive to enter
the marketplace. The governance characteristics of PMFs also make them better
suited than FMFs for munificent environments, because they enjoy better access
to capital and labour markets, and are consequently better able to make investments
in, and leverage specialized and co-specialized assets (Chandler, 1990).
FMFs may thus find themselves at a competitive disadvantage relative to PMFs as
the economic value of economies of scale and scope rise.
Complexity refers to the heterogeneity and range of factors in various environmental
segments (Dess and Beard, 1984), as well as ‘differences in competitive
tactics, customer tactics, customer tastes, product lines, and channels of distribution’
across markets (Miller and Friesen, 1984, p. 277). As environments become
more complex, so too must organizations by using more elaborate formal routines
and coordinating mechanisms and by adding staff departments to buffer core
activities.
We reason that more complex environments represent a double-edged sword
for FMFs. On the one hand, FMF governance affords them unique abilities to discover
opportunities, due to their advantages with regard to interstitial capabilities
(i.e., their capabilities to discover de novo and frame breaking innovations and fill
market and institutional opportunities left unrecognized and/or unexploited by
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other forms of business enterprises). On the other hand, FMFs are less well suited
to exploit opportunities in complex environments since their form of governance
inhibits the development of sophisticated organizational systems (Redding, 1990).
The latter effect occurs largely because FMFs tend to disdain formal routine and
resist delegation and decentralization of authority and responsibility (Schulze et
al., 2001). In contrast, the PMF is a superior governance tool for the exploitation
of complex environments because of its affinity for routines and its ability to
delegate and monitor decision-making using sophisticated strategic controls (Hitt
et al., 1990). Such exploitation advantages are often definitive in complex environments
(Chandler, 1990). FMFs therefore tend to face a net disadvantage in
complex environments, even when they may have been the first to discover market
opportunities and pioneered the industry, or niche.
Dynamism can be broadly conceptualized as the rate of change and the degree
of instability in the environment (Dess and Beard, 1984), and is reflected in the
amount and unpredictability of change in ‘customer tastes, production or service
technologies, and the modes of competition in the firm’s principal industries’ (Miller
and Friesen, 1984, p. 277).We reason that the more dynamic the environment, the
better suited is the governance structures of the FMF, all else (i.e., munificence and
complexity) being the same. In this regard, the authority, legitimacy, and incentives
that accrue to the founder promote entrepreneurial alertness. More specifically, the
wide discretion and legitimacy afforded owner-managers in FMFs and their incentive
to use less specialized assets and processes as a means of reducing financial risk
have positive implications regarding dynamic environments. This occurs because
less specialized assets support a wider range of uses (Chatterjee and Wernefelt, 1991)
and may promote the kind of organizational agility needed to respond quickly to
ephemeral business opportunities (Chen, 1995). Furthermore, because FMFs
operate under a veil of secrecy, they are advantaged in dynamic environments not
only in terms of speed, but also in terms of surprise.
In more stable environments, however, the balance of relative advantage favours
PMFs. Here, speed to market and strategic flexibility are less vital. Environmental
stability also allows firms to benefit from the superior efficiency of specialized
assets and increases the probability that their development costs will be recovered.
Finally, less dynamic environments are better suited to the types of complex
organizational processes that characterize PMFs. For example, formal information
technology systems that engage in deliberate search for specific information may
allow PMFs to gather and leverage market information in ways that FMFs cannot
(Leonard-Barton, 1992).
EVOLVING TOWARDS THE THRESHOLD
Like the mythical figure Icarus whose wax wings led him to fly so high that his
wings melted, successful firms often possess capabilities which at first lead to
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success, but which invariably sow the seeds of their own decline (Miller, 1990). In
this section, we describe how successful FMFs follow an evolutionary trajectory
that propels them towards a threshold where the capabilities that brought them
success in the past are insufficient to carry them forward.
Organizational forces drive one aspect of this evolutionary process. Successful
FMFs – that is, those firms with founders possessing capabilities well suited for
their competitive environments – are generally presented with opportunities for
continued growth through, for example, expansion of their geographic coverage
and by offering closely related products and services. Pursuing these opportunities,
however, expands the scale and scope of the firm’s operations, which in
turn, taxes the founder’s ability to exercise effective control and also their ability
to acquire the necessary additional human and financial resources. Pursuing these
opportunities also forces the successful FMF to deal with a progressively
more complex environment, in terms of the heterogeneity and range of environmental
factors, for which its form of governance leaves the firm ill-equipped to
address.
