Intrinsic Motivation and the Patterns of Firm Growth : A Developmental Perspective

Intrinsic Motivation and the Patterns of Firm Growth:
A Developmental Perspective
Hagen Worch
Max Planck Institute of Economics
Evolutionary Economics Group
Kahlaische Strasse 10, 07745 Jena, Germany
E-mail: worch@econ.mpg.de
Tel.: +49-3641-686836
Fax: +49-3641-686868
Paper prepared for
the DIME Workshop “Motivations and Incentives: Creating and Sharing Knowledge in
Organizational Contexts”
ISCTE, Lisbon, March 30-31, 2006
Abstract: This paper analyzes whether, in addition to contractual concerns, the motivational
relationship between employers and employees influences the scope of the firm. Research on
incentive structures discovers two distinguishable types of coordinating a workforce, namely
through intrinsic and extrinsic motivations. While the former refers to activities an individual
is motivated to do without any apparent reward, the latter relates to activities that are
stimulated by monetary rewards. We show that these two modes of coordination result in
different interaction patterns between the entrepreneurs and the employees. As a firm grows
and the number of employees increases, retaining the established interaction patterns becomes
difficult. We then show that firms differ in their patterns of organizational change depending
on the initial mode of coordination. An entrepreneur attempting to increase the extrinsic
motivation through a particular incentive might – under certain circumstances – crowd out the
intrinsic motivation of the employees. In this case, the opportunistic behavior of the
employees increases substantially. In contrast, an employer who succeeds in encouraging
intrinsic motivation enhances the chances to expand the boundaries of the company without
enhancing the employees’ opportunistic behavior. Thus, the developmental patterns vary
between firms with different modes of coordination.

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1. Introduction
The coordination of a workforce is a central issue in understanding the scope of the
firm. Research on the coordination problem has extensively explored the contractual
relationships between owners, managers and employees. Scholars in economic theory, in
particular, have stressed the importance of optimal incentive structures to reduce shirking and
opportunistic behavior (e.g., Grossman and Hart 1986; Hart and Moore 1990; Holmstrom and
Milgrom 1991, 1994; Baker 1992; Baker, Gibbons and Murphy 1994, 2002). In addition to
contractual concerns, motivational aspects tend to be similarly important in the relationship
between employees and employers (Kahneman, Knetsch and Thaler 1986; Blinder and Choi
1990; MacLeod and Malcomson 1998; Fehr and Schmidt 1999, 2004; Fehr and Falk 2002;
Brown, Falk and Fehr 2004). However, motivation as a mean for coordinating a firm is hardly
explicable with theories that are merely based on opportunism. Theorists in organization
science have therefore applied different behavioral assumptions for analyzing coordination
and the interaction within firms (e.g., Barnard 1938; Simon 1947; March and Simon 1958;
McGregor 1960; Cyert and March 1963; Thompson 1967). Simon, March and Cyert, for
instance, were the first in organization theory considering cognitive limitation of human
decision-making (Simon 1947; March and Simon 1958; Cyert and March 1963). Building on
this psychological predisposition of human beings, they developed an organization theory
emphasizing that decision-making processes and organizational behavior is limited by the
way people perceive and make sense of information. They argue that interactions between
employers and employees occur under these limitations. Consequently, these limitations also
affect the coordination of the workforce in a firm organization.
Considering the limitations of the cognitive capacity of humans to perceive and make
sense of information was a fundamental new perspective in organization theory. This
perspective did not only apply a different behavioral assumption to analyze the firm. Rather,
it acknowledged that the cognitive limitations of human decision-making condition the
interactions between individuals, independent of whether they tend to behave opportunistic or
cooperative. In fact, this psychologically grounded perspective on human interactions allowed
scholars to develop theories explaining under which conditions individuals tend to behave
opportunistic or cooperative in organizational environments (e.g., Ichniowski, Shaw and
Prennushi 1997; Tyler and Blader 2000; Nagin, Rebitzer, Sanders and Taylor 2002). As will
be seen, entrepreneurs influence decisively whether the character of the interactions within a
firm is opportunistic or cooperative. This has far-reaching consequences in understanding the
coordination problem and the patterns of change. If the cognitive limitations of human
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decision-making play such a central role for coordinating a firm’s human resources, then they
are also likely as important in explaining organizational transformation processes, in which
the firm changes its coordinative framework and establishes new managerial layers.
