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Corporate Governance, Business Strategy, and the Dynamics of Networks: A Theoretical Model and Application to the British Cotton Industry, 1830–1980 Steve Toms and Igor Filatotchev

Abstract Steve Toms University of York, UK Igor Filatotchev King’s College London, UK

This article develops a theoretical model to explain the variation of network structures and network dynamics according to industry and firm resource characteristics and the extent of resource dependency. It incorporates an accountability and corporate governance dimension and thereby seeks to explain the long-run processes of industrial and corporate change. To verify the theoretical framework, the article examines the long-run evolution of network structures in the British cotton industry. It shows how this industry developed network structures as part of the process of industrialization and then goes on to explain how these structures prevented flexible and timely responses to the later challenges of restructuring and re-equipping. The article also shows that the application of the theoretical model offers an opportunity to reinterpret the history of this archetypal industry. Keywords: strategy, networks, governance, Lancashire cotton textiles

Organization Studies 25(4): 629–651 ISSN 0170–8406 Copyright © 2004 SAGE Publications (London, Thousand Oaks, CA & New Delhi) www.egosnet.org/os

There is an increasing amount of research on network characteristics and dynamics and their links with organizational outcomes for network participants. Economics and management researchers have increasingly recognized that the network form of organization may be a superior analytical tool to the polar opposites of Williamson’s (1975) organizational continuum of internalization and contracting (Powell 1990; Thorelli 1986). In certain contexts, networks themselves may be a basis for creating and sustaining competitive advantage (Poire and Sabel 1984; Porter 1990). As a result, ‘organizational networks... are increasingly seen as a very promising form of trans-organizational relationships’ (Bachmann 2001: 337). However, an alternative view suggests that the promotion of regional clusters and networks may inhibit the growth of firms and of the region by promoting the formation of inward-looking, anti-entrepreneurial regional cliques. Institutional research, with its focus on imitation and mimetic isomorphism as drivers of network influence, suggests that network members tend to adopt the same practices as their network partners even if these practices are counterproductive in a rapidly changing environment (Beckman and Haunschild 2002; Westphal et al. 2001). This view explicitly stresses the negative effects of entrenchment among groups of employers and worker associations that can exercise a debilitating influence on the competitiveness of a regional economy by pricing DOI: 10.1177/0170840604040678

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its goods out of international markets (for a discussion, see Filatotchev and Toms 2003). Lastly, opportunistic behaviour by network members may increase the risk of ‘hold-up’ and ‘lock-in’ problems and create costs of bonding and mutual monitoring (Zaheer and Venkatraman 1995). Following previous research, networks are conceptualized in this study as modes of organizing economic activities through inter-firm coordination and cooperation (Grandori and Soda 1995: 184). These modes of organization consist of contractual relationships between network participants together with social arrangements (Granovetter 1985), in particular, interlocking directorates (Beckman and Haunschild 2002; Westphal et al. 2001). Specifically, in the analysis that follows, we focus on the social and contractual basis of interaction between directors. As a longitudinal variable, interlocking directorates act, or fail to act, to reform network characteristics as antecedent conditions alter. In the case of failure, this may follow from the negative effects of lock-in caused by opportunistic behaviour by network members. Despite considerable efforts, a number of conceptual and empirical gaps have been identified in the research on business networks. First, previous studies are predominantly focused on analysing a particular type of network or regional cluster, whereas empirical diversity in organizational form and industry evolution suggests that various network characteristics may coexist within the same industry (Rose 2000). Second, most previous research on organizational outcomes of network membership is based on static conceptual frameworks, and network dynamics have received relatively little attention (Casson 2003). Third, a number of more recent studies on network governance (for example, Gulati et al. 2000; Jones et al. 1997; Zaheer and Venkatraman 1995) suggest that general governance factors may also impact on network formation and characteristics. However, there is very little research on the possible roles of such governance elements as ownership structure, interlocking directorships, and involvement of financial institutions (Beckman and Haunschild 2002; Nooteboom 1996). The article extends previous research on network characteristics and makes a number of contributions. Specifically, it argues that network characteristics are a function of the resources available to the firm and the extent to which firms are accountable to outside stakeholders for those resources. In other words, it aims to synthesize the resource-based view of the firm and resourcedependence theory. This is consistent with Burt’s (1992: 61) definition of social capital, which is ‘at once the structure of contacts and the resources they each hold’. The latter is extended to incorporate the notion of accountability within a corporate governance framework. In addition, we extend further the strategic management research on links between organizational resources and strategic restructuring in turbulent environments (for an extensive literature review, see Kraatz and Zajac 2001) by analysing the impact of network characteristics and their dynamics on strategic change in a declining industry. To accommodate a theory of the firm in this fashion, it must be supposed that hierarchy substitution for pure market functions (nexus of contracts) is a necessary condition for the existence of firms, and also that substitution will always be partial. In other words, networks reflect the degree of market or