Ecological forces drive the second aspect of the evolutionary process. The governance
attributes of FMFs, which empower and embolden their founders to be
alert to entrepreneurial opportunities, make them particularly well suited to be
first movers in new industries or in previously undiscovered market niches
(Kirzner, 1997). In this regard, the threat of others entering such a niche is initially
deterred because the population lacks legitimate solutions; i.e., suppliers need
to be educated, employees are hard to find, capital sources are wary, and institutional
rules may need to be changed (Carroll, 1985). This allows the FMF a
brief window of opportunity to exploit its discovered opportunity, free from direct
competition.
To the extent that the FMF is successful during this window, however, it attracts
second movers, some imitators, others innovators, and some coming from the professional-
managed ranks, with their own distinctive set of governance-engendered
capabilities and strategies. Some firms may enter with a generalist adaptation strategy,
whereby they expand its scope in non-overlapping, or unrelated, resource
spaces. Others may enter via a specialist adaptation strategy, whereby they extend
its scope by diversifying into overlapping resource niches that facilitate the sharing
of value activities and the transferring of knowledge. With a rise in niche density,
however, legitimate solutions are discovered that reduce uncertainty about takenfor-
granted solutions (Aldrich and Fiol, 1994). At the same time, institutional
support emerges and evolves for newly selected organizational forms (Carney and
Gedajlovic, 2002b), which further develops the market and enhances its attractiveness.
Said differently, as density rises, environments tend to become more
munificent, more complex, and less dynamic – the very environmental features
that we proposed to be unfavourable to FMFs due to limitations stemming for their
form of governance as well as the relative advantages of PMFs.
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OVERCOMING THE THRESHOLD
In the prior section, we argued that organizational and ecological evolutionary
forces can propel the successful FMF on a trajectory towards a threshold point
where their resources are no longer able to support their growth opportunities.
Daily and Dalton (1992) noted that the successful resolution of these problems
usually requires that the founder cede control to professional managers. And, while
crossing the threshold to becoming a PMF is possible, we argue in this section that
the legacy of FMF governance makes such a transition difficult.
An important obstacle to a successful transformation stems from the fact that
founders derive both economic and non-economic benefits from ownership and
leadership of their firms.Crossing the threshold invariably means that some of these
benefits will be compromised or disappear altogether. For example, by delegating
decision authority to a management team, the scope of the founder’s property rights
is compromised. Transformation also means that the FMF’s personalized and
idiosyncratic nature is likely to be diluted. In this regard, crossing the threshold to
become more ‘professional’may involve substantial opportunity cost for the founder,
especially since the perquisites and privileges afforded owner-managers often yield
benefits that resist quantification and may be derived from activities (e.g., parental
altruism or nepotism) not perceived as legitimate in the context of a PMF.
As a result, the founder’s opportunity costs may remain uncompensated by new
owners, thus giving founders a real incentive to resist the transformation, even
when the financial or operational necessity for the transformation is apparent
(Burkart et al., 2003). This may explain why control battles between founders and
professional managers are commonplace in threshold firms, and why venture
capital firms are generally reluctant to invest in them, unless they are granted the
right to replace the founder should conditions warrant.
Changing the formal governance structure from FMF to PMF is one thing;
changing the artefacts engendered by founder-managed governance is quite
another. Difficulties in such a transformation arise because firms possess organizational
attributes and capabilities that reflect their founding conditions (Stinchcombe,
1965) and develop patterns of interacting with stakeholders and their task
environments that become deeply rooted in their organizational memories and
repertoires (Nelson and Winter, 1982). In this regard, the idea that the firm belongs
to the founder often becomes deeply ingrained in the values (goals, performance
targets) and culture of most FMFs, resulting in taken-for-granted and sometimes
fatalistic behaviours on the part of the firm’s other actors (e.g., ‘if that’s what the
boss wants . . . it’s his/her firm’). As a consequence, FMFs may fail to learn even
when presented with the data and opportunity to do so. Moreover, the transition
to professional management introduces a new set of values and culture that are
often incompatible with the firm’s founding values and culture, and are therefore
likely to be resisted.
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In this sense, FMF governance may put in place intractable path dependencies
and learning disabilities that hamper a firm’s ability to successfully cross the threshold,
even if the founders perceive the need for such change and are willing to relinquish
control of their company. These path dependencies constitute a legacy of
founder-management that needs to be successfully managed if the organization is
to take advantage of its new governance and alter its resources, processes, values
and culture to forms more consistent with its age, size and environmental conditions.
Such a gauntlet of inhibiting factors mean that the effective transition from
FMF to PMF will seldom be easy, and in the majority of cases, will not be undertaken
or successfully completed.
