Table Of ContentStudies in Economic Ethics and Philosophy
Series Editor Editorial Board
Peter Koslowski F. Neil Brady
James M. Buchanan
Richard De George
Jon Elster
Amitai Etzioni
Gerard Gäfgen
Serge-Christophe Kolm
Michael S. McPherson
Yuichi Shionoya
Philippe Van Parijs
Springer-Verlag Berlin Heidelberg GmbH
Lorenzo Sacconi
The Social Contract
of the Firm
Economics, Ethics and Organisation
With 10 Figures
Springer
Prof. Lorenzo Sacconi
Centre for Ethics, Law & Economics (CELE)
LIUC - Universitä Cattaneo di Castellanza
Corso Matteotti 22
I-21053 Castellanza (VA)
Italy
"Originally published in Italian under the title:
Lorenzo Sacconi, Economia Etica Organizzazione"
© 1997 Gius. Laterza & Figli Spa, Roma-Bari. The English language edition
arranged through the mediation of EULAMA Literary Agency.
English language edition revised and translated by the author.
ISBN 978-3-642-63135-1 ISBN 978-3-642-57300-2 (eBook)
DOI 10.1007/978-3-642-57300-2
Cataloging-in-Publication Data applied for
Die Deutsche Bibliothek - CIP-Einheitsaufhahme
Sacconi, Lorenzo: The social contract of the firm: economics, ethics and organisation /
Lorenzo Sacconi. - Berlin; Heidelberg; New York; Barcelona; Hong Kong; London; Milan;
Paris; Singapore; Tokyo: Springer, 2000
(Studies in economic ethics and philosophy)
ISBN 978-3-642-63135-1
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[ ... ] At this moment the King, who had been for some time
busily writing in his note-book, called out "Silence!" and
read out from his book,
"Rule Forty-two. All persons more than a mile high to leave
the court."
Everybody looked at Alice.
"I'm not a mile high," said Alice.
"You are" said the King.
"Nearly two miles high," added the Queen.
"Well, I shan't go, at any rate," said Alice: "besides, that's
not a regular rule: you invented it just now."
"It's the oldest rule in the book," said the King.
"Then it ought be Number One" said Alice.
The King turned pale, and shut his note-book hastily.
LEWIS CARROLL, AUCE 'SADVENTURES IN THE WONDERLAND
v
Preface
1. A code of ethics, i.e. the set of moral rules governing an organisation,
a firm or an association, may be implicit or explicit, tacit or recorded, either
orally or in writing. It may grow up in an apparently spontaneous way or be
deliberated by a formal process; it may be published and transmitted in an
informal way or via formal procedures of communication and development.
Obviously more or less formal ethical rules governing the running of the firm
and business in general have always existed as principles leading the behav
iour of the entrepreneur or values embedded in the corporate culture and in
the beliefs of those who run the firm and work in it, as well as the ethical
norms of the professions, arts and works. In the last twenty years, however,
the phenomenon of corporate ethics has begun to grow up very fast and ex
tensively. In large-scale multinational companies, business associations, pub
lic offices, universities and hospitals - all organisations with complex inter
nal bureaucratic and hierarchical structures - the tendency to draw up and
write down explicitly formulated ethical codes, formally decided by the man
agement and communicated to employees via formal procedures and training
programs and reported to external consumers or service-users, suppliers and
public offices is not any more the exception but the rule. According to em
pirical research into the phenomenon of corporate ethical codes in the US -
taking American firms classified by Fortune as the point of reference - the
number of firms with a code of ethics grew from 8% in 1980 to 93% in 1990.
This is not the place for an empirical research into the phenomenon of
corporate codes of ethics!. The scope of this study is, on the contrary, essen
tially theoretical, both in the explanatory and normative senses. The relevant
question is, therefore: why has the phenomenon of corporate ethics spread so
widely, beyond the contingent historical facts? In other words to fmd out
whether there is an explanation in terms of the rise of institutional and gov
ernance structures of the firm, in accordance with the properties of efficiency
For empirical researches that first reported the phenomenon of ethical codes at
an international level see Center for Business Ethics (1988,1994), Molander
(1987), Benson (1989), Langlois and Schlegelmilch (1990). For a theoretical
discussion of the subject, representing also the frrst stage in this study, see Sac
coni (1991) ch.6, 7 and 9.
VII
PREFACE
and stability generally called for by neo-institutional economics, from which
we can predictively deduce the appearance of a code of ethics within a formal
organisation which is usually based on hierarchical principles.
Unlike the law, a code of ethics is not enforced by legally binding sanc
tions (even though legal incentives for the adoption and setting up of a corpo
rate code of ethics have recently been introduced in the US2). Thus a code of
ethics must first of all have an endogenous explanation in terms of self
enforceability3. Our deduction of corporate ethical codes is both a potential
explanation and a justification in the sense of Social Contract theories. Our
hypothesis is that corporate ethics is a matter of transformation in the forms
of corporate governance that involves evolutionary stability of norms, con
ventions and institutions and may be characterised in terms of behaviours
mutually in equilibrium among economic agents. At the same time, it can be
explained and justified as the result of fair and efficient partial social con
tracts between all the components of the firm and more generally those
groups of agents (the stakeholders) who have an interest at stake in the run
ning of the firm.
2. The title of this book - The Social Contract of the Firm -syntheti
cally describes its content. Let us look at the main thesis to be discussed in
the book: the logical premise for success and stability of the firm as an insti
tution, capable of regulating and organising economic transactions, is its
Constitutional Social Contract, even though implicit, among its stakeholders.
