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The Evolving Identity of the Firm. Cognitive Peculiarities and Idiosyncratic Perceptions

The Evolving Identity of the Firm. Cognitive Peculiarities and Idiosyncratic Perceptions

Research into the theory of the firm began with the publication of “The Nature of the Firm” (Coase, 1937), which led to the appearance of four essential questions about the nature of the firm. Why do firms exist? Why are these organized the way they are? Why are there firm boundaries? Why are firms heterogeneous? These questions led to the emergence of many research programs starting with the 1970s, in the seminal works of Alchian & Demsetz (1972), Jensen & Meckling (1976), in transaction-cost economics (Williamson, 1981), in behavioral theory (Cyert & March, 1963), a theory that considers that firms create value by compensating for individual cognitive limitations, and so on. But the effort to integrate firm theory and entrepreneurship is relatively young, especially when we emphasize that modern firm theory was based on the “production function view” (Langlois & Foss, 1999), assuming a predetermined set of production possibilities, starting from a homogeneous interpretation of the firm, in a binary input-output relationship. The firm begins to become dynamic with the emergence of the heterodox Austrian perspective, suggesting that firms create value through their ability to combine the judgments of numerous individuals (Penrose, 1959). 

Theory of the firm 

Penrose (1959), on whose insights we will rely the most in this analysis, stated that firms obtain a comparative advantage due to organization-specific resources, due to some peculiarities of production and implicitly some organizational skills. Penrose believes that firms have a limit imposed by managerial characteristics, the ability of managers to introduce new goods or services and adapt to these changes. This research starts from the premises of Penrose, but tries to emphasize the importance of spontaneous cognitive and normative elements found within the firm, given the epistemic differences between all economic agents, and the way in which firms can become active in other productive spheres. At the same time, this analysis allows the transition to the theory presented in this paper, namely the appearance of a cognitive identity of the firm situated in the social-world, in an evolutionary production structure, in which we find certain specific normative principles, but also an economic rationality. And the spontaneous incorporation of economic agents and firms in the social-world facilitates the aforementioned epistemic exchange, necessary for modifying the cognitive peculiarities of firms, but also allows the incorporation of these organizations in meaningful pragmatic relationships with all existing goods and services in a social production structure, which occurs as a result of autonomous interaction processes. This exchange emphasizes that a firm does not have a classical limit, but a potential cognitive limit, which can be overcome following the active emergence of a new internal perception, at the firm level, and new subjective expectations. These new perceptions and interpretations of the external world shape the entrepreneur’s ability to innovate (Barbosa, 2014). But each economic agent has a limited perceptual horizon, which is inherently linked to the intercorporeal structure of prior experiences, hence the importance of active and interactionist participation in a social-world, through which it has access to other experiential horizons. 

The normative-cognitive institutional framework and agent perception 

All economic processes are enactive because these are situated in a social-world. These economic activities presuppose the prior existence of an evolutionary socio-cognitive institutional context, in which we are tacitly integrated and which allows us to engage in autonomous processes of meaningful interaction. The whole economic reality is based, thus, on an intersubjective behavior situated in a normative context. Thus, all institutions are socially extended cognitive structures (Gallagher, 2013), being enactive constituents of the interaction processes, these institutions representing the means through which a certain rationality is conferred to the social-world and which facilitates the emergence of congruent expectations of economic agents.

At the same time, social institutions incorporate the historical and normative peculiarities of a social group. These normative and cognitive peculiarities imprint certain potential limits to the development of economic processes, given the incorporation of a limited set of experiences that could have acted on the social behavior of economic agents, in other words, imprint a certain specificity of the action. Institutions, as cognitive factors, constrain and lead to specific socio-economic processes, congruent with existing cultural values. This constraint, as we will discuss, is temporary, modified as other social principles arise through interaction. This means that social institutions are only enacted following the emergence of dynamic and intercorporeal processes of interaction, economic agents using these normative means to initiate an action, but also to be in a significant relationships with all existing goods and services. Thus, we can affirm that the social-world represents the background of intersubjective life, it is formed of complex normative-communicative practices reflected in an institutional structure and that allows an active and evolutionary reflection of individual peculiarities. Therefore, the social-world is characterized by the relational autonomy, by autonomous processes of interaction, and this autonomy is referring to the ability of the economic agent to take a decision in relation to the socio-normative values of the group of which he forms a part, in relation to the potential limits of the normative and cognitive institutional structure, “( ... ) the constraints imposed by social interactions, as well as the possibilities enabled by such interactions, is such that the economic reasoning is never just an individual process carried out by an autonomous individual, classically understood” (Gallagher et al., 2019). At the same time, it should be known that each decision is made in relation to the previous experiences of an economic agent, experiences facilitated by this situated cognition, but also presupposes an enactive factor, as we will see, the decisions made by an economic agent having non-linear repercussions on the future development of economic processes, but also on social institutions. 

