Mr. Smith goes to flatland: institutions, public policy and the bossless company

3.1 Economic freedom

There is a well-known association between entrepreneurship and economic freedom (Kreft and Sobel, 2005; Nyström, 2008; Bjørnskov and Foss, 2012). In fact, in a sense, they are two sides of the same coin, because a crucial part of economic freedom is the freedom for entrepreneurs to plan and create business ventures as they think best. As a result, almost by definition we observe far more innovative entrepreneurial activity in regions with high levels of economic freedom than those with low levels (e.g., Zhu and Zhu, 2017). It follows naturally that just as entrepreneurs in free markets have greater scope to experiment with new products and processes, so too do they have more room to experiment with innovative organizational models, when permitted.

It might seem then that higher levels of economic freedom are conducive to the emergence of a larger number of bossless firms. However, this conclusion would be premature: more experimentation does not mean that entrepreneurs will choose any particular type of organization, only that they will have the most choice and greatest opportunities to find the types that work best for them. And what “works” is ultimately a matter of the perceived costs and benefits of organizing. In fact, the historical record does not suggest that greater economic freedom alone is likely to lead to fewer hierarchical firms; if anything, the reverse appears to be the case. To take two opposing examples, in the United States, the modern corporate hierarchy emerged and flourished at the end of the 19th century, a period of relative and growing economic freedom (Prados De La Escosura, 2016; Foss and Klein, 2022, pp. 140–145). At the same time, the disappearance of economic freedom, as for instance under socialist or communist regimes, is often associated with a greater emphasis on cooperatives or similar organizations with little or no formal, traditional hierarchy (e.g., Ong, 2006; Gijselinckx and Bussels, 2014) [3]. Cooperatives in particular continue to be presented as alternatives to the evils of the corporation and modern capitalism (Ellerman, 1997). Although researchers often argue that the principles of cooperation were simply distorted by authoritarian regimes (Chloupkova et al., 2003; Ong, 2006; Gijselinckx and Bussels, 2014), cooperatives were nevertheless far more common under such regimes in the 20th century than in relatively free-market Western countries [4].

At present, the majority of firms that pride themselves on being bossless or nearly bossless are based in the United States, specifically, in California, in and around Silicon Valley. California regularly scores at the bottom of rankings of economic and personal freedoms among the 50 states (e.g., Stansel et al., 2021). Furthermore, in the later 20th and early 21st centuries, countries in which flatter companies thrived were often those with heavily interventionist economies. In India, cooperatives featured prominently in the first five-year plans and were intended to play a crucial role in economic planning (Dubhashi, 2005). Similarly, the Mondragon cooperatives were founded in Spain under a repressive political regime that dictated wages and controlled substantial parts of the post-war economy. This economy was so weak that “businesses did not have to be very good to succeed” (Clamp, 1999, p. 9). Today, the same cooperatives continue to enjoy success even as Spain continues to score relatively poorly in measures of economic freedom, especially in areas like credit market and labor market regulation (Gwartney et al., 2022, p. 160; see below for more on these issues). Many more examples could be listed. A common thread in these historical cases is that they are driven by a combination of anti-capitalistic (basically, anti-hierarchy) ideology and top-down economic planning. Insofar as this is the case, they provide a foil for the market-based experimentation discussed above. Almost by definition, a lack of economic freedom increases state control over economic affairs, including the power to encourage or enforce organizational change.

Anecdotally then, there is not an obvious connection between high levels of economic freedom and the emergence of bossless firms. This does not prove, however, that economic freedom encourages traditional hierarchy, nor does it prove that a lack of economic freedom encourages flatter organizations. Growth and development are complex and many factors besides economic freedom influenced their course in the 19th and 20th centuries. Rather, our point is that economic freedom alone does not seem to explain where and why entrepreneurs experiment with removing hierarchy, which seems to happen for many different reasons and under various institutional settings. As we explain below, in some contexts, a lack of economic freedom appears to expand managerial authority, whereas in some specific cases, it incentivizes flatter organizing. Furthermore, the absolute number of bossless firms is still small around the world and represents a tiny portion of existing companies. The exact numbers are unknown because there is currently no effective way to measure; nevertheless, if a relatively high level of economic freedom were all that was required for them to emerge, we would expect regions like Singapore, Switzerland and Estonia to boast many bossless firms. Yet, no such trend exists at the moment.

