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2022 | Book

Governing Continuous Transformation

Re-framing the Strategy-Governance Conversation

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About this book

This book transposes the ‘free-energy principle’, as espoused by the neuroscientist Karl Friston, to strategic governance, and forming the new concept of Free-Energy Governance (FEG). This concept lays the foundation for a new logic of governing continuous transformation. In addition to guiding the structure, cognition, and capabilities of success in strategic renewal, FEG provides a systematic and practice-relevant approach to predicting a firm’s potential for entropy.

Using this new concept, the author shows that the success of continuous strategic renewal and business innovation, elements crucial for firm survival, are determined by the triplet of a firm’s structure, cognition, and dynamic board capabilities.

“How to govern large organizations in times of high uncertainty and permanent change? To answer this pressing question, … Bijan Khezri has been the first to apply [the free energy] principle to management science … This book is an eyeopener for every reflective leader.¨

Professor Oliver Gassmann, Director of the Institute of Management and Technology, University of St. Gallen

“I really enjoyed reading this book. It was both exciting and reassuring to see how the same fundamental ideas can be found in fields as disparate as nonequilibrium steady-state physics and theories of governance.”

Professor Karl. J. Friston; Director of the Wellcome Centre for Human Neuroimaging

“Using a term often applied to best-selling novels, ‘it is a page turner’ in which I learned something new in every chapter! Every board member, all executives and scholars interested in strategic leadership and governance must read this book if they wish to remain relevant in the coming transformational decades.”

Michael A. Hitt

University Distinguished Professor Emeritus, Mays Business School, Texas A&M University

Former President, Academy of Management, and former Editor, Academy of Management Journal

"We could not ask for a better author to initiate this new conversation in the board research community and convey its merits to the world of board practice."

Martin Hilb

Professor Emeritus, University of St. Gallen

Founder and Managing Partner, International Board Foundation and President of Swiss Institute of Directors

“Set against a wide swath of literature, the book impressively makes the case for a new logic of strategic renewal in which the board of directors plays a central role.”