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hierarchy substitution (Fruin 1998) and are therefore adopted according to transaction-cost considerations. It is also assumed that organizations are open systems (Katz and Kahn 1966) so that they resemble networks and are interdependent with those elements of the environment they transact with (Pfeffer 1982: 192). In this context, resource-dependence theory assumes that firms have active choice and therefore power in responding to external pressures, but relative power may be contingent on the configuration of the resource-user to resource-provider relationship (Pfeffer 1981, 1992, 1997; Frooman 1999). Such relationships are usefully examined from a governance perspective where power is a function of moral hazard and information asymmetry. These asymmetries are symptomatic of hierarchical, market, and network relationships. It is thus sensible to extend network analysis to include the stakeholder groups (Freeman 1984) upon which the network depends for its resources. Although the power of an organization or group of organizations might be increased by reduced resource dependence (Provan et al. 1980), power can also be increased if the level of resource dependence remains constant, but information asymmetries or stakeholder monitoring costs rise. Although asymmetry in the exchange relationship is assumed in resourcedependence theory (Pfeffer and Salancik 1978: 53), the notion of accountability extends this to reflect institutional norms (DiMaggio and Powell 1991) or divergent, historically contingent, political economic relationships (Cooper and Sherer 1984; Hopwood 1987). Hence a final advantage of synthesizing the resource-based view and resource-dependency theories is that they assume a dynamic environment and are therefore appropriate for explaining organizational change (Penrose 1959; McKay 2001). To examine these processes through time, the study examines the British cotton textile industry in the period 1830–1980. Textiles were of central importance to the industrialization of Britain and have played a similar role in economic development in other economies. Recent studies have emphasized networks as part of a functioning industrial district, reflecting the dynamics of the industry’s development during its long history (Mass and Lazonick 1990; Rose 2000). In the British case, the industry provides a focus for the role of external versus internal economies of scale, resource dependency on customer and supplier groups within the vicissitudes of world markets, and accountability of managerial networks to external stakeholder groups, particularly banks, promoters, and financial syndicates. Although there are many attributes of this diverse industry that could have been addressed, the role of directors, in particular their interlocking relationships, is used to illustrate the evolution of network characteristics during the period. While it is beyond the scope of this article to challenge the established historiography, some reinterpretation of the evolution of the industry is nonetheless the result. The remainder of the article is divided into several further sections. The second section elaborates the theoretical model in greater detail. The third section applies the model to the history of the British cotton industry, first, in its expansion phase 1830–1914 and then in its decline phase, 1920–80. The fourth section discusses the implications of the reinterpreted empirical evidence and of the theoretical synthesis.

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Corporate Governance, Business Strategy, and the Characteristics of Networks: A Theoretical Model

This section briefly introduces the main theoretical elements of the proposed research model. Organizational diversity (strategy content) and ownership, governance, and accountability (strategy context) are discussed in turn. Network characteristics are explained as the outcome of the interplay of these elements. Network evolution through time is modelled as a function of industry growth and strategy context and content. The discussion then explains how the main aspects of the network literature (such as trust, information and transaction cost, institutions, and social change) are integrated into the model. Lastly, we provide an outline of dynamic interlinks between network characteristics and firm-level strategic decisions. Traditionally, business network research has focused on the strategic resource content of business activities. According to this view, managerial and entrepreneurial resources drive growth and diversification (Whittington and Mayer 2000). Such resources might include specialized production facilities, trade secrets, and engineering experience (Teece et al. 1997). They might also include firm-specific, idiosyncratic knowledge assets (Castanias and Helfat 1991). Such firm-specific factors are traditionally considered as the major drivers of strategic change according to the resource-based view (Barney 1997). At the same time, specialization may in certain periods of history and stages of economic development promote flexibility, replacing standardization and scale economies (Piore and Sabel 1984). Meanwhile, clustering of firms in industrial districts, trade associations, and other networked organizations may be promoted through sharing trade secrets and drawing on local pools of experience and skilled labour. These resemble knowledge pools or agglomeration-based external economies of scale originally described by Alfred Marshall (Kamien et al. 1992; Marshall 1890). Synthesizing these relationships, it can be proposed that organizational diversity and network characteristics are likely to be closely influenced by how the firm accesses resources. However, resource provision by external stakeholders, usage, and coordination should be properly monitored and protected from the opportunistic behaviour of network members (Gulati et al. 2000; Jones et al. 1997). Therefore, in addition to strategic resource content factors, the second important dimension of the analytical framework presented in this article is accountability, which refers to the processes whereby the stewards of the business are held accountable to its owners and other external stakeholders through the processes of corporate governance. Openness and secrecy in networks depend on existing patterns of control through agency and delegation (White 1992: 93). According to Casson’s (2003) typology, networks are transparent or opaque and this is consistent with the accountability perspective. Accountability also suggests an emphasis on the quality of information flow and facilitates a broader perspective than merely emphasizing the Chandlerian view of technology and the exploitation of associated scale and scope economies (Casson 1997; Hamilton and Feenstra 1995; Langlois and Robertson 1995).