3.2 Technological innovation

The pace of technological innovation is another crucial aspect of the business environment that influences organizational decisions. Two questions are worth mentioning: first, whether an innovative business environment encourages bossless organizing and second, whether bossless firms themselves are more innovative than their competitors. In this subsection we address these questions together. As with economic freedom, though, the results may at first seem counter-intuitive. Supporters of the bossless narrative typically argue that abolishing hierarchy in firms will eliminate bureaucratic micromanaging and pave the way for more innovative, worker-led projects that are more agile and adaptable. If this is the case, it is reasonable to think that bossless companies are in a good position to respond to the needs of rapidly changing industries driven by technological progress.

Importantly though, an innovative technological setting may not be conducive to organizational innovation; in fact, evidence suggests the opposite is true. Rapidly changing technology requires firms in competitive environments to make quick decisions to keep up, and this is something that many flat companies struggle to do. To take only one example, Valve Corporation was faced with a choice between keeping its flat organization and maintaining its commitment (and even its very ability) to create innovative software (video games). It chose to largely abandon software development rather than sacrifice its bossless model (Möller and McCaffrey, 2021). In other words, firms cannot have their cake and eat it too, and there are often tradeoffs between different forms of innovation, e.g., between product and organizational innovation. Further, organizational change is more long-term and potentially carries wider and deeper implications for company life and performance than conventional product innovation, making it less attractive to risk-averse firms.

More generally, while it is true that change requires flexibility, bossless firms are not necessarily more innovative than hierarchical firms. Speaking of the historical cooperative movement, the economist Ludwig von Mises wrote that,

there is no record of any important innovation which owes its introduction to the cooperatives. While private business, overburdened by taxes from which the cooperatives are exempt, improves, year by year, the quality and increases the quantity of products and fills the markets with new articles unheard of before, the cooperatives are sterile. (Mises, 1990 [1947], p. 240)

Along these lines, lack of guidance from management can lead to creative inertia and decision paralysis—as again illustrated by Valve, which has struggled with these exact problems for years (Möller and McCaffrey, 2021). In more traditional companies, managers play a facilitating role, crafting rules and guidelines for decision-making that are put into practice by employees. By striking the right balance of generality and specificity, effective managers allow employees to use their own best judgment to respond quickly to changing conditions, for instance, by creating simple rules (Eisenhardt and Sull, 2001; Foss et al., 2022). Of course, this does not imply that formal hierarchy is always more flexible, or that it is never a good idea to flatten an organization. It simply means that, for many firms, some degree of hierarchy is necessary and desirable.

Globalized trade has taken advantage of technological change to open vast new labor markets and enable companies in the developed world to offshore significant numbers of jobs. At the same time, technological advances have made many businesses more modular and specialized. This, in turn, means less vertical integration and more outsourcing of different parts of the production process. Yet there are still plenty of managerial responsibilities to go around even in less vertically integrated firms: “Even a broken-up value chain requires a managerial hierarchy to organize, supervise, adjust, and sometimes renegotiate the operations at each stage of production” (Foss and Klein, 2022, p. 108). The scope of the activities that are feasible within management hierarchy may be shrinking for some companies, but it is not disappearing altogether (Foss and Klein, 2022, pp. 104–109).