Collectivity and individuality 

Economic agents are incorporated into a socio-cognitive structure necessary for the initiation and development of embodied processes. No action is initiated in isolation, but interdependently, in a close enactive relationship with the social-world, but also with the previous experiences of the economic agent. Therefore, the unique experiences of the agent lead to the formation of a selective temporary-hermeneutic interpretation, an interpretation that underlies the idiosyncratic perception or understanding of a business opportunity, hence, “the relationship between objective economic variables (...) and the expectations of individuals are dependent on the interpretation that agents provide to them” (Bellet & Durieu, 2004, p. 236). As the flow of experiences is unique, the perception of the economic agent is limited, which also imprints certain limits on his productive abilities. But these limits are overcome by a form of active interaction with economic agents with another experiential framework, given the relational autonomy, which will expand the perceptive abilities of the economic agent and will represent a new t0 moment of knowledge, through which other meanings can be attributed. Thus, we cannot know exactly how future phenomena will act on the perceptive capacity of the economic agent, this being the reason why, in dealing with uncertainty, the economic agent is “boundedly rational” (Simon, 1947). Therefore, we affirm that the future is unknowable, though not unimaginable (Lachmann, 1976). Starting from this brief presence, we can affirm that the entrepreneur, as an economic agent, is a process-in-time, his perceptive capacity being situated in a social-experiential, but also evolutionary context. And this phenomenon can be described in the form of a circular causality, in which “perception is the source of memory, but also the product of memory” (Fuster, 1995, p. 87). In other words, time and knowledge are in an interdependent relationship.

If we have emphasized the evolutionary character of entrepreneurial perception, we can make two observations. Firstly, we highlight the importance of the non-linear passage of qualitative time, which is heterogeneous and idiosyncratic, connecting in a t0 moment all previous experiences. Therefore, each phase of time as lived is differentiated from its predecessor and its successor (Boettke, 1994, p. 114). Secondly, this work starts from the subjective approach (Lachmann, 1986) of the Austrian School, which affirms that learning is an integral component of entrepreneurial discovery (Kirzner, 1973), but emphasizes the intersubjective and situated nature of the economy, through which we can explain the epistemic entrepreneurial evolution as a consequence of integration into the social-world. And starting from this observation, we will integrate the resource-based approach (Penrose, 1959) with the evolutionary and intersubjective entrepreneurial knowledge, which is coagulated in the emergence of a non-deterministic cognitive identity of the firm, of idiosyncratic peculiarities of the organization. Thus, we understand entrepreneurship implies social interrelationship, in contrast to classical entrepreneurial theories that tend to be centered on individualistic behavior (Schumpeter, 1934). 

Idiosyncratic firms, management team and cognitive differences 

Each firm represents a socio-cognitive entrepreneurial extension, allowing the distributive exercise of creativity (Aldrich & Wiedenmayer, 1993). This description reflects the subjective character of an organization, being made up of economic agents with heterogeneous preferences and experiences, which means that “[...] the contents of the human mind, and hence decision making, are not rigidly determined by external events. Subjectivism makes room for the creativity and autonomy of individual choice” (O’Driscoll & Rizzo, 1985, p. 1). This subjective heterogeneity will mean that each allocative decision within a firm has certain temporal limits, each such temporal moment leading to the existence of another knowledge and implicitly to the perception of other consequences. This phenomenon, from a situational and intersubjective perspective, emphasizes the importance of entrepreneurial creativity coagulated within a firm, these cognitive organizations having the ability not only to discover, but also to create investment opportunities following active interaction with customers, existing technologies and other stakeholders (Buchanan & Vanberg, 199; Minniti, 2004).

Entrepreneurs acquire experience-based knowledge of “[…] the particular circumstances of time and place” (Hayek, 1945). This experience-based knowledge is an invisible asset (Itami & Roehl, 1987), which allows the entrepreneur to identify in a unique way productive capacities of resources and implicitly to participate cognitively in the development of a bisociation within a firm (Koestler, 1964). This bisociation refers to connecting the heterogeneous perceptions of the economic agents incorporated into a firm from which the identification or realization of opportunities that others have not imagined or implemented can result (Smith & Di Gregorio, 2002).