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Capital dependence as a special case of resource dependence facilitates the notion of accountability in terms of governance factors such as ownership structure, the governance roles of corporate boards and institutional investors. Previous studies of interrelationships between ownership patterns, strategy, and performance have shown that large, outside stockholders have the incentive and the power to ensure that managers do not misuse resources and that they operate the firm efficiently (Bethel and Liebeskind 1993; Hoskisson et al. 1994). Research from a resource-dependence perspective has also emphasized the crucial role of outside institutional investors in providing the firm with the resources needed to survive and to function efficiently (Pfeffer 1972a; Wagner et al. 1998). Transparency of networks follows from capital dependence on these investors when, as a result, they impose more open governance structures. In particular, the relationships between resource providers and a focal firm, formalized through board representation, can improve information flows (Kroszner and Strahan 2001) and provide vital links with the firm’s environment that can help in obtaining the financial resources needed for effective restructuring (Pearce and Zahra 1991; Pfeffer 1972b; Provan 1980). In addition, restructuring expertise is directly related to the board diversity of a focal firm measured in terms of board size, the number of outside directors, and the number of outside directorships (‘interlocks’) each individual board member holds in other organizations within the industry and outside. For example, transparent networks that are based on heterogeneous ‘interlocks’, which include external resource providers, may improve a focal firm’s learning and strategic flexibility (Westphal et al. 2001). Alternatively, opaque, homogeneous, inter-board links (for example, between firms in the same industry or regional cluster) increase imitation and mimetic isomorphism within the network and lead to resistance to change (Beckman and Haunschild 2002). To summarize, it may be assumed that managerial unwillingness or lack of capacity to undertake change may impede strategic expansion, restructuring, and long-term survival in proto-industrial and declining industries such as textiles. These attitudes may be a function of governance and resource-based constraints, especially financial constraints (Filatotchev and Toms 2003). If organizational diversity is combined with the earlier perspective on accountability, this now provides a more detailed understanding of network characteristics and the processes that might influence their evolution through time. Figure 1 provides a summary of these relationships, best envisaged as two interacting continua with the extreme theoretical cases of pure hierarchy and pure market at either end of the vertical axis and of total transparency and complete secrecy at either end of the horizontal. The horizontal axis characterizes accountability as transparent or opaque and the vertical axis shows the degree of organizational diversity or the resource base of the firm as narrow or extensive. Each circle represents a combination of extremes and the arrows show that firms may be located along either continuum (directly extending Williamson in the case of vertical position). From a dynamic perspective, this framework allows movement through time from one state to another and also horizontally as network accountability varies through time. Diagonal movement occurs when the resource base and accountability

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Figure 1. Dynamic Determinants of Network Characteristics

structures vary simultaneously. On the horizontal axis, the degree of transparency will be a function of the degree of dependency on external stakeholders for resources, especially financial resources, which creates reciprocal agency, monitoring, and transaction costs. Opaque networks are unaccountable to external stakeholders and more likely to be self-sufficient in resource terms. Transparent networks, on the other hand, demonstrate accountability and are more likely to be resource dependent. At the same time, on the vertical axis large and diverse organizations, by definition, have control over a wider resource base and have the option of internalizing them using a hierarchical structure. Similarly, small-scale and specialized firms draw on a narrow resource base and will draw on market inputs for non-specialized functions. Following Williamson (1985), networks are seen in the literature as ‘hybrids’, in the context of substituting network relationships for organizational hierarchies (Ahmadjian and Lincoln 2001: 685). However, following similar logic it is also possible to arrive at a network as a hybrid through a process of market substitution. Since pure markets and pure hierarchies constitute the extremes of the vertical continuum in Figure 1, it follows that the replacement of hierarchy by hybrid arrangements is likely where there is low risk of opportunistic behaviour, ease of monitoring, and low asset specificity (Williamson 1985). The opposite conditions therefore lead to a similar process of replacement of market arrangements with a network hybrid.

Resource Base

Extensive Type 3: Hierarchyoriented, opaque networks

Type 4: Hierarchyoriented, transparent networks

Type 2: Market-oriented, opaque networks

Type 1: Market-oriented, transparent networks

Narrow Low

High Resource Dependency


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Following Williamson (1975, 1985, 1992) and Fruin (1998) and taking a markets and hierarchies perspective on Figure 1, if networks are assumed to combine elements of both, then they will tend to replace one or the other. Thus, if there is a pure market and a network develops, it will tend to encompass market processes. Examples might include inter-firm arrangements to control supply and price, particularly where firms with narrow resource bases lack the market power to do so singly. Similarly, if there is hierarchy, network development accompanies the strategic decentralization of the original internal relationships (Fruin 1998: 9). Examples might include spin-offs, an increase in the strategic autonomy of business units in a holding company, outsourcing to associated companies, and enforcement of supply via dedicated contracts to replace formal integration. Where networks replace markets or hierarchies, ownership ties and interlocking directorships might be used to police arrangements. Also, accountability of network members to external resource providers may reflect the politics of regulation and ideology (Davis et al. 1994). Competition policy, company law, and rules governing financial institutions are the obvious examples (Fligstein 1990). The absence or presence of such rules influences the viability of secretive cartels and the level of protection offered to external stakeholders. Meanwhile, prevailing ideology may influence the extent to which managers acquiesce to or promote accountability to external stakeholders (Lazonick and O’Sullivan 2000). For the purposes of analysis, these dynamic interdependencies can be set out as a network typology corresponding to the circles in Figure 1: Type 1 Market-oriented, high external resource dependency (resourcedependent) networks. Type 2 Market-oriented, low external resource dependency (self-sufficient) networks. Type 3 Hierarchy-oriented, low external resource dependency (selfsufficient) networks. Type 4 Hierarchy-oriented, high external resource dependency (resourcedependent) networks. Figure 1 is a dynamic model that explains network development and changes in network structure. Pure markets and pure hierarchies, which lie at either end of the vertical continuum in Figure 1, are useful theoretical abstractions, but are rarely found in practice. Similarly, information is always costly to acquire, but valueless if never exploited commercially, suggesting the impossibility of totally efficient markets (Grossman and Stiglitz 1980) and also, therefore, the horizontal extremes of total and zero accountability. Networks are hence common and easy to identify in most business situations. Because networks can evolve from hierarchies or markets, they may display similar characteristics once the evolutionary process is complete. It is therefore important to distinguish these dynamic movements from the comparatively static situations implied merely by Williamsonian market or hierarchy substitution. This requires differentiation between hierarchy and market substitution in terms of process and the dynamic characteristics of the