Given these issues, it should come as no surprise that, as indicated above, traditional firm hierarchy became the dominant business form in the late 19th century, an era of rapid technological innovation and global economic expansion (Foss and Klein, 2022, p. 144). We do not suggest a simple causal relationship between these facts. Nevertheless, traditional management has stood the test of time and endured countless waves of technological change—even innovations that enabled flatter organizations. These last include computing and Internet technologies that make work more modular and outsourcing and spinoffs more feasible, seemingly reducing the need for managerial oversight and coordination (Foss and Klein, 2022, pp. 103–111, 238–240). Yet throughout these sea changes, bossless companies have remained the exception rather the rule. Further, even successful firms like Morning Star and Valve are not obviously more innovative than their more traditional competitors. Once again, these general examples do not definitively answer the question either way, but they do imply that the relationship between bossless organizing and innovation is complex and requires tradeoffs, especially tradeoffs between different types of innovation.

3.3 Uncertainty

Economists have argued for centuries that uncertainty is a crucial aspect of the entrepreneurial market process. The fact that production takes place in time means it is necessary to speculate about the future when planning any action. In the marketplace, this implies uncertainty-bearing by entrepreneurs, who use judgment to appraise future prices. There are many potential causes of uncertainty in this process, including changing consumer preferences, the introduction of new technologies and weak institutions (e.g., Bylund and McCaffrey, 2017; Packard et al., 2017; Bylund and Packard, 2022), each of which carries implications for entrepreneurs deciding how to structure their firms.

Similar to technological innovation as discussed above, uncertainty requires prescient decision-making, often in time-sensitive conditions and using scarce resources that have different potential uses within the firm. In this context, “A well-structured hierarchy helps firms buffer unanticipated shocks” (Foss and Klein, 2022, p. 242). Managers establish strategic priorities and rules for how to use resources (Eisenhardt and Sull, 2001) and can also negotiate any resulting conflicts between the parts of the firm that get the resources they want and those that do not. This is all difficult if not impossible to do, however, if there is no authority to which to appeal. In a bossless firm, actors may be unwilling or unable to cope with uncertainty without some form of hierarchy to aid in decision-making. Oliver Williamson describes disturbances or uncertainties that arise within organizations that

require coordinated responses, lest the individual parts [of the organization] operate at cross-purposes or otherwise suboptimize. Failures of coordination may arise because autonomous parties read and react to signals differently, even though their purpose is to achieve a timely and compatible combined response … Although, in principle, convergent expectations could be realized by asking one party to read and interpret the signals for all, the lead party may behave strategically—by distorting information or disclosing it in an incomplete and selective fashion. (Williamson, 1991, p. 278) [5]

As Williamson points out, individuals can and often do interpret signals and other stimuli differently, which can lead to conflict. In addition, different interpretations enable strategic behavior. Of course, even if it is feasible to resort to authority to interpret signals in a consistent way, as Williamson suggests, this would appear to embrace hierarchy and abandon the bossless narrative. Conventional hierarchies are usually designed to avoid hidden information problems like moral hazard by ensuring effective monitoring and incentives. But in a flat firm in which all employees are on an equal footing, it is unclear how this could be done. One approach, used by companies like Valve, is to use a peer-review system to track performance and compensation, but these kinds of methods are prone to abuse, especially through informal authority relations or powerful personalities (Foss and Dobrajska, 2015).

We cannot know without investigating whether situations requiring a coordinated response are more common than alternative scenarios when management is unnecessary. Yet the evidence clearly shows that coordination is necessary in at least some cases. And if hierarchy can help mitigate uncertainty in certain conditions, it is reasonable to infer that firms without hierarchy will be at a disadvantage when faced with those same conditions. Abolishing hierarchy is not a viable solution for all organizations. A lack of hierarchy creates uncertain by removing the possibility that conflicts can be easily resolved through appeal to a higher authority. This uncertainty in turn makes action more costly and discourages behavior that could potentially lead to conflict.

This also hints that bossless firms will find it easier to thrive in more stable and certain environments. Yet uncertainty is the rule in the market economy, while stability and certainty are exceptions. So which kinds of institutional environments or environmental conditions are most likely to create stability and incentivize more firms to de-boss? Two possible examples are stagnant industries and industries hampered by significant government intervention.