Thus, we can affirm that the productive activity of a firm organically reflects prospective entrepreneurial plans in relation to the cognitive skills held by the management team. And these skills are not static, but dynamic, subjective visions of economic agents undergoing changes in time, as other processes of interaction occur. The relevant interaction processes can be contextualized, of several types, from interaction within the industry, to interactions within the team. New subjective visions can then facilitate the emergence of other perceptions, which can lead to the emergence of a distinct absorptive capacity (Kor & Mahoney, 2004). These subjective visions impose certain practical limitations on the potential growth rate of the firm, managerial and entrepreneurial capacities being endogenous properties of economic agents, but not marketable elements (Teece, 1982). But these are strictly temporary limits, as we have already remembered. 

The cognitive profile of the firm 

We observe, at this point, the social positioning of the entrepreneur. No interaction process can be carried out in isolation, but strictly in relation to the incorporation of the entrepreneur in a socio-cognitive institutional context. And on the basis of this incorporation into a socio-institutional structure, economic agents accumulate experience-based knowledge that they use in a heterogeneous entrepreneurial function. Therefore, entrepreneurship is based exclusively on the distinct experiences of the members of an organization and implicit in their distinct ability to act. And this specific knowledge of the firm evolves over time as a result of historical interactions between the firm’s resources and the management team (Penrose, 1959), but also as a result of random events and efforts to solve current problems. Their experiences within the firm allow them to identify more precisely the opportunities that fall on the firm’s internal strength (Andrews, 1980). At this point we have two forms of heterogeneity. The first of these, managerial and epistemic heterogeneity, signifies the consolidation of a cognitive identity of the firm. Second, the heterogeneity of the resources owned by the firm, these resources being congruent with the internal vision of the firm and implicitly with the epistemic skills of the team.

Starting from Penrose’s subjective and heterogeneous approach, we understand that “it is never resources themselves that are the inputs in the productive process, but only the services that the resource can render” (1959, pp. 24-25). Which means that the cognitive identity of the firm will lead to a unique internal form of creativity, managerial resources dictating the quality and versatility of the services offered by the firm through the use of heterogeneous capital resources (Mahoney, 1995). Managers have a certain familiarity that concerns the “knowledge about the unique characteristics of machinery, physical environment, people, performance strategies, and jobs in a particular section at a particular time” (Goodman & Leyden, 1991). When managers engage in interactionist processes with other firms or other sectors and observe distinct ways to use the resources owned, they would develop an internal knowledge, which they would apply differentially within a firm, by the appearance of other resources or by modifying the services they want to obtain from the use of existing resources. This is why we state that the firm has a primary temporary limit, which refers to the goal and the early entrepreneurial expectations. We may add that not only real resources matter, but also the skills and cognitive values of the economic agents contractually incorporated in a firm, related to individual reactions to uncertainty, their affectivity and self-efficacy, and the degree to which they are actively participating in the perceptual and epistemic evolution of the managerial team. These cognitive differences of economic agents lead to the existence of several strategic options, necessary to avoid decision inertia (Levine et al. 1993). Thus, cognitive differences are necessary for perceptual transformation and implicitly for overcoming the cognitive limits of the firm, necessary for survival in a competitive economic environment, characterized by a continuous transformation.

And these cognitive peculiarities allow the unique identification of an investment opportunity in an information flow (Walsh, 1995). At this point, an observation is required. In an organization, every bit of experience-based knowledge can be internally transmissible, but the experiences of economic agents cannot be transferred, they produce subtle changes in individuals and cannot be separated from them (1959, p. 53). But this individual knowledge is added non-linearly to the cognitive identity of the firm and implicitly to the creativity of the organization, hence the importance of an entrepreneurial team that contains various perspectives (Tushman & O’Reilly, 1997) in the emergence of innovation.