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model, either by reference to the ex ante conditions (predominantly hierarchy or predominantly market) or to the forces impelling vertical movement. More interesting than mere identification and classification of networks, therefore, are the cause and effect relationships governing their timedependent dynamics. In this article, we focus on the forces governing these changes. The firm’s ability to internalize resources, including knowledge assets that underpin managerial economies of scope, is a function of the firms’ resource base and therefore the presence of internal economies of scale and scope. Conversely, narrow resource bases and external economies of scale and scope exert a pull towards markets. At the same time, if firms are selfsufficient in resources or if a network can be used to share resources on such a basis, the network will have no recourse to outside resource providers and monitors. On the transparency side of the continuum, the use of a network to secure access to outside resources requires the involvement of outside resource providers and structures of governance and accountability to mediate network relationships. From this analysis, it can be seen that trust tends to be low on the left-hand side of Figure 1 and high on the right. This is broadly consistent with Casson’s (2003) view, in which trust is based on personal contacts in a context of repeat transactions. A number of recent studies on trust in organizational behaviour research also suggests that cooperation is a more likely result when transactions are repeated through time (see, for example, Bachmann 2001; Reed 2001). However, previous research has not provided a comprehensive analysis of the interrelationships between accountability, corporate governance, and trust. While Marshall’s (1890) discussion of industrial districts has little room for concepts such as business networks and trust (Langlois and Robertson 1995: 125), the model in Figure 1 provides a clear and explicit linkage between trust, Marshallian external economies, and network characteristics. To summarize, the above discussion has suggested a number of possible determinants of network characteristics and their dynamics. In general, the model suggests that variation in resource base under conditions of unchanging accountability or a constant resource base under conditions of varying accountability will produce vertical or horizontal movement. As an example of the former, reduced asset specificity in a hierarchy-substituting hybrid may lead to greater market orientation among network participants (Ahmadjian and Lincoln 2001: 692–693). As an example of the second case, reduced capital dependency may lead to reduced accountability of network members to outsiders. More likely are simultaneous changes in the organizational resource base and accountability, where the consequence is diagonal movement. In this case, the above two examples can be combined to consider their net effects so that changes in asset base and therefore the degree of asset specificity are also very likely accompanied by changes in capital dependency and thus changes in the degree of accountability. This analysis also indicates that when a particular industry is characterized by a high degree of heterogeneity in terms of organizational structures and governance arrangements, it can sustain a range of networks with different characteristics. A radical change in the industry’s environment (for example,


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the end of a growth phase and beginning of decline) would require the strategic reorientation of its members, and strategy research suggests that differences in organizations’ resource endowments may affect their propensity for strategic change under turbulent conditions (for a review, see Kraatz and Zajac 2001). Building on this research we suggest that network characteristics may also impact on the strategic decisions of individual companies, and some types of network that are built around inherited resources and related governance arrangements may promote or prevent strategic restructuring. For example, in an environment of industrial decline, self-sufficient and opaque networks that are based on homogeneous, within-industry board interlocks may encourage managerial entrenchment and sustained efforts to preserve the status quo. Instead of proactive strategic restructuring, these organizational outcomes provide incentives for collusion and price fixing among the network members. Alternatively, resource-dependent and transparent networks that are cemented by interlocks among heterogeneous network partners may support strategic restructuring by providing access to external (financial) resources and, more importantly, facilitating learning and the strategic flexibility of focal firms (Beckman and Haunschild 2002; Westphal et al. 2001). The corollary of these arguments is that ex ante organizational diversity and governance arrangements shape networks within industries. However, when industry fortune changes, existing networks will impact on ex post restructuring efforts in response to decline. As a result, within the same industry one can expect a wide diversity of strategies and organizational outcomes. While the validity of these arguments may be assessed with reference to their congruence with the theories from which they have been drawn, the above synthesis has necessarily involved a degree of abstraction. It is thus useful to examine the utility of the model with reference to the longrun development of an actual industry. The remainder of the article will therefore assess the model with reference to changes in governance structures, organizational resources, and network characteristics of the British cotton industry. The evolution of the industry approximately follows a series of stages, during which each of the four types of network outlined in Figure 1 could be observed playing an important role. Within the typology, transition phases can also be identified and these are set out in Figure 2, which extends Figure 1 to incorporate these dynamics.