Professor Constance E. Helfat, Tuck School of Business at Dartmouth

Table of Contents

Frontmatter

Part I

Frontmatter
Chapter 1. ‘Thinking Born of Curiosity, Revolt, and Change’
Abstract
Environmental complexity and velocity have been dominant moderators in strategy and governance research. The underlying structure of environmental change has become increasingly distributed and discontinuous. The disintermediating nature of information technologies is challenging entrenched business models as well as logics of organizing. Centralized top-down strategy processes are rather anti-clocked unless dynamically and generatively intertwined in real time with bottom-up stimuli and data emanating from field operations in pursuit of prediction error minimization. Neither established logics of organizing nor prevalent corporate governance models are a match for ‘wholesale digital reinvention’ and continuous strategic renewal. In fact, akin to the AI evolution from a supervised to a deep learning logic, corporate governance is challenged to evolve from a supervised and rule-based (‘best practices’-centric) learning system to one of unsupervised (un)learning, i.e., self-organization. To survive, the firm must be conceived as one cross-hierarchically integrated inference machine. Organizing is generative prediction error minimization. Strategy is redefined as top-down/bottom-up predictions processing. “The search for knowledge is not nourished by certainty: it is nourished by a radical absence of certainty […] thinking born of curiosity, revolt, change” (Rovelli 2021).
Bijan Khezri
Chapter 2. Sensing, Sensemaking, and Strategic Renewal
Abstract
Sensing and sensemaking form one unitary act and together can be considered a non-operational (cognitive) meta-capability (or dynamic capability). There is no sensing without sensemaking and vice versa. And there is no organizational sensemaking in the absence of a clearly defined deep (existenital) corporate purpose. Generative processes of top-down/bottom-up hypothesis testing (i.e., prediction error minimization) rather than top-down heuristic simplification are guiding the path to navigating a discontinuous world. It is neuroscience’s predictive coding that allows us to take management research’s strategic cognition and, more specifically, the nexus of structure and cognition one step further to provide a more complete and practice-relevant framework for applying sensing and sensemaking in the context of strategic renewal. Effectively, sensing and sensemaking are empowered by the circular causality of top-down knowledge structures (prediction models, predictions, hypotheses, and guesses) and bottom-up stimuli/data stemming from resource markets. By default, uncertainty and complexity are subjective concepts but are consistently deployed in management research as objectively determined. Environmental sensing and sensemaking are non-sensical in the absence of having set the firm’s purpose and context in the first place. Once we define sensing, sensemaking, and strategic renewal in form of action-centric circular causality linking purpose, prediction models, predictions, and prediction error minimization, a new logic of strategic renewal emerges—dynamically connecting structure (hierarchy), cognition, and capabilities.
Bijan Khezri
Chapter 3. Microfoundations of Strategic Governance
Abstract
There is no universal governance model. The strategic role of the board does vary as a function of culture, laws, governance orientation, ownership structure, and firm-context. The period of 1998–2001, a time of financial markets ‘irrational exuberance’ dominated by a governance orientation centered around stock price considerations, has given birth to today’s compliance-driven governance logic ruling public companies. Simply put, ever since corporate governance has been estranging the board as a uniquely integral part of strategy process. Coincidentally, during this very period, management research started complementing thereto demographic input-output models with behavioral and cognitive dimensions. While opening a new conversation around the cognitive microfoundations of board effectiveness, to this day, the study of the board’s strategic role remains confined to the board room and treats environment as an exogenous variable. The top-down cultivated ‘hierarchical disconnect’ so characteristic of traditional corporate governance (TCG) and strategy processes is more likely to fuel prediction error, reinforcing the perception that the world is unpredictable and uncertain. Indeed, the very limitations of corporate governance research may be an astute reflection of the very real and often self-inflicted limitations of the board’s strategic role. Shareholders are challenged to ensure that the board’s full (strategic) potential is not wasted. More specifically, there is a need for a new (self-organizing) governance logic.
Bijan Khezri
Chapter 4. Free Energy Principle (FEP)
Abstract
The ‘free energy principle’ (FEP) is a first-order principle of ‘least action’, empowering self-organization. FEP commands the generative process of active inference (Ai) dedicated to minimizing the (information-theoretical) mathematical difference between top-down predictions and action-generated bottom-up stimuli—in pursuit of minimizing error, surprise, and entropy. The power of Fristonian Ai is fundamentally fourfold: (1) it is a pure belief-based setting in dynamic and non-stationary environments; (2) the Ai agent carries out epistemic exploration to account for uncertainty by making inferences in Bayes-optimal fashion; (3) the reward signal so characteristic of reinforcement learning is removed; and, finally, (4) Ai sets free the collaborative human-machine AI potential so integral to the multi-intelligence firm as the mathematical expression of beliefs in form of probabilities provides the very common denominator to align humans with machines. There are only two distinctions that matter: ‘what is known and unknown’ and ‘what is in our control and what is not’. There are four states: active (action), internal (firm resources), sensory (perception), and external (unknown and hidden behind the Markov blanket). According to Free Energy Governance (FEG), free energy principle-powered Ai is the future site of organizational becoming.
Bijan Khezri
Chapter 5. Conclusion
Abstract
Strategic renewal research is now confronted with important challenges concerning process design, cognition, and dynamic capabilities. Sensing and sensemaking of relevant signals as a basis for initiating strategic renewal are preceded by an action-centric and explorative engagement with the world. We are moving from co-aligning organization with environment in form of adaptation to co-creation as firms build agility through distinctive environmental enactment. All existing frameworks and studies in corporate governance as well as strategic cognition remain characterized by one or a combination of the following fundamental limitations: (1) environment and environmental change are generally treated as objective reality; (2) strategic renewal is treated as a top-down ‘content’ rather than a top-down/bottom-up ‘process challenge’; (3) strategic renewal is studied at the managerial level but only marginally at the board level; (4) formal processes only are the focal unit of analysis; and (5) demographic and universally measurable variables dominate with no due consideration for strategy-relevant meta-capabilities at the board level. FEG introduces a novel cross-hierarchical generative (inference centric) framework empowering the firm as a generative model of its eco-niche. Shareholders and board directors must reinterpret the board’s ‘strategic relevance’ in a discontinuous world. If not, the board is prone to turn into (or remain) a source of inertia compromising firm performance and survival.
Bijan Khezri