3.4 Industry stagnation and capital requirements

Industries can stagnate when, e.g., competition is fierce, technological development peaks, product development slows, consumers are brand-loyal and profits are correspondingly low. In these more secure and less uncertain scenarios, established firms with secure market share have greater opportunities to flatten; in fact, reducing management hierarchy may be the only viable strategy for a firm with increasingly slim margins, if it cannot cut costs or increase revenues in more conventional ways. This is an internal incentive that encourages less hierarchical organizing.

Importantly, stagnant industries also face external threats of innovation that challenge industry leaders and require radically reshaping organizations. A now-familiar example is Netflix revolutionizing the video rental industry, and many other disruptive companies fall into a similar pattern. Traditional rental businesses required significant land and capital assets for brick-and-mortar locations. Netflix completely changed these asset requirements by eliminating the need for multiple physical business locations, replacing them with distribution warehouses. Netflix's success thus produced a company that was flatter than its established competitors, because requiring fewer assets, franchise locations, etc., also meant a reduced need for coordination through hierarchy (Uber, discussed below, offers a similar case). Moreover, by changing asset and ownership requirements, Netflix also changed the way firms in the industry could be feasibly organized, and the traditional rental industry disappeared as a result. A stagnant industry with large capital requirements created an ideal opportunity for a low-asset, low-hierarchy competitor. It should be clear then that innovation can work in favor of bossless firms—when the conditions are right.

4.1 Labor markets

All management hierarchies involve different roles or functions that are determined by authority relations. Entrepreneurs, as the ultimate decision-makers within the firm, must estimate the costs and benefits of each role and relationship to determine the best organizational structure. A direct implication is that the relative costs of different kinds of employment contracts matter greatly when designing business organizations. Factors that drive up the cost of traditional labor relations likewise encourage experimenting with alternative models that economize on the costs of hierarchy. Exactly which alternatives will be most attractive though depends on the particular circumstances of the firm. What is more, government interventions can provide conflicting incentives to the same company.

For instance, laws mandating employer-provided health insurance coverage, maternity leave, or other benefits that make employment contacts more costly, encourage firms to reduce the number of people who are classified as employees. Uber drivers are a commonly cited example: the company treats them as independent contractors, so they are often exempted from benefits schemes on the grounds that they are not legally employees (Bales and Woo, 2017). Uber inevitably has many more drivers than it does management positions and, therefore, flattening or delayering at the lowest level of the company is much more cost-effective than at higher levels. This is in the nature of the work Uber does: under different cost conditions, managers could be the more expensive layer. Like Netflix, Uber is not completely flat, but it is a significant example of a company that flattened relative to competitors, e.g., traditional taxis. The app-based contractor model eliminated the need for the company to own or maintain fleets of vehicles while economizing on regulatory compliance. Uber is not a perfect example though, because while was able to remain relatively flat, it was not necessarily more bossless: for several years after its founding it maintained a traditional management structure and simply delayered at the bottom. But the overall point we wish to make is that the choice to avoid traditional employment contracts was driven by Uber's specific cost structure: different firms face different relative costs, and it is perfectly plausible that, for other companies, middle management is the costliest layer. Incidentally, the Uber case does have some relevance for bossless organizing, as it appears that the contracting model enabled Uber to eventually flatten its organization at the top as well. Roles like Chief Operating Officer and Chief Marketing Officer have more recently been eliminated as the top management team has been delayered and more direct communication established between the chief executive officer (CEO) and the remaining roles (O'Brien, 2019).

Similar effects can be expected from other interventions into labor markets: high minimum wages discourage employers from hiring traditional employees, because self-employed persons are exempted from minimum wage rules. Unionization incentivizes changing workers' legal status to sidestep collective bargaining laws. Each of these interventions rewards flatter companies that remove either layers of employees (receiving benefits) or managers (overseeing compliance, etc.), depending on their relative costs. In both cases though, rank-and-file employees are more likely to be affected, as management is far less likely to have wages near the legal minimum, or to want to encourage union activity. And crucially, absent these labor market interventions, there would be less economic reason to reorganize companies by delayering or otherwise downsizing to begin with. In this light, the actions of companies like Uber appear less like market innovations and more like reactions to increasing labor market regulation.