CONCLUSION
Like Zahra and Filatotchev, we explore the challenges faced by threshold firms,
which Daily and Dalton (1992) describe as FMFs faced with resource constraints
requiring founders to cede control to professional management. While Zahra and
Filatotchev present a knowledge-based theory, this paper presents a governance
theory of FMFs and their evolution towards the critical threshold described by
Dalton and Daily. Despite the disparate theoretical perspectives, the two papers
offer quite similar portrayals of the organizational problems FMFs encounter as
they approach the threshold. For instance, both papers indicate that FMFs rely
heavily on their founder’s abilities for their early success, have tendencies to exhibit
intuitive decision making processes and have a narrow range of capabilities reflecting
their nascent conditions and early niche selection. Importantly, both papers
also emphasize that the environments of successful FMFs tend to evolve in ways
that present them with new organizational challenges and which require fundamental
change to their organizational processes.
The two papers differ, however, with respect to the underlying causes and consequences
of these organizational issues. We argue that the organizational challenges
faced by threshold firms are deeply rooted in governance characteristics
(i.e., the incentives, authority and legitimacy), which imbue them with characteristic
capabilities, disabilities and path dependencies. In contrast, Zahra and
Filatotchev focus primarily on the management of learning and knowledge issues.
While their analysis suggests that path dependent processes play an important role,
they do not directly addresses the origins of those path dependencies. In this
regard, we believe that Zahra and Filatotchev’s underspecification of the governance
antecedents of these knowledge and learning problems may have led them
to underestimate the tractability of the issues that must be addressed by threshold
firms for their successful resolution. Our thesis has been that the management of
these problems involve more than functional, techno-economic considerations
since they are deeply rooted in the legacy of founder management and require
fundamental changes to an organization’s resources, processes, values and culture.
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In closing, we note that governance theory holds much promise with regard to
many issues of theoretical and practical importance to management scholars,
because it encompasses issues pertaining to human agency, power-dependence
relations and normative claims regarding the role and purpose of an organization
(Carney and Gedajlovic, 2003). At the same time, we think that this potential has
been unrealized, largely because most management scholars have borrowed
narrow conceptualizations of governance from the fields of economics and
finance. For years, such conceptualizations have been criticized for their stark and
unrealistic depictions of human and organizational character as well as their
failure to pay sufficient attention to contextual issues (e.g., Granovetter, 1985;
Lubatkin et al., 2004; Perrow, 1986).
Rather than ignoring such factors, or treating them as ceteris paribus conditions,
we have made them central to our governance theory by describing how the governance
of an organizational form can be usefully conceptualized as a coherent
system of incentives, authority relations and norms of legitimacy. We believe that
the result is a richer and more realistic treatment of governance and one that provides
the basis for generating practical and theoretical insights regarding the character
and capabilities of FMFs and other types of organizations as well. In this
regard, we firmly believe that a governance perspective need not entail a stark and
arid portrayal of organizations and actors and that both management theory and
practice would benefit greatly from richer and more realistic conceptualisations of
governance in management research.
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Ideas of this paper:
This is a research paper about “Crossing the Threshold from Founder
Management to Professional Management in governance prospective” written by Eric Gedajlovic, Michael H. Lubatkin and
William S. Schulze.
They argue that the challenges faced by threshold firms are deeply rooted in governance characteristics (i.e. the incentives, authority and legitimacy) which saturate them with characteristic capabilities, disabilities and path dependencies. Whereas Zahra and Filatotchev (2004) reason the principal problem facing threshold firms relates to organizational learning and knowledge management, they suggest resource acquisition and utilization to be equally important. Moreover, they argue governance theory is more able than a knowledge-based perspective to explain the root causes of the learning and resource issues faced by threshold firms as well as the complex set of processes involved in their effective management.
They give some information about the foundarmanaged firms that FMFs often fail at a relatively young age, many of those that survive seem to hit a juncture in their evolution at which stagnation sets in and their resources are no longer able to support their growth opportunities. They also suggest that most threshold FMFs are incapable of successfully negotiating this transition.
They first describe how founder-management imbues FMFs with a
particular blend of incentives, authority relations, and norms of legitimacy that
makes this governance form particularly well-suited for growth and survival in
nascent and/or fragmented and heterogeneous markets. Next, they discuss how this blend of incentives, authority and legitimacy interacts with the external environment to affect the nature and pace of learning and capability development within the FMF. Specifically, they give reason that FMFs are more likely to be born and prosper when the environment they face is low in munificence and complexity, but high in dynamism. They then describe why successful FMFs tend to reach a knowledge and resource crisis as organizational and ecological evolutionary forces propel them into environments that become increasingly munificent, complex, and stable – conditions that FMF governance leaves them poorly equipped to deal with. They conclude by discussing their paper’s theoretical and managerial implications, points of intersection with Zahra and Filatotchev’s paper, and offer some general comments regarding the potential contribution of governance theory to organizational analysis.
GOVERNANCE AND THE PRE-THRESHOLD
FOUNDER-MANAGED FIRM
In this part they discuss the theories about governance. Their analysis of firm governance, which reduces relationships within firms to simple dyadic principal-agent relationships between economically rational and motivated actors, offers an arid and superficial portrayal of the FMF.
