Understanding the Benefits of Capitalism through the Lens of a New Theory of the Firm

Abstract

A theory helps us to see the world better and ask better questions. In this paper, the Pragmatic Theory of the Firm clarifies the firm’s purpose and showcases the benefits of viewing a firm as a holistic system in which knowledge building is the critical determinant of long-term performance. The Knowledge Building Loop is a practical six-step looped process for improving the accuracy and reliability of our knowledge. This way of looking at knowledge building is not only useful in business but also in everyday problem solving. To illustrate this point, the six steps are used to provide novel insights as to how the Wright brothers taught the world how to fly. Learning how to fly and how to improve corporate governance both entail knowledge building. The Pragmatic Theory helps approach one critical corporate-governance issue: most boards are primarily composed of directors with a worldview (one of the six components of knowledge building) rooted in command-and-control hierarchical organization. Dealing with this issue is more important than mandates promoting gender diversity for boards. Overall, the paper takes two different but related perspectives. On the one hand, economic progress depends upon a society supporting a free market economy in which firms ideally compete on a level playing field to innovate and efficiently deliver value to customers. On the other hand, at a deeper level, long-term progress is achieved through firms with viable knowledge-building cultures that benefit all of their stakeholders.

Keywords: capitalism, purpose of the firm, pragmatic theory of the firm, knowledge building, innovation

JEL Classification: P1, D2, O3, D8