However, outside the specific labor market conditions discussed above, there is a more general incentive in the opposite direction. That is, government intervention can also have the effect of incentivizing the expansion of the management hierarchy. In fact, practically all forms of intervention can influence the composition and/or the size of the management team in some way (Mises, 1944, pp. 69–71). The greater the risk and the impact of government regulation, the more costly it becomes, and the more necessary it is to devote resources to maintaining positive relations with government, by keeping up with regulatory compliance, lobbying for protections and privileges and so on. This eventually requires specialized management roles, often in middle management but reaching potentially to the highest levels of the firm. It is reasonable to argue that without interventions in labor markets, etc., these positions would become pointless and would be eliminated, thus flattening firms' hierarchies.

4.2 Intellectual property rights

In general, barriers to entry limit competition and provide a kind of artificial stability for companies struggling to deal with uncertainty. In this subsection we discuss a specific example: legal protection through intellectual property (IP) laws. IP laws are particularly important given the business environment of the 21st century, which is increasingly technology-focused, online and service-based. In this context, property rights to intangibles take on greater importance than they did in traditional sectors like manufacturing and retail.

Flat or bossless firms appear more likely to succeed in legal environments in which IP rights are strongly enforced. Physical manufacturing requires a certain amount of centralization and/or coordination of production and, therefore, benefits from traditional management, whereas the production of intangibles is more likely to be modular and require less geographical proximity between employees and less direction of physical work, thus favoring a more bossless setting. As explained above, in general, the fewer interdependencies in work and the less significant uncertainty is perceived to be, the more likely it is that removing hierarchy will be feasible. IP rights, which are a form of legal monopoly, allow firms to work within the relatively stable and predictable confines of the legal system, as opposed to the uncertain market. They “artificially” remove uncertainty and enable experiments with flatter organizations. Of course, knowledge-based firms can still face interdependency problems, so this barrier to entry is not a guarantee that companies will go bossless. Our point is that IP laws help create conditions in which this is more feasible.

Valve is again a prime example. It began as a software company (creating original video game IP), but it has since shifted to managing other developers' IP through Steam, its distribution platform and community hub. Although it has mainly given up software development, it is still active in designing and producing several other middleware and hardware products, including virtual reality (VR) headsets and portable gaming devices. However, these projects have met with mixed results in terms of financial success and, in any case, provide only a small part of the company's financial value. Yet in its role as publisher of thousands of games from third-party developers, Valve has taken on the task of Digital Rights Management (DRM) for much of the copyrighted content sold on Steam. For Valve, DRM is primarily a way to require players to use Steam in order to have access to their games. In fact, DRM transforms the nature of game sales: rather than buying a game outright, players now essentially buy a license to play the game through Steam. In other words, Valve's main platform business consists of managing a complex network of IP rights, whether its own or the companies' who publish through it. Without enforceable IP rights, the costs and benefits of running Steam would change substantially: mainly they would increase, because Valve would not be able to externalize the costs of enforcing its agreements to society at large via the legal system.

4.3 Subsidies, credit and preferential tax treatment

The legal and economic characteristics of bossless companies can also give them a distinct advantage over traditional firms when it comes to fiscal policy. It is difficult to find cases where public policy directly and explicitly incentivizes experimenting with alternative forms of organizing, but here again cooperatives provide an instructive example, because their form is explicitly recognized in the business law of many countries. (The early advocates of cooperatives even had their own “bossless narrative” in which democratic, worker-owned enterprises were supposed to replace industrial firms.) In addition, while most economists who study organization and the theory of the firm do not discuss bossless companies specifically, many write about the economic problems of cooperatives.