Part II

Frontmatter
Chapter 6. Structure: Synergizing Governance and Operational Channels
Abstract
Upper Echelon View (UEV) and Prediction Processing Framework (PPF) address FEG’s structural dimension. Indeed, Upper Echelon is the site of strategic decision-making. However, UEV suffers from several limitations. There is no explicit consideration for the board of directors and the linkage of Upper Echelon into the rest of the organization, i.e., the coupling of governance and operational channels, is unidirectionally top-down and therefore, at best, incomplete. How the field data can systematically talk to Upper Echelon and influence their values, perception, and attention remains a black box. The prediction processing framework (PPF) embraces structure more holistically, addressing the hierarchical disconnect and, more importantly, the circular causality between top-down predictions and bottom-up stimuli. Dissonance-bearing messages occur at the firm’s stimuli level (bottom) close to resource markets long before top leadership has ‘any sense’ of a looming challenge. PPF is determined by three ‘categorical imperatives’: (1) Upper Echelon’s prediction models and predictions must be ‘explainable’; (2) each of the hierarchical layers must have formal and informal interfaces coupling each layer to the next layer; and (3) the firm’s generative model is the firm’s eco-niche. PPF provides an entirely new perspective and language embracing strategic renewal as a matter of bottom-up/top-down prediction error minimization, not least setting free the full potential of the human-machine interface.
Bijan Khezri
Chapter 7. Cognition: From Superposition to Reality
Abstract
Attention-Based View (ABV) and Enactivist Approach (EA) address FEG’s ‘cognition’ dimension. To this day, strategy management research is not entirely de-chained from its very path dependency of putting perception ahead of action, i.e., putting environment ahead of strategy. While ABV’s structure-cognition nexus is FEG’s critical building block, ABV erroneously treats action as a consequence of perception. Once we embrace attention as action-generated, we start understanding that clever analysis in form of belief-updating follows action-generated stimuli, not the other way around. ABV is trapped in the ‘old-school’ limitations imposed by ‘bounded rationality’. In a discontinuous and distributed (quantum) world, agents’ ‘bounded rationality’ is ‘meaningless’ as enactive inference empowers ‘the world to deliver a supervisory signal’. Effectively, agents off-load ‘the burden of cognition’ to the environment. Bounded rationality is replaced by extended cognition. The boundedness of human cognition is effectively neutralized. There are at least as many reality models as there are economic actors. Every organization chooses—akin to holding (acting upon) a light torch in the darkness—which environmental significance to attend to. Whatever the torch highlights is equivalent to breaking a quantum wave of probabilities—moving from superposition to reality, intermediated by the Markov blanket. Environmental enactment is essentially a purpose-directed, inter-active, inferential, and social learning (sensemaking) process.
Bijan Khezri
Chapter 8. Capabilities: Duality Management
Abstract
Dynamic Capability View (DCV) and Antagonistic Neural Networks Perspective (ANNP) address FEG’s ‘capabilities’ dimension. The board’s cognitive capabilities in terms of meta-managing interdependently opposing logics as unity are increasingly relevant to continuous strategic renewal. Duality management—such as vacillation between exploitation vs. exploration and balancing financial and strategic control—is established as a dynamic board capability. Effectively, FEