There is a small industry of commentators who decode the Berkshire Hathaway (BHI) Annual Letter to Shareholders – which includes Bill Gates.\u00a0 Their findings vary but the letter released this February was especially interesting (in Gates Notes<\/em> – \u201cthe best ever\u201d).\u00a0 Most focused on BHI\u2019s financials, only to be expected.\u00a0 But the letter included wide-ranging remarks by the \u2018Sage of Omaha\u2019 on the economy, the history of US productivity, and today\u2019s social inequality.\u00a0 Few remarked his stating that an economy driven by rising productivity leads to job losses for people whose skills get outmoded or when production moves elsewhere.\u00a0 Or that \u2018safety nets\u2019 are needed, fabricated in Congress\u2019s \u2018contentious clashes\u2019.\u00a0 His analysis was ultimately sunny as he argued US productivity would continue upwards, the US\u2019s \u2018secret sauce\u2019.\u00a0 Few disputed this, given we are only beginning to digest the contrary view provided in Robert Gordon\u2019s monumental The Rise and Fall of American Growth<\/em> (Princeton University Press 2016) – a few pages longer than Thomas Piketty\u2019s equally monumental Capital in the 21st<\/sup> Century<\/em> (Belknap 2014) (also applauded in Gates Notes<\/em>).\u00a0 If economy-wide productivity increases no longer pay for the safety nets Congress finally fashions, Buffett\u2019s sun sets.\u00a0 Perhaps the 99%\u2019s and Reich\u2019s \u2018anxious class\u2019 sense a different future.<\/p>\n <\/p>\n Of course Buffett is a practicing manager and less interested in academic talk and macro-generalities than in the specifics of the firms in which BHI invested – whose managers were surely measured on how they pushed their firm\u2019s productivity ahead.\u00a0 His letter was a superb lesson on \u2018business models\u2019, the topic of much sloppy academic talk.\u00a0 But Daniel Gross, executive editor at strategy+business<\/em>, seemed alone in noting the letter\u2019s display of Buffett\u2019s deeper grasp, his own \u2018secret sauce\u2019.\u00a0 Buffett\u2019s tale of what happened to BHI\u2019s Dexter shoe-making operation differed from the usual story of overseas competition\u2019s impact.\u00a0 It suggested a more fundamental business model or \u2018theory of the firm\u2019 – that firms can sometimes evolve faster than the people they employ.<\/p>\n <\/p>\n How can this happen?\u00a0 As shareholder value overtook firm growth as the goal, Wall Street innovated with maneuvers that included liquidating the firm, laying off its people, and directing the funds released into different lines of business.\u00a0 So long as relevant markets existed, tangible (tradable) assets can be reallocated almost instantly.\u00a0 People, less tradable, get left behind.\u00a0 Buffett was not sympathetic, writing \u201cWhen Wall Street gets innovative, watch out!\u201d and that BHI \u201conly goes where it is welcome\u201d, recognizing every firm is more than its tradable assets and has been created by a workforce and community whose future cannot be airbrushed out with simplistic finance talk.\u00a0 Entrepreneurial managers have a double responsibility; to make the firm\u2019s future, but also to deal with its past.<\/p>\n <\/p>\n There has been plenty of discussion about the \u2018structural unemployment\u2019 resulting from investor-oriented strategizing.\u00a0 There is also a huge literature on \u2018change management\u2019 – but little attention to firms changing faster than the people who bring them to life.\u00a0 Firms are actually puzzles we do not understand well – as Nobel-winner Ronald Coase pointed out in 1937 when he asked why firms exist and are as they are.\u00a0 The most familiar metaphors for firms are: (a) carefully designed and operated machines, (b) communities of motivated people, or (c) as Citizen\u2019s United vs FEC<\/em> suggested, economic actors or \u2018persons\u2019 themselves.\u00a0 None tell us much about firms and people evolving at different rates.\u00a0 What was Buffett thinking?\u00a0 Gross explained people face barriers to change that firms do not and so have fewer options and \u2018levers to pull\u2019.\u00a0 True, but there seems to be more to it and maybe Buffett intuited something about the nature of firms, to use Coase\u2019s term, that is unlike the nature of either people or machines.\u00a0 Perhaps, being so thoughtful about the nature and social place of private sector firms, as well as successful, he knows something about (c) that informs BHI\u2019s investing.<\/p>\n <\/p>\n The recent Citizen\u2019s United vs FEC<\/em> and McCutcheon vs FEC<\/em> judgments have centuries of legal debate behind them showing corporate lawyers are far from agreed about what firms are – even if management academics have no such doubts.\u00a0 On the one side are \u2018corporate nominalists\u2019 who see the firm as a bundle of contracts between individual shareholders governing their property and its application.\u00a0 On the other, \u2018corporate realists\u2019 who see firms as distinct legal entities with a \u2018personality\u2019 and rights and duties in the socioeconomy.\u00a0 The 1930s development of \u2018managerialist\u2019 ideas, recognizing how in large corporations managerial control overwhelmed the share-owners\u2019 rights, led many to see victory for the \u2018realists\u2019.\u00a0 In the 1970s the tide was reversed by neoliberal \u2018agency theorists\u2019, sometimes to the extent that, along with pillorying government, managers were characterized as \u2018the problem\u2019 for corporate governance rather than its solution.