Therefore, we can say that each firm has a cognitive identity. This refers to variable epistemic-productive and cultural capacities that are consolidated within the firm and that influence the development of the productive act within the organization. As we discussed, learning is eminently intersubjective and habitual, based on a unique experiential and interactionist structure of each economic agent actively incorporated in a firm. Which means that we find certain individual peculiarities that coagulate at the organization or firm level. This is why the uniqueness of the firms is given by the qualitative aspects of managerial resources (Barney & Arikan, 2001), which influence and are influenced by the cognitive identity of the firm. Continuing, organizations can be defined as “[…] goal-directed, boundary maintaining, and socially constructed systems of human activity” (Aldrich & Ruef, 1999, p. 2). But to assume that a firm has fixed limits would mean the elimination of epistemic differences and the implicit capacity for intersubjective participation. Each firm tends to evolve according to cognitive skills, the fallible identification of social needs or preferences, and these are inherently related to the embedded economic agents and implicitly their skills and perceptions. Put differently, these entrepreneurs learn, create and initiate n entrepreneurial opportunities through interaction with an unpredictable business environment (Witt, 1998), and this unpredictable business environment is due to the perceptive differences of the other firms situated in an institutional context. The distinct expectations and visions of the economic agents represent a plurality of beliefs and tacit knowledge, allowing the development of combinations of complementary creative resources (Prahalad & Bettis, 1986). But we could add that the combination of resources is not the only important variable, but also the uniqueness that transcends from this creativity. The growth of a firm is an evolutionary and cumulative process, regarding both the resources owned and its management (Spender, 1996).  

The evolutionary timeline 

If we need to provide an evolutionary timeline of the firm, we can say that the experiential structure of an entrepreneur will be reflected in the emergence of a perspective, which he will use to identify social needs and initiate a present production process. This experiential structure of the entrepreneur will represent the t0 cognitive moment of the firm. A firm, like an economic agent, represents a process-in-progress, being strictly an extension in the social-world of an imaginative entrepreneurial function, this being “a mode of exploration of the environment drawing on implicit understanding of sensorimotor regularities” (O’Regan & Noe, 2001), meaning that the entrepreneur can perceive a need subjectively only on the basis of a socio-interactionist activity, of a prior socialization in an institutional framework. Thus, in an intersubjective perspective of entrepreneurship, decision alternatives are not determined by the environment, but this environment offers n possibilities of action (Cole, 1978), each possibility being identified as beneficial due to the present perception and implicitly the identified productive capacities of the goods, which are described in terms of heterogeneity. And this phenomenon will translate into a unique way of organizing the firm, especially when we know that the capabilities of a firm and, implicitly, the owned resources influence the present expectations of the entrepreneur about the future (Boulding, 1956), expectations that change with the emergence of other bits of internal knowledge. In other words, the firm represents both a legal and a cognitive structure of intersubjective action. In this paper, we focus strictly on cognitive limits.

After exercising the entrepreneurial imaginative function, thanks to previous social experiences, the entrepreneur will organize the firm in a unique way, which will mean a certain departmental division, managers with a certain productive quality, certain heterogeneous capital goods and so on. This is the t0 moment of the firm, the first cognitive identity. This will ultimately lead to shared experiences and implicitly a non-substitutable organizational capital (Prescott & Visscher, 1980). The potential production capacity of the firm is congruent, at all times, with the social and experiential limits of the incorporated economic agents, but also with the principles coagulated at the firm level, limits that fluctuate with the appearance of other processes of interaction. Therefore, the more distinct perceptions are integrated into an organization, the more will the imaginative capacity of a firm regarding other investment opportunities be expanded (Holcombe, 2003).

Cognitive identity can also be understood as an informal structure of a firm, representing the normative and perceptual horizon of the firm, but also a certain shared meaning necessary for the future socialization of economic agents. This shared meaning implies the development of a complex communicative set, of a jargon, which will be the basis of the intra-firm activity. This cognitive identity guides and constrains, facilitates the emergence of a positive productive arrangement, providing a form of coordination necessary for the development of dynamic peculiarities in a team. These peculiarities ultimately lead to a certain familiarity (Zenger & Lawrence, 1989) and to the complementarization of the comparative advantages of all economic agents. Thus, in a social-world, there are firms, each with its own management, having the ability to be influenced and to exert influences on this social context. As firms are cognitively and complementarily interconnected, each presents certain epistemic and cultural peculiarities, which will be translated into a specific form of production, in an innovative capacity and certain cultural principles. And this interconnectivity will lead both to the possibility of introducing new productive stimuli in the social-world, and to the testing of the goods and services offered in relation to the social-world. 

The role of managers 

We were just discussing the choice of managers by entrepreneurs. These choices will be relevant given that managers will be the basis for departmental coordination. Therefore, the epistemic capabilities of managers are considered optimal by the entrepreneur-founder, and these capabilities come from prior interaction processes. The values of these managers will be translated into an idiosyncratic departmental evolution, in which there may be a communicative decentralization, which means that the original means of production are stimulated to participate actively in the productive development, or there is a cognitive centralization, through which managers assume rigid leadership positions. These peculiarities will add to the firm’s primary cognitive identity, given that the firm is a process-in-progress, producing a new identity arrangement, which will be translated into the firm’s informal culture, in the appearance of shared meanings. This identity arrangement is necessary for dynamic coordination within the firm, providing a certain organizational cohesion. Which means that a form of knowledge is developed “that some group of individuals usually conforms to (even unconsciously) in order to carry out purposive action” (Foss & Garzarelli, 2006). This coordinating element imprints certain unconsciously accepted rules that reduce the entropy of the firm, simplify the informal reality within the firm, which will facilitate the existence of autonomous processes of interaction whose results can be anticipated ex-ante, having an already accepted communicative set. This cognitive identity of the firm leads, therefore, to a process of convergence in time of the expectations of the economic agents, through which the optimal exercise of the production processes is pursued, optimal from a fallible perspective, related to the experiential horizon limits within the firm. This convergence will change over time as cognitive identity changes. At the same time, this identity can not only be understood as having a materially productive facilitation role, but also a normative role. In other words, it facilitates the emergence of different enforceable cultural properties, such as the active participation of all economic agents in the entrepreneurial act, the emphasis on long-term production planning, the existence of a low time preference, which will mean the existence of unused capital for uncertain events with potential, and so on; these being the underlying normative principles. These are properties relevant to the activity in the social world, by dictating the reactions in the face of uncertainty, the model of productive planning, each property having the ability to influence the development of the firm’s production. Therefore, starting from this cognitive identity, each firm has a specific response in the face of uncertainty, in the face of a recession, these unexpected events acting on the future behavior of the firm, on the development of a new antifragility. And these normative and cognitive properties are reconfigurable, they affect the idiosyncratic allocation of resources. 

Communication and cognition 

As there is the possibility of engaging in autonomous processes of interaction, given the cognitive-communicative structure of a firm, economic agents use the identity set in which they were socialized to reach a productive intersubjective communication within the organization, using certain spontaneous and informal internal rules. As the identity arrangement facilitates the coordination of subjective expectations, we come to the importance of identity evolution. Given that each firm has a relational autonomy, i.e., in relation to the sector in which it operates and implicitly with the social-world, and each firm has its own identity formed spontaneously, we understand that it can exert influences and can be influenced by other firms. Thus, the identity of each firm is also precarious, in which each subsidiary process becomes relevant and significant for the macro process of the firm, “which means that if the system was not organized like a network of processes, under otherwise equal physical conditions, isolated component processes of the system would tend to run down or extinguish” (De Jaegher et al., 2016). Thus, a firm represents an autonomous system maintained by complementary and interconnected relationships between departments and economic agents, hence the possibility of regenerating cognitive identity in time, by incorporating other economic agents. Which emphasizes that the identity of the firm remains functional only as long as all autonomous processes work, the elimination or appearance of another department modifying ex-post this identity. And this clarification is relevant because it emphasizes both the importance of the internal processes of the firm, and the importance of the cognitive pressure that comes from the social-world in which the firm was situated. Each firm is also inherently linked to external social processes, hence the importance of affordability, of productive imagination, each capital or final good being produced in other epistemic and cultural circumstances. And this communicative capacity, given that a firm is situated in the social-world, allows the emergence of cognitive pressures, epistemic exchanges that can lead to the modification of the structure of the firm. 

Conclusion 

The firm reflects unique cognitive characteristics, is characterized by a certain degree of flexibility and potential epistemic expansion. If the entrepreneur-founder or one of the firm’s managers, on the basis of autonomous interaction processes, specifically identifies a social need or the opportunity for a productive expansion, another internal subjective expectation occurs. There is an epistemic imbalance between the present production of the firm and the potential production that resulted from this intercorporeal identification of a new opportunity. At this point, other skills will be spontaneously developed, and these will lead to other potential interactions, the goods or services produced at a previous epistemic level will be considered in this new epistemic state as obsolete. What is pursued are the introduction of new economic functions of goods, new ways of production, a vertical expansion of the firm; in other words, there is both the production of new goods, and the modification of the functioning or quality of those present, depending on the new perceptual framework. These new perceptions will be introduced into the internal production processes, which will lead to the modification of the productive architecture within the firm. This modification of the productive architecture will mean the incorporation of other economic agents, with relatively different competences and cognitive skills, and they, given the organizational flexibility, will act on the normative framework in which they will be socialized, in a mutual relationship, but also on the limits of productive knowledge present, the normative framework giving them a complex basis of communication and significance. These new active components participate, thus, in the modification of the cognitive identity of the firm, it having, from now on, another organizational set and another portfolio. 

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OEconomica No. 1, 2016