This social contract must exist if the institution is to be justified, and de facto
it exists if the firm is to be a stable institution, recognised as legitimate by
those who work and transact with it and in it -given an economic and organ
isational context where every agent enjoys some degree of freedom of action
and strategic decision-making4• A code of ethics is no less than the explicit,
written or otherwise, manifestation of this constitutional social contract (an
See US Federal Sentencing Guidelines, Ch.8, Sentencing of Organisations, No
vember 1991; cf. EOA News (1996).
Hayek (1986) voU speaks generally in these terms about rules of conduct; both
Arrow (1986) and Sen (1993) speak specifically about the finns' codes of ethics.
4 The idea of a margin of freedom and discretionary decision hold by any member
of a fonnal organisation, notwithstanding his position into the hierarchy, was
first introduced in the sociological theory of organisation by Michel Crozier
(1963, 1986), but now it is a standard assumption in the economic theory of in
ternal organisation, see for example Tirole (1986) and Aghion and Tirole (1997).
VIII
PREFACE
overview of the whole theory is given in ch.l). Its content is the set of con
stitutional principles that would be recognised as rational and hence accept
able in the agreed social contract amongst the stakeholders of the firm. As in
any social contract theory, the Social Contract of the Firm is focused on two
main problems:
(1) To find out the terms of the hypothetical agreement amongst the firm's
stakeholders of the firm in an ex ante perspective, i.e. in the perspective of
individuals who have to decide whether to enter a firm seen as a cooperative
social venture amongst different stakeholders for their mutual advantage.
They, from a hypothetical, impartial and impersonal stand point, ask the
question of what agreement may be acceptable on the part of all those who
cooperate via the firm (the answer is given by the normative model of social
contract of the firm which is the subject of ch.l and ch.2).
(2) To understand the endogenous mechanism generating appropriate incen
tives that induce to comply with the social contract itself, as seen in the ex
post perspective, i.e. in the perspective in which agents can decide whether or
not to comply with the social contract, which has been hypothetically agreed
in the ex ante perspective. To take seriously the ex post perspective means
that the decision by an agent to comply with the social contract has to re
spond to his rational self-interest (the answer to this problem, i.e. the theory
of reputation effects, is presented in ch.3).
Solving problem (2), the social contract would prove to be self-enforcing.
Thus it can be understood as a set of moral general principles, accepted by
social conventions or by a code of ethics seen as a co-ordination equilibrium
and not in need to be strictly enforced by the law. In the case of the social
contract of the firm, however, this analysis is further complicated by two
other aspects: first, the existence of radical uncertainty or lack of knowledge,
ambiguity and vagueness, due essentially to the emergence of unexpected
events, which escapes the usual treatment in terms of statistical uncertainty
and constitutes the main source of contract incompleteness. Second, the la
tency of abuse ofa uthority, which is related to the exercise of power by those
who legitimately hold a position of governance authority within the firm,
which in turn is inherently related to the solutions the theory of the firm sug
gests to contract incompleteness. As we shall demonstrate, the two problems
are closely linked: radical uncertainty facilitates abuse of authority (see ch.l
and ch.4, were this point is raised on the basis of the path-breaking Kreps'
contribution to the economic theory of corporate culture). All this makes the
firm potentially unstable as a control structure, since the expectation of abuse
IX
PREFACE
of authority leads one to not respect or not enter into the hierarchical relation
ships that enable the finn to organise transactions efficiently. Radical uncer
tainty and the risk of abuse of authority within hierarchy creates more need to
take a fair and efficient social contract as a reference point, in order to gener
ate reciprocal expectations among the parties so as to back their cooperation.
At the same time, however, they drastically complicate the compliance prob
lem, that is the problem of conformity to nonns, contracts and also to the
moral constitution itself, which would guarantees justification and legiti
macy. The joint solution to these problems is set out by the theory of the code
of ethics as rational deliberative procedure which is the main constructive
part of this book (see in particular chs.5, 7 and 8). To develop such theory we
needed new technical tools for modelling incomplete contract and the delib
erative ethical procedure, which we have found in some logic of limited rea
soning: fuzzy set theory (see chs.6 and 8) and default logic (see chs.5 and 8).
x
Acknowledgements
This book is largely the English translation of the one I published in Ital
ian under the title Economia, etica e organizzazione in 1997. In that book I
acknowledged my debts toward a number of Italian colleagues, amongst
whom let me at least remember here again Michele Grillo. After more reflec
tion, I must also recognise some less direct debts to David Gauthier and Ken
Binmore. In many senses the theory of the social contract of the firm, which
elaborates on many ideas drawn form the theory of games, has grown up
through explicit (in many occasions during the past years) and implicit (al
ways inside my mind) confrontation with their own quite different (between
them and also respect to the mine) contributions to the larger subject of
'game theory and social contract'.
Translating from Italian to English requires professional skills that I had
not at the moment when the project was started. Those skill have been pro
vided by Terry Bland, who helped me in preparing the basic translation on
which I worked to improve the English version of the book. However this is
not just a translation but in marty points it is also a true improvement of the
original text, and some of these are not only expositional but also - I suspect
- theoretical improvements. I have got the suggestion to introduce them by
the discussions following presentations of the basic ideas of the original book
in many seminars and workshops. Let me remember only a few of them: the
5th Conference on Economic Ethics and Philosophy held in Mariernrode
(Hannover) in 1997, the seminars at the Department of Economics of the
University of Trento and at the Department of Economics of the University
of Siena in 1998, a workshop at the 11th EBEN Conference on 'The Ethics of
Participation' held at the Centrum Voor Economie en Ethiek, Katholieke
Universiteit Leuven 1988, and the research group on 'Rationality, Norms and
Organisation' at the Centre of Ethics, Law & Economics, LIUC University,
Castellanza. The helping suggestions by all their participants is here collec
tively acknowledged.
XI