\u00a0 Maximizing shareholder value (MSV) is nominalism\u2019s battle-slogan, corporate social responsibility (CSR) is realism\u2019s.\u00a0 The call for \u2018more ethical management\u2019 is realism pushing back against nominalism\u2019s recent dominance.\u00a0 For the most part management academics pay no attention to corporate law debates, choosing whatever position best suits the theory they purvey – without bothering to justify their choice as lawyers must when arguing real cases.\u00a0 In contrast, Buffett is a practicing manager, aware of the dichotomy and its implications.\u00a0 But with what resolution?\u00a0 What is his working \u2018business model\u2019?\u00a0 His letter suggested a model that escapes both corporate lawyers and management academics.<\/p>\n <\/p>\n The American educationalist and philosopher John Dewey added to the legal debate in a 1926 article, arguing that realists treating firms as \u2018legal persons\u2019 misunderstood the complexity of \u2018personhood\u2019 in a capitalist democracy.\u00a0 The dichotomy should be dismissed as confusing, obscuring the nature of the firm and the roles of investor and manager alike.\u00a0 But Dewey also noted the concept of the corporation, to use Drucker\u2019s term, had a \u2018chameleon-like\u2019 ability to change with the times.\u00a0 In a footnote he recalled the older view of the firm as a \u2018legal fiction\u2019 which, stripped of its legal baggage, presents the firm as an \u2018idea\u2019 – not captured by either nominalist or realist views – noting such \u2018imaginary creatures\u2019 are \u2018notoriously nimble\u2019.\u00a0 Today most theorists are stuck on one or other horn of the dichotomy, from where firms seem inherently static and lifeless, given changing assets or people is a challenge.\u00a0 Thus \u2018entrepreneurship\u2019 often gets confused with \u2018change management\u2019.<\/p>\n <\/p>\n But some are not so stuck, and Buffett may be among them.\u00a0 Katsuhito Iwai, probing the differences between American and Japanese firms, embraced the firm\u2019s \u2018dual nature\u2019, both nominalist and realist.\u00a0 Rather than being tied to or defined by its tangible assets or its people, each firm is the flexible imaginary creature Dewey sighted inhabiting the middle ground between nominalist and realist abstractions.\u00a0 How can this be?<\/p>\n <\/p>\n Intangible assets, such as \u2018know how\u2019, shed some light here.\u00a0 Buffett\u2019s letter included many comments on intangible assets, the huge part they play in BHI, and the difficulties they present accountants, managers, and investors.\u00a0 Nominalist theorists presume the meaning of assets is self-evident and that the firm\u2019s accounts show the tangible and real.\u00a0 Against this Edith Penrose pointed out the \u2018nominalist fallacy\u2019, that in practice assets are only as valuable as management\u2019s ideas about how they can be applied.\u00a0 At the other horn, realists presume people calculate rationally and know their purposes and aims.\u00a0 Dewey pointed to the \u2018realist fallacy\u2019 that people do not know their own minds fully, that their tacit understandings matter.\u00a0 Imai argued, as most of us do, that tacit knowledge emerges in the middle ground as people with assets pursue a shared idea or purpose.\u00a0 Crucially this imaginary substance is living but cannot survive the cessation of the firm\u2019s practice, its liquidation.\u00a0 So the shareholders cannot reallocate it.\u00a0 A \u2018going concern\u2019 has imaginary content that cannot be sold, yet is fundamental to its ability to transform the imagining that holds the horns of the dichotomy together into economic value.<\/p>\n <\/p>\n This is not news to experienced managers.\u00a0 But it is not easy to operationalize or explain as part of a specific firm\u2019s business model, as Buffett did in his 2016 letter.\u00a0 His language was homespun rather than academic, thank goodness, but not lacking in precision or power.\u00a0 He identified three notions of a firm – nominalist, realist, and imaginary – so as to explain managing their intersection.\u00a0 With a real business to run his model did what those of economists or management academics failed to: help BHI\u2019s managers (1) embrace their particular firm\u2019s trinity, (2) synthesize it into value-creating practice, and (3) highlight the risks of dichotomies between their firm, its people, and its surroundings, risks that are the focus of business ethicists and principal-agent theorists.\u00a0 Leveraging from the insight that the nominalist, realist, and imaginary can change at different rates, Buffett\u2019s model outlined answers to Coase\u2019s questions about the nature of the firm – practical answers that bring the BHI shareholders\u2019 concerns about productivity, managerial ethics, and financial performance together.\u00a0 A secret sauce indeed.<\/p>\n <\/p>\n About the author:<\/strong><\/p>\n JC Spender trained first as a nuclear engineer then in computing with IBM. \u00a0He moved into academe as a strategy theorist, opening up a subjectivist\/creative approach that complements mainstream rational planning notions of strategizing. \u00a0This 40-year project was brought to completion in Business Strategy: Managing Uncertainty, Opportunity, and Enterprise (OUP 2014).<\/em><\/p>\n","protected":false},"excerpt":{"rendered":" There is a small industry of commentators who decode the Berkshire Hathaway (BHI) Annual Letter to Shareholders – which 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