Networks and Governance in the Lancashire Cotton Textile Industry

Type 1 in Figure 1 features market-oriented, high external resource dependency networks. Such networks are likely to occur in new and growing industries and are characterized by low initial asset specificity and a high risk of opportunism. In the early textile industry, networks of individuals replaced market processes utilizing the putting-out system. Monitoring problems and high rates of defalcation led to the internalization of these relationships by

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the factory system. However, these firms were strictly limited in scope and resisted hierarchical arrangements, partly because of the lack of managerial talent (Pollard 1965). Continued reliance on market processes meant that the evolving networks had the appearance of market-oriented hybrids. From 1830, the majority of firms participated in what resembled the classic Marshallian industrial district, with a high degree of specialization by process. The completion of the railway network in the 1840s linked coalfields, cotton towns, and factor markets. External economies of scale and narrow resource bases at the level of the individual firm formed the antecedents of inter-firm cooperation within the network. Horizontally specialized firms were located around regional centres of specialization (Kenney 1982). Each area possessed its own distinctive technical education and machinery (Lorenz 1994), providing firms with access to agglomeration economies such as pools of specialized labour. Examples include the coarse spinners of the Oldham district, the fine spinners around Bolton, and the weavers of North-East Lancashire (Farnie 1979). Commercial and financial services were essential for local manufacturers to reach export markets and to access working capital for the long credit cycles that this involved (Chapman 1979), and this promoted high dependency on credit providers. These linkages formed the basis of social interactions between entrepreneurs and market operators and their network structures. In Manchester, cotton entrepreneurs acted collectively to form their own joint-stock banks in the 1840s (Jones 1978: 105). In Oldham, the cooperative societies were able to create the largest single-site mills in the industry by raising finance from share lists of the local population using a one shareholder-one vote system. Directors and auditors in these new mills exercised an intermediary accountability function between the mill manager and salesman and well-attended quarterly shareholder meetings, earning nominal fees in return. This system promoted transparent governance structures and a relatively efficient stock market in turn promoted managerial accountability (Toms 1998). Type 2 in Figure 1 describes similar market-oriented networks, but with reduced resource dependence and accountability. As industries grow and capital accumulates, firms are more likely to find themselves in this position. In textiles, dependency evolved into new institutional structures, replacing acceptance houses and banks with futures markets and stock markets while trade associations regulated prices, wages, and output (Jewkes and Gray 1935; Mass and Lazonick 1990: 16–17). Judgement of prices, and hence margin, and also regular liaison with particular brokers and merchants in the difficult futures markets of Liverpool and Manchester were the crucial ingredients of entrepreneurial success for the cotton spinner (Chapman 1996; Toms 1996a). Exchange membership and linkages with broker and warehousing firms developed around these functions (Farnie and Nakaoka 2000), and these contacts created vertical networks between producer, customer, and supplier organizations. These new institutions, particularly cotton and yarn futures markets, internalized the role previously performed by the banks on behalf of the firm and assisted the development of more opaque network structures. Poor


Figure 2. Network Dynamics in the Lancashire Textile Industry, 1830–1980

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remuneration and managerial economies of scope based on deal networks in Manchester and Liverpool provided incentives for building crossdirectorships to exploit private profit opportunities (Toms 2002). Meanwhile, the prolonged slump of the early 1890s provided the opportunity to buy blocks of cheap shares and secure control of mills from the cooperators (Toms 2001). Groupings of multiple directors and promotional cliques are identifiable from archival records (Toms 2002). These promoters raised finance from known contacts. Finance was also raised using spare cash from existing companies. These processes cemented homogeneous, industry-focused, directors’ interlocks. The result was that companies that had previously been controlled by a broad shareholder base were consolidated into business empires controlled by cliques of directors and cross-shareholdings. In terms of Figure 2, which presents the transition phases of networks in the industry, this represented a shift from bottom right to left, from Type 1 to Type 2, reflecting reduced dependence on the local community for financial resources. The same pattern was repeated in several other sub-sectors of the industry and reflected profit levels in excess of the capital required to fund the growth required by increases in the efficient scale of production in single mill units. Where profits were made in private concerns from single mill enterprises, a common pattern was reinvestment in the construction of new mills or the purchase of existing enterprises as going concerns. Interlocking directorships

Extensive Shiloh; Whitecroft, 1950–80

Resource Base

LCC; CEM; other federal combines, 1930–60

Industrial district; individual empires, 1890–1950

Early manufacturers, 1830–50; Oldham, 1860–90

Narrow Low

High Resource Dependency

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were used to create business groups of operationally independent firms. For instance, William Birtwistle (1855–1936) and his emergent group of companies provide a good example of the type of empire building associated with entrepreneurs prepared to buy up businesses as going concerns, thereby creating networks of related, but unintegrated companies. By 1914, Birtwistle was ‘one of the most powerful men in the trade’, although none of the individual firms was particularly large (Birtwistle Group n.d.). Another example was Thomas Burrows (1839–1906), who acquired control of several mills in the Burnley district. None of these was significant in its own right, but their combined size made Burrows a significant entrepreneur. This pattern of business organization and development was typical and similar to other multi-business enterprises formed by interlocking directorates, for example, Fielden, Horrocks, Osbourne, and Tootals (Toms 1993, 1994, 1996a, 1996b). In summary, Lancashire firms retained only narrow resource bases within the company, while directors were able to amass financial resources. Again, these tendencies promoted market-substituting, self-sufficient networks with opaque accountability structures, indicated by a shift from right to left in Figure 2. The net result of these processes, which were further underpinned by the reflotation boom of 1920, was to reinforce the cliques of interlocking directorships that controlled much of the industry. This control remained a crucial feature of the industry in its decline phase. A survey using the annual returns of these companies in the 1950s revealed a pattern of interlocking directorships and a rump of residual, small private shareholders (Filatotchev and Toms 2003). Table 1 shows that the typical Lancashire director sat on the boards of far more companies in comparison to national averages. The average director of the typical large British company in 1950 held just the one board position. In contrast, the Lancashire director held three or four board positions, with a significant minority holding more than six. This governance structure reflected the 19th and early 20th-century developments referred to above. Hence, the most common type of interlock was in other cotton industry companies. The average age of each director in the Table 1 sample was 59 years, suggesting that while many had served during the crisis years of the interwar period, a minority had also participated in the development of earlier directorial cliques. At the same time, it is suggestive that centralization of directors’ power acted as a barrier to the development of new managerial talent. Instead of institutional ownership, substantial shareownership by directors, their families, and members of founding families persisted. To summarize, the majority of firms in the industry were classic ‘Berle and Means’ companies, with powerful, networked directors and weak, inactive shareholders (Berle and Means 1932). When industry decline had set in, the strategy response on an enterprise level was a function of the system of corporate governance and the narrow, specialized, and increasingly obsolete resource base. Realizable values for production assets were low as shrinking markets created overcapacity and undermined the second-hand market. These assets were highly specific, especially machinery, and in most cases were of old vintage (Miles 1968:

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Table 1. The Distribution of Directorships in British Enterprises, 1950

Cotton Textiles, 1950 (1) No. of directorships per person 1 2 3–5 6 or more

19.2% 13.2% 43.7% 23.9%

All British Enterprises (2) 87.4% 8.5% 3.9% 0.2%

Sources: Annual Returns (form E) Companies House and PRO files and Scott (1997: 117). Notes: (1) Percentage of directors in each category from a sample of 167 directors from 45 quoted textile companies (2) Percentage of directors in each category from the top 250 British enterprises. The percentage is estimated from Scott (1997: 117), which provides breakdowns for the years 1938 and 1976. the figures shown here are an average for those two years.

38–39). Re-equipment meant investment in new, but more expensive technology with high replacement cost. Thus, the only rational strategy from the point of view of financial claim holders was to realize value from the continued use of assets. Because this offered no solution to the problems of overcapacity, the main mechanism used by interlocking directors to control inter-firm relations was the use of the industry association. Hence, specialized firms survived on meagre, but positive cash flows, shared out according to the price-fixing rules enforced by employers’ organizations such as the Yarn Spinners’ Association. In this fashion, self-sufficient cliques of directors replaced market processes, shared resources, and prevented exit from the industry. The specialized marketing and production structures that had created competitive advantage before 1914 were by the 1920s and 1930s the subject of increasing criticism from contemporaries (Lazonick 1983). Hence, the main block to rationalization was the opacity of governance structures and the intransigence of the self-sufficient directorial cliques that had built up before 1914. In other words, specific network characteristics described by Type 2 created serious barriers for effective restructuring in the declining industry. Type 3 in Figure 1 illustrates the development of networks that are hierarchy-substituting hybrids with low external accountability. It is necessary to look primarily in the post-1920 period for cases of hierarchy substitution effects promoted by cross-directorships. Forced rationalization by Bank of England intervention occurred as a solution to the problems of overcapacity and the problem of capital secured on overvalued assets and as a solution to free-riding violations of price-fixing agreements organized by industry members (Higgins and Toms 2003). This promoted consolidation of the resource bases of many firms, while entrenched directors resisted transitions to greater accountability. Reformers advocated a more concentrated industry, as a means of driving down unit costs, while retaining the advantages of external economies (Keynes 1981: 583). Subsequent research has shown that those firms that widened their resource base through vertical integration were more successful in this period (Higgins and Toms 1997).

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Amalgamations such as the Lancashire Cotton Corporation (LCC) and Combined Egyptian Mills (CEM) were originally formed with the express purpose of rationalizing the industry (Bamberg 1988). Although some closures followed, the immediate net effect of these amalgamations was to internalize significant proportions of coarse spinning (LCC) and fine spinning (CEM) within holding-type structures. These amalgamations widened their resource bases in terms of productive capacity and specialist staff, thereby allowing headquarters coordination of what were previously market transactions. On the LCC’s formation in 1929, a new management structure was imposed and decisions previously made at plant level (for example, on product range) were centralized (Bennet 1933). The amalgamations also rationalized by selling off or closing down the least efficient units, thereby reducing their dependency on the Bank of England and other external financial stakeholders. The effect was to create secrecy and to promote price-fixing agreements utilizing intra-industry connections. Although LCC and CEM were originally conceived as holding companies, they subsequently developed into networks of semi-independent business units cemented by interlocks and collusion in terms of price and quantity setting. These processes allowed extensive resource networks to develop (as indicated by the vertical movement in Figure 2) in parallel to the surviving firms in the industrial district model. Despite (and because of) the importation of outside managers, the companies found the process of matching production in individual mills to the large number of small orders very difficult relative to the efficiency with which this had been traditionally carried out using the markets of Liverpool and Manchester. As suggested by Williamson (1975), the number of units to be coordinated imposes limits on the size of hierarchies. Low asset specificity combined with overcapacity prompted greater independence within a network otherwise linked by interlocks. Under the new leadership of Frank Platt the LCC, for example, reverted to the traditional federal model adopted by earlier amalgamations in 1900 and 1920 and in which local directors retained power, with high degrees of autonomy in terms of securing orders, production arrangements, and transactions with suppliers and customers (Bennet 1933; Bamberg 1984–86: 719). Although they differ in terms of fundamental contextual factors, such as scale, products and markets, the autonomy of the individual business unit in these combines is similar to the model of the modern transnational corporation that has a number of relatively independent subsidiaries abroad and that falls between hierarchies and networks (Bartlett and Ghoshal 1999). Such decentralization of holding structures and development of networks of cross-directorships were implicated in the strategies of several firms in the post-1945 period. The LCC obtained agreement in target mills by exploiting boardroom linkages. Networks of interlocking directors across otherwise independent companies formed the basis for subsequent absorption into the larger firms. Examples include the LCC’s acquisition of A. A. Crompton, Argyll, and Durban Mills and Shiloh’s amalgamation with Park and Roy Mills. These combinations facilitated the organization of capacity sharing through price maintenance, which remained legal until the abolition of the Yarn