This chapter proceeds as follows. The next section describes the cognitive
underpinnings of organizational behavior and how this may shape the coordination of a
workforce. We argue that the limitations of human decision-making considerably affect how
entrepreneurs and managers coordinate firms. In the third section, the focus is on how growth
affects the interactions between firm members, and therefore challenges the pre-established
coordination system. It further reveals that the transformation process shows some significant
regular features. Finally, the forth section analyzes the developmental processes of firms and
examines the organizational transformations that firms experience as they grow.
We provide an explanation why firms change their organizational structure, and why –
despite of the regularities – companies follow different growth patterns. Section five
concludes the paper.
2. Cognitive underpinnings of organizational behavior and the consequences for
coordinating a firm organization
In his seminal work on administrative behavior, Simon (1947, ch. 5) introduced the
argument that cognitive processes have a crucial impact on human behavior in organizations.
He explicitly acknowledges the limited capacity of human beings to process information. This
limitation is usually referred to as bounded rationality. But Simon’s (1947, 1955, 1979)
notion goes beyond the mere meaning of imperfect knowledge. In this sense, decision-making
is not only the optimization of a particular cost-benefit problem under limited information.
Decision-making is a cognitive process that involves to consciously focus, channel and
distribute attention to particular issues and not to others (Ocasio 1997). Understanding what
firm members perceive and how they make sense of the perceived situations is directly linked
to decision-making and firm behavior (March 1997).
Recent findings on people’s limited capacity to process information suggest that human
beings tend to be able to think about only one issue at a time. All information relating to one
particular issue becomes organized in a complex mental categorization system referred to as a
cognitive frame (Anderson 2000, ch. 5). Consequently, an individual’s perception of a
specific task depends on the information processed within the cognitive frame relating to the
task. Various processes, such as communication, experiences, observations, heuristic
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principles, or other processes of social learning, shape and reshape a cognitive frame
(Bandura 1986, ch. 2). In this sense, a cognitive frame builds the basis for individual
reasoning and decision-making. More precisely, it constrains individual reasoning, decision-
making and behavior to those activities and actions that an individual perceives. With
communication and social learning processes shaping perceptions, it is through these
processes that alternatives for decision-making and human action are formed in the cognitive
frame. Further, as human beings tend to avoid dissonances and seek consistency in their
reasoning and decision-making (Festinger 1957, 1964; Elio and Pelletier 1997; Politzer and
Carles 2001; Johnson-Laird, Girotto and Legrenzi 2004; Simon, Snow and Read 2004), they
aim continuously to derive one consistent cognitive frame with regard to a specific issue. This
cognitive process limits the number of directions to which individuals channel their attention
and restricts an individual’s set of actions to those ones that the cognitive frame considers and
forms (Loasby 2001, 2002).
Considering these cognitive limitations, Witt (1998, 2000) develops a theory of the firm
that explicitly models the interactions among firm members and the dynamics of their
relations under these constraints. Following his approach, the starting point for a theoretical
analysis is the firm as an entity primarily shaped by an entrepreneur’s visions and goals. The
firm is an organization, in which an entrepreneurial business conception finds its expression.
A business conception is defined as the imagination of an entrepreneur of what to achieve and
how to do it (Witt 1998, p. 162). The imaginative act is a cognitive process in which an
entrepreneur builds an understanding of the products or services to be offered, and of how to
coordinate their making (Witt 1998, pp. 163). At the same time, the employees establish their
own understandings of how to perceive and interpret the entrepreneur’s business conception,
i.e. the firm’s intention, goals, rules, and procedures. As a result, making sense of what the
business conception means and implies may vary among the firm members. The entrepreneur
and the employees may have different cognitive frames about the firm’s business conception.
Hence, coordinating the workforce within a company is not solely an issue of incentives but
also involves establishing and enhancing the firm member’s understanding about the business
conception.
Communicating and conveying a business conception is a cognitive process, in which
an entrepreneur essentially shapes as to how the firm members perceive the conception (Witt
1998, 2000). Importantly, the need to communicate the entrepreneurial conception has a
strong impact on coordinating the firm’s employees. This is because an entrepreneur who is
succeeding in instilling a shared understanding may, to a certain extent, discourage the
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emergence of opportunistic behavior among the firm members. In other words, an
entrepreneur may enhance the chances to run the firm and expand its boundaries without
inducing the employees’ opportunism. The underlying reason for this effect on coordination is
that communication is a process of social interaction. As it will be seen later in detail, social
interactions shape the cognition of those who are communicating. This way, interacting
individuals may perceive the subjects, about which they discuss, similarly. Consequently, the
chances for people to hold diverging interpretations about these subjects tend to decline.