As with many companies seeking to reduce or eliminate hierarchy and install flatter, more “democratic” models, cooperatives have so far failed to entirely supplant traditional corporations. Already in the mid-20th century, Mises observed that cooperatives were “merely dim shadows of what they were designed to be in the ambitious schemes of their first promoters” (Mises, 1990 [1947], p. 238). Today they remain a small portion of businesses in most developed nations (Groot and van der Linde, 2017). Furthermore, to the extent that they have grown or internationalized, many cooperatives have often had to give up some of their original organizational structure or identity (e.g., Heras-Saizarbitoria, 2014). A full discussion of the costs and benefits of different cooperative models is beyond the scope of this paper. We also do not comment on any underlying arguments about the economics of cooperative organization (e.g., Hansmann, 1991). Instead, we use cooperatives as case studies of some ways in which fiscal policies support the creation of less hierarchical firms.

Contemporary researchers, particularly those who are supportive of cooperatives, frequently argue for the need for public subsidies or similarly favorable policies to support the formation of cooperatives and protect them from competition (e.g., Gunn, 2006, pp. 351–353; Molk, 2014; Groot and van der Linde, 2017). This should be unsurprising, as historically many successful cooperatives benefitted from policies such as subsidies, easy loan terms and tax exemptions (Porter and Scully, 1987). We discuss each in turn.

Rural electric cooperatives in the USA and other countries provide examples of direct government subsidies (Orzechowski, 2001; UNDP, 2009). More recently, the Affordable Care Act gave a $2 billion subsidy to health care cooperatives in the USA (Molk, 2014, p. 901). Such subsidies are relevant because they target organizations with specific legal and ownership structures that are highly relevant to bossless companies, especially insofar as widely diffused ownership, such as exists in cooperatives, tends to mean flatter firms with fewer management layers—that is, more bossless firms. Naturally, subsidies make it more attractive to engage in certain kinds of business, or to use certain kinds of organization.

Cooperatives have also benefitted greatly from relatively low-cost forms of finance that are not always available to traditional corporations. They often have access to low-interest loans and loan guarantees backed up by local or national public organizations (e.g., Porter and Scully, 1987; Orzechowski, 2001; UNDP, 2009). The first Mondragon cooperative was founded by using a loan to buy an existing enterprise (Clamp, 1999, p. 10). And in addition to receiving favorable loan terms, organizations like credit cooperatives can also be in a position to grant better terms to their own customers. The Mondragon group again provides a useful example. Its early growth was driven by its creation of a credit union that financed further new cooperatives. The success of that financial institution was supported by Spanish law, which, at the time, “allowed payment of slightly higher interest by credit unions than by banks, adding incentive for savers to use [it]” (Gunn, 2006, p. 352).

Preferential tax treatment also plays an important role in creating favorable conditions for the emergence of flatter companies (Porter and Scully, 1987). It is well known that firms frequently respond to increased tax and regulatory burdens by restructuring and “slimming down” management by delayering. Crucially, higher tax levels create incentives to reduce the range of things that can be taxed. This can mean redefining the boundaries of the company, as in the above example of independent contractors. That approach eliminates the need for employers to make national insurance and other contributions for employees, especially highly-visible big-ticket employees like top managers. Lower tax levels make these burdens less onerous and encourage the formation of more traditional, hierarchical firms.

In countries like Estonia, Ireland, Mexico, Romania and the USA, financial cooperatives can qualify for income tax exemptions in certain circumstances (McKillop et al., 2020). USA housing cooperatives have likewise received favorable tax treatment (Hansmann, 1991). More generally, Employee Stock Ownership Plans that diffuse ownership, making it more equitable and democratic, have proved valuable to companies because they come with large corporate tax deductions (Ellerman, 1997, pp. 75–81). In all these cases, there are rewards to flattening and eliminating hierarchy in firms. A practical case involves a recent change to USA tax law that provided greater tax savings to farmers who sold their products to agricultural cooperatives. This law motivated many smaller and family-owned producers to set up their own cooperatives (which were inevitably smaller and featured minimal hierarchy) and some larger firms to restructure in order to legally qualify as cooperatives and thereby receive the befits of the new tax breaks (Bunge and Rubin, 2018).