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Spinners’ Agreement in 1958. Unrelated diversification, for example the acquisition of brickmaking and electrical companies lacked strategic fit, but were made to help retain managerial talent within the firm’s resource base (Filatotchev and Toms 2003). Where firms were not integrated directly into the managerial hierarchy, contracts were secured through cross-directorships, for example in the finishing industry. Cyril Lord Ltd and other amalgamations, such as the Shiloh Group, proceeded on the same lines (Filatotchev and Toms 2003). An illiquid and inefficient capital market compounded the difficulties faced by shareholders in monitoring their investments (Higgins and Toms 2000). Diversification reflected existing networks and promoted further interlocks, and these tended to exploit only local business contacts. In the case of the Bleachers’ Association, new ventures were confined to Lancashire because its directors preferred to do business over drinks and on the golf course (Jeremy 1993; Singleton 1996). Nowhere did these transactions promote greater accountability. Instead of relying on large, professionally managed hierarchies, these firms continued to reflect the network relationships of the directorial cliques that had come to dominate the industry. This system of governance and opaque accountability illustrates that rationalization of organizational resources is not in itself sufficient for industry restructuring. Access to outside resource providers was also required, but increasingly difficult to secure. The final empirical case to consider is the relatively few combines that were able to extend their resource base through further diversification by drawing new finance providers into their networks. In Figure 2, these simultaneous processes resulted in the rightward diagonal movement illustrated. Shiloh and the Bleachers’ Association (later Whitecroft plc) (Jeremy 1993) used external networks that involved City contacts to raise financial resources, which in turn facilitated diversification and widened the resource base of the firm. These actively restructuring firms were also involved in networks based on interlocking directorships and cross-share ownership, but these heterogeneous networks linked them with financial resource providers outside the declining industry, thereby increasing transparency. Managerial economies of scope now reflected techniques of financial control in portfolio businesses rather than the traditional specialized knowledge of the Lancashire region. Diversification meant that the survivors became less like mainstream textile companies and increasingly conglomerate in form. As a result, their network characteristics featured hierarchy substitution and increased accountability to external resource providers. Only where there had been a previous history of amalgamation was there evidence of a modern model of corporate governance, that is, increasing institutional shareholding and the growing importance of board interlocks with firms outside the industry. The last years of the LCC illustrate that widening the resource base through diversification was a necessary, but not sufficient condition of effective longterm strategic restructuring. Such strategies also required extending the network of business contacts beyond the traditional industrial district, particularly to secure the support of City-based financial backers. By 1962 it had become apparent that the reduction in capacity brought about by the

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Cotton Industry Act of 1959 had been offset by the substantial rise in imports, and excess capacity remained a problem. In these circumstances, the LCC board proposed to accelerate its programme of acquiring other mills, possibly in collaboration with other combines. Although the strategy continued to reflect interlocking directorships, the firm’s political lobbying power remained weak. In the face of takeover threats, the objective of the LCC board was to create powerful groupings that could lobby government to defend Lancashire’s dwindling share of the domestic market based on the directors’ power base of local networks. Lack of political influence undermined the financial viability of the LCC’s restructuring plan and paved the way for the Courtaulds takeover of the LCC. The need to create powerful groupings also explained the Courtaulds takeover of FCSDA subsequent to its acquisition of the LCC (Rose 2000: 287–288) and also why the rationalized industry that emerged after 1965 was one of the most concentrated in the world.

Governance, Business Strategy, and Networks: Discussion and Future Research

The above discussion has emphasized the roles of resource location, economies of scale, and specialization. In the case of the Lancashire textile industry, the development of external economies of scale coupled with specialization in production has much in common with traditional explanations of its rise and fall. Another important dimension, the role of accountability and governance, has also been emphasized in the above narrative. Combined with an analysis of the resource base of participant companies, this has been used to analyse the principal features of the dominant business networks. In particular, the concentration of power among directors and its parallel dispersal among shareholders played a significant role in the evolution of the industry. The theoretical framework presented above offered a typology of networks and identified two processes likely to interact jointly to account for dynamic transitions in network structure. The typology can now be used to summarize the dynamic evolution of the industry that is revealed in detail by the earlier narrative. For the majority of the period 1860–1960, most firms gravitated towards an industrial district whose principal characteristics were its specialized resource base and internalization of external economies of scale using a network structure of directors that promoted self-sufficiency, secrecy, and independence from external stakeholder groups. These processes were self-reinforcing and impeded movement in response to changes in economic conditions. Most of these firms therefore moved towards and became locked into Type 2, market-oriented, low external resource dependency networks. Earlier firms (before 1860) had a greater dependency on banking and overseas agency networks. Other firms for limited periods also developed networks of greater openness. In Oldham, in the period 1860–90, a cooperative ideology and resource sharing by small investors promoted transparent accountability. This was a temporary phenomenon, since the principal method of raising finance (new stock-exchange share issues) facilitated manipulation by insider