Moreover, a singular focus on incentives ignores important sociopolitical factors that affect the probability that particular individuals, or groups of individuals will engage in self-interested pursuits (Granovetter, 1985;Lubatkin et al., 2004).
They propose that a more fully specified treatment of FMF governance and its influence on organizational learning and capability development requires a consideration of not only incentives, but also the character of authorityrelationships and norms of legitimacy that prevail in FMFs (Carney and Gedajlovic, 2003).
Moreover, the strategic, organizational and resource allocation decisions of
owner-managers in FMFs have the inherent legitimacy afforded the owners
of private property. In contrast, authority in firms managed by professional,
salaried managers is generally widely diffused across a managerial hierarchy
and is vested in the position, or function, not the individual. Managers in such
PMFs hold fiduciary powers ‘in trust’ and must justify decisions in terms of
their impact on the welfare of others. In the remainder of this section, we
describe how the system of incentives, authority relations and norms of
legitimacy inherent to FMF governance provides these firms with advantages
and disadvantages that are manifest in characteristic capabilities and
disabilities.
FMF Governance and Capabilities
Founders are individuals who demonstrate the alertness, character and temperament needed to exploit a discovered opportunity (Kirzner, 1985).
They perceive as ‘first best’ in terms of their personal (subjective) utility. This helps explain why FMFs tend to strongly reflect the expertise and personality of their founder (Miller et al., 1982), which itself is the product of a multitude of background (informal) institutional influences,
including their upbringing, education, social contacts, cultural heritage and
work experience.
The second source of FMF advantage stems from the fact that its governance
structure provides strong incentives for efficiency and parsimony (Brickley and
Dark, 1987).
third source of advantage is rooted in the veil of secrecy that FMF governance
provides. While founders of nascent FMFs must bear the consequences of their
actions, they rarely need to justify, or expose their decisions to the scrutiny of others,
nor need they disclose the terms and conditions of the deals they make with business
partners and suppliers and buyers of resources. This veil can be a benefit in
circumstances where the terms of exchange are potentially controversial, such as
when deals need to be cut with gatekeepers in emerging markets, or when decisions are made to shed and/or re-deploy firm resources from an existing activity to newer, and perhaps less legitimate economic pursuits.
FMF Governance and Disabilities
While the governance structure of FMFs may engender advantages that make
them capable of entering and competing in marketplaces in ways that widely-held
PMFs may find difficult, these advantages come bundled with offsetting and sometimes toxic disabilities that tend to accumulate over time. There are five
reasons.
1) The nascent FMF is overly dependent on its founder, which makes
it highly prone to failure and can cause key stakeholders to discount the firm’s
legitimacy.
2) These resource and learning problems are exacerbated by the fact that
FMF equity shares are privately held.
3) The governance structure of FMFs makes their founders vulnerable to
self-control problems.
4) Private ownership and the threat of self-control problems may combine
to make it difficult for the FMF to match the terms of employment offered by
other types of firms.
5) To the extent that founders value the veil of secrecy that their governance
provides, it makes FMF’s poorly suited to raise external capital through
public equity markets.
FMF GOVERNANCE AND ENVIRONMENTAL FIT
In this section, they argue that whether FMF governance results in a net competitive advantage is contingent upon the attributes of the firm’s competitive environment. Specifically, we reason that by virtue of their unique form of governance, FMFs are more likely to be born, grow, and thrive when the environment they face is characterized by low levels of munificence and complexity, but by high levels of dynamism.
Environmental stability also allows firms to benefit from the superior efficiency of specialized assets and increases the probability that their development costs will be recovered.
Finally, less dynamic environments are better suited to the types of complex
organizational processes that characterize PMFs.
OVERCOMING THE THRESHOLD
We argue in this section that the legacy of FMF governance makes such a transition difficult.

Conclusion:
An important obstacle to a successful transformation stems from the fact that
founders derive both economic and non-economic benefits from ownership and
leadership of their firms. Crossing the threshold invariably means that some of,
they provide us main factors about the crossing thresholds from FMFs to PMFs. ignoring such factors, or treating them as ceteris paribus conditions,
we have made them central to our governance theory by describing how the governance of an organizational form can be usefully conceptualized as a coherent system of incentives, authority relations and norms of legitimacy. They believe that the result is a richer and more realistic treatment of governance and one that provides the basis for generating practical and theoretical insights regarding the character and capabilities of FMFs and other types of organizations as well. In this regard, we firmly believe that a governance perspective need not entail a stark and arid portrayal of organizations and actors and that both management theory and practice would benefit greatly from richer and more realistic approaches of governance in management research.

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