Instead, commonly shared understandings may emerge; for instance about a business
conception as it is frequently communicated. If the firm members’ understandings of the
business conception converge with the entrepreneur’s understanding, they tend to accomplish
their tasks according to the communicated conception. Then, the extent to which the
entrepreneur has to introduce incentives decreases. Even scholars in organizational economics
who are not following an evolutionary approach have highlighted that factors such as
motivation (Bewley 1995), trust (Baker, Gibbons and Murphy 1994), and fairness
(Kahneman, Knetsch and Thaler 1986; Blinder and Choi 1990; MacLeod and Malcomson
1998; Fehr and Schmidt 1999, 2004; Brown, Falk and Fehr 2004) affect decisively the
coordination of a firm’s workforce. Thus, beside of the fundamental necessity to convey the
business conception, the entrepreneurial communication process plays also a central role in
influencing the motivation and behavioral patterns of the firm members in achieving the
assigned tasks.
Despite of the substantial influence that cognitive processes have on motivating the
employees, relying on incentive mechanisms remains an important alternative option for
entrepreneurs in coordinating the firm. In this case, the employees’ motivation to achieve the
assigned tasks derives from extrinsic rewards rather than a commonly shared understanding
of the entrepreneurial business conception. The main concern of entrepreneurs is then to
reduce shirking and opportunistic behavior. Hence, relying mainly on incentives on the one
hand and facilitating primarily the instilling of a business conception on the other hand
represent two very different modes of coordination. The distinction between these two modes
is crucial throughout this paper. In following Witt’s (1998) notion, I refer to the former mode
as the cognitive leadership regime and to the latter mode as the monitoring regime.
Entrepreneurs in either mode of coordination follow a business conception, which is the
basis of their economic activities. In both modes, the entrepreneurs aim to convey their
business conception and to make sense of it within the firm. However, the specific direction
to which they channel the firm members’ attention varies. An entrepreneur, who tends to
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operate with instructions and incentives, channels attention to these aspects of coordination.
The focus is not on conveying the business conception itself but rather on instructing it and on
conveying the incentive system, which then ensure running the business conception
effectively. In other words, the entrepreneur attributes the stimuli to instructions and
incentives. Consequently, the employees’ cognitive frames tend to primarily pay attention to
these stimuli, i.e. the entrepreneur’s instructions and incentive mechanisms. Their focus is on
making sense of these aspects, on acting according to the incentives, and on finding ways how
to respond to them. Regarding the business conception, an entrepreneur’s and the employees’
cognitive frames have little in common. While the entrepreneur forms a comprehensive
understanding about all aspects of her business conception, the employees channel their
attention predominantly on understanding the incentive mechanisms.
What are the behavioral consequences of this mode of coordination? Apparently, the
employees’ intrinsic motivation is not supported. Intrinsic motivation refers to activities an
individual is motivated to do without any apparent reward, while extrinsic motivation relates
to activities that are stimulated by monetary rewards. Regarding the relationship within a
firm, an employer attempting to increase the extrinsic motivation through a particular
incentive might – under certain circumstances – crowd out the intrinsic motivation of the
employees (Frey and Oberholzer-Gee 1997; Frey and Jegen 2001; Fehr and Gächter 2002). In
this case, the opportunistic behavior of the employees increases substantially (Fehr and List
2004; Falk and Kosfeld 2005). As a result, the loss of intrinsic motivation has to be
compensated by intensifying monitoring and control. Thus, a company relying on instructions
and incentives tends to crowd out intrinsic motivations and therefore induces a behavior
among the firm members that requires an increasing effort for control.
In contrast, an entrepreneur, who tends to intensively communicate the business
conception, is likely to generate commonly shared understandings about the firm’s operations.
Recurrently communicating her business conception, an entrepreneur shapes – consciously
and unconsciously – the employees’ perceptions (Kozlowski and Doherty 1989). This way,
the information in an employee’s cognitive frame tends to become similar to the
entrepreneur’s understandings of the business conception. Converging perceptions result in
commonly shared interpretations. This affects insistently the behavior and therefore the
coordination of a workforce. For instance, if commonly shared interpretations exist among
firm members regarding the procedures to achieve a particular goal, an entrepreneur can
coordinate this task with fewer instructions. In turn, when problems emerge and they are
perceived similarly, employees’ motivations for providing a solution have strong intrinsic
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underpinnings. Therefore, entrepreneurs focusing their coordination effort primarily on
communicating their business conceptions are more likely to achieve a coherently running
firm without having to rely as much on incentives or monitoring. Internal coherence is
defined as the concurrence between the entrepreneur’s and the employees’ understanding of
the business conception comprising the intentions, goals, rules and procedures of the
company. In this case, entrepreneurs and employees tend to have similar cognitive frames
about the business conception.
Research in social psychology underpins this line of arguing. The results indicate that
constructive communication among firm members reinforces the strength of their
relationship. A longstanding argument is that employees being encouraged to voice their
opinion perceive organizational processes as more satisfying and fair, respectively (Folger,
Rosenfield, Grove and Corkran 1979; Lind, Kanfer and Earley 1990). Perceiving fair
procedures enhances the employees’ self-esteem (De Cremer, Van Knippenberg, Van
Knippenberg et al. 2005), and it becomes more likely that they act in favor of a superior’s
intentions and decisions (Van den Bos, Wilke and Lind 1998). Also sharing events with other
members of a group affects the constructive relation in the group positively (e.g., Gable, Reis,
Impett and Asher 2004). These interactive processes strengthen the constructive character of
an existing employer-employee relation. As employees strongly identify with a group, they
tend to adhere to the group and support its continuous existence and operation even if it is
threaten to break up (Van Vugt and Hart 2004). Together, these processes are important in
building, keeping, and enhancing constructive relations. Importantly, as a firm organization
facilitates this kind of constructive relationships through intensive communication, it is likely
to induce trust among its members to a certain extent (for a review see Kramer 1999).
Trustful relations shape organizational behavior in a specific way. This is key in
understanding how perceiving and processing information are linked to decision-making and
behavior. Perceiving and processing information requires in the first place encoding the
received information and behavior. As to how information and behavior is encoded depends
on whether a relationship is based on trust or on distrust. When firm members are distrustful
and suspicious, they then engage in intensively considering and testing alternative
interpretations and meanings of the received information (Schul, Burnstein and Bardi 1996;
Fein, McCloskey and Tomlinson 1997; Schul, Mayo and Burnstein 2004) and the received
behavior (Fein, Hilton and Miller 1990; Hilton, Fein and Miller 1993). Compared to a
distrustful environment, human beings in a trustful context pay less attention to potential
alternative interpretations. They directly channel their attention to the perceived information
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and behavior and draw inference from it more intensively. Hence, the building of a consistent
understanding of the entrepreneur’s business conception is more likely in an organization
with constructive relationships between the entrepreneur and employees.
As seen above, intensive communication fosters the emergence of shared interpretations
and instills intrinsic motivation. In addition, it creates an environment of constructive and
trustful relations, which further facilitate the process of building internal coherence. Under
trustful und constructive relationships, employees are less likely to be distracted from
channeling their intentions to the entrepreneur’s business conception, which they do in the
case of distrust. This way, communication-based firms induces relationships in organizations
that favors an organizational environment in which employees are intrinsically motivated to
pursue the entrepreneur’s business conception.
In sum, the two modes of coordination differ regarding the entrepreneurs’ distribution
of the stimuli. Entrepreneurs attribute stimuli so that employees channel attention on acting
according to the incentives in instruction-based companies and on pursuing the business
conception in firms with extensive communication. The motivational consequences are
promoting intrinsic motivation in the one case, and relying on extrinsic incentives in the
other. These different motivational consequences derive from cognitive limitations of humans
to channel attention and to be persuasive in focusing on issues. As a result, organizational
behavior of the employees varies with the mode of coordination. While intrinsically
motivated employees are likely to directly support the achievement of a business conception,
employees acting upon extrinsic incentives show little motivation to accomplish a specific
business conception beside of carrying out the entrepreneur’s instructions correctly and of
performing according to the implemented incentives. In this sense, extrinsically motivated
employees behave opportunistically, which requires an entrepreneur to intensify monitoring
and control. The following section further scrutinizes the interaction patterns between
employers and employees in these two regimes as firms grow. Understanding these
relationships is crucially important for assessing the dynamics of organizational behavior.