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groups and the usurpation of control by cliques of directors. Oldham firms therefore underwent transition from Type 1 to Type 2 in the 1860–90 period. The LCC, from its inception in 1929, was intended to be a centralized, professional hierarchy. This was never a substitute for the relatively efficient markets of Manchester and Liverpool, and until 1960, the LCC operated as a more decentralized organization, allowing autonomy to the managers of individual mills and basing its acquisition strategy on local knowledge and contacts. The firms represented a tightly related network that was held together by cross-ownership of shares and directors’ interlocks. For the period 1900–60, the LCC (from 1932) and other larger firms moved towards Type 3 networks. Surviving groupings in the later period were able to diversify away from cotton as the industry declined and to sustain a wider resource base. To do this, they had to secure outside finance and accede to new structures of accountability and governance. Type 4 describes the networking characteristics of this strategy. For the majority of firms characterized by the Lancashire model of network capitalism, industry growth encouraged the concentration of directors’ power. In turn, this undermined accountability and acted as a barrier to restructuring during decline. While emphasizing the role of accountability, the above discussion has also showed how the ownership and management structure of the industry interacted with organizational diversity. Hence in the 19th century, the rise of specialization also promoted the informally interlocked group of firms. In the 20th century, interlocks reinforced specialization and acted as a constraint on restructuring. Only in the minority of cases, where board interlocks and cross-share ownership involving stakeholder organizations outside the industry were associated with organizational diversity, were recovery strategies achieved. From the 1890s onwards, the Lancashire textile industrial district developed a highly unusual system of governance. It was based on diversified directors and non-diversified shareholders (in the conventional model of Anglo-Saxon economies, it is the other way round). Although industry decline and the failure of the vast majority of firms to adapt to new trading conditions may be explained by a wide range of firm and industry-level factors, this model of corporate governance certainly contributed to a deepening organizational crisis in this very important sector of the UK economy. As the case study suggests, the model has proved useful in analysing and to a certain extent reinterpreting the evolution of an important industry. It illustrates the dynamic relationship between resource sharing and resource dependence and the formation of network characteristics. In the case presented here, growth of external economies of scale promoted resource sharing, network self-sufficiency, and increasingly opaque accountability. When growth became decline, the narrow resource base and self-sufficient opacity operated jointly to prevent orderly retreat from a declining industry. In industries facing secular decline, firms must utilize their network structures to reconfigure by obtaining new resources for re-equipment or diversification and therefore secure access to outside financial resource providers. Network contacts with City-based institutions were therefore

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important for the surviving firms and their absence explains the LCC’s ultimate failure in the early 1960s. In the general case, consideration of such network relationships between groups of firms and capital providers may offer a useful additional dimension of organizational analysis. Although the empirical sections of the article have provided some detail, a possible criticism is that the model has drawn on other theoretical perspectives selectively in order to derive features useful for explaining the characteristics of one industry. Therefore the true test of its value will be its utility when applied to other industries, districts or networks, or applicability in developing research methodologies to examine network dynamics in other organizational contexts.

Note

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An earlier version of this article was presented at the Academy of Management meeting, Denver, August 2002. The authors would like to thank the participants for their constructive comments. We would also like to thank Reinhard Bachmann and an anonymous reviewer. Regarding data sources, annual returns (form E) for 51 textile companies were obtained from Companies House, London and the Public Record Office, Kew (File BT/31). Additional data were obtained from Lancashire County Record Office (LCRO); T. and R. Eccles DDX/868/7/1, profit and loss accounts and balance sheets; Geo. Whiteley Ltd, LCRO, DDX/868/21/5, balance sheets; and from the Stock Exchange Official Intelligence, 1890–1965.

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Steve Toms

Steve Toms is Professor of Accounting and Business History at the University of York. He earned his PhD on the finance and growth of the Lancashire cotton textile industry from the University of Nottingham in 1996. He has published extensively in the fields of accounting and business history in journals such as Accounting Organizations and Society, Accounting and Business Research, and Business History. Address: Department of Management Studies, University of York, Grimston House, Heslington, York YO10 5DD, UK. E-mail: [email protected]

Igor Filatotchev

Igor Filatotchev is Professor of International Strategic Management at King’s College, London. He earned his PhD in Economics from the Institute of World Economy and International Relations (Moscow) in 1985. He has published extensively in the fields of corporate governance and strategy in journals such as Academy of Management Journal, Strategic Management Journal, California Management Review, Journal of International Business Studies, and Journal of Management Studies. Address: The Management Centre, King’s College London, 150 Stamford Street, London SE1 9NN, UK. E-mail: [email protected]