3. The effect of growth on coordination
As the number of employees increases in a firm, one apparent consequence is that the
intensity of communication declines. That is either in terms of time one spends in average
communicating with all other members, or in terms of the percentage of members one reaches
in a firm by communicating to the same extent to any person as one did prior to the growth.
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Because communication is a fundamental process in creating commonly shared
understandings and developing commitment toward a company, declining communicative
interaction has a dramatic impact on coordinating a firm. A lower intensity of communication
reduces the intensity with which firm members channel attention to the same topics. In
particular, the firm members’ coherent understanding of the business conception decreases in
communication-intensive regimes. Accordingly, intrinsic motivation looses increasingly its
central relevance in inspiring the employees’ behavior. In control regimes, firm members are
less likely to fully make sense of the instructions’ content.
Considering this effect, declining communication makes it more and more unlikely that
an employee interprets perceived information in the same way as other employees, or as the
entrepreneur. In particular, the information in an employee’s cognitive frame begins to
diverge from the entrepreneur’s understanding of the business conception and from the
meaning of her instructions, respectively. This is because the intensity of communicating
renders too weak for an entrepreneur to persuasively influence the employees’ attentional
focus. Then, an entrepreneur is little effective in conveying and attributing the stimuli as to
shape sufficiently the cognitive frame of the employees. As perceptions increasingly fail to
converge, a commonly shared understanding about the business conception is less likely to
emerge in communication-intensive regimes. Consequently, communication-decreasing
hampers to sustain the intrinsic underpinnings of the employees’ behavior to work toward the
entrepreneurial business conception. In instruction-based regimes, instructing becomes
increasingly ineffective in directing employees.
Increasing difficulties of conveying a commonly shared understanding of the business
conception derive also from another angle. Any new firm member does not only decrease the
average time one firm member communicates with any other, but brings the own knowledge
and prior experiences into the firm. Hence, the number of perspectives and interpretations
increases as an organization grows. The cognitive frame of a newly hired employee is likely
to perceive the business conception differently as the entrepreneur or other employees within
the firm. The reason for this is that other stimuli influenced the new employee prior to her
appointment. Her attentional focus was on the organizational context of the previous company
but not on the one of the hiring firm. Thus, with more members joining a firm, instilling a
commonly shared understanding of the firm’s business conception among employees
becomes increasingly difficult. The perspective-increasing effect reinforces the
communication-decreasing effect. It facilitates the deterioration of intrinsic motivations in
communication-intensive regimes with firm members’ behavior being less likely to be merely
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driven by a commonly shared understanding of the business conception. Perspective-
increasing also reinforces the communication-decreasing effect in instruction-based regimes.
It increasingly prevents instructing the workforce in these organizations effectively.
Growth processes affect both modes of coordination alike. Independent of the
organizational setting, both regimes face difficulties in coordinating the business operation as
more members join the firm. This strongly indicates that growth thresholds seem to be a
serious threat for virtually all growing firms. Though the problems arise through dynamics
that differ in the two regimes, the underlying reasons for the challenge to occur are the same.
Cognitive constraints of human beings in channeling attention lead to a dynamic with
decreasing alignment in communication-intensive organizations and serious threats for
enforcing the instructions in instruction-based regimes. This negatively affects the
effectiveness of the coordination of any organization. In sum, this section has shown how
firms independent of their coordination regime face a growth threshold. Thresholds seem to
change the interaction patterns in an organization systematically. They are regular appearing
challenges during the growth process of firms.
4. Developmental patterns in growing firms
After having described the emerging threshold as one regularity of firm growth, this
section assesses possible organizational responses available to the firm. Any such response
toward a growth threshold implies organizational adaptation. This means that the
entrepreneurs have to rearrange the interaction patterns. In the following, we analyze the
implications of these responses for the growth process. Of particular interest is whether the
responses, and therefore the subsequent growth patterns, are contingent on the initial mode of
coordination.
As the previous section has shown, the underlying reason for ineffectiveness occurring
in a communication-intensive regime’s operations is intimately linked to a decline in
commonly shared understandings. A growing organization gets increasingly diverse.
Consequently, reestablishing effective operations depends largely on regaining internal
coherence about the interpretations of the business conception. However, an entrepreneur
does not have the option of simply further increasing the overall communication among the
firm members. For the same reason as ineffectiveness of the operations occurred in the first
place, enhancing commonly shared interpretations through further facilitating communication
in an expanding firm is constrained by human limitations of information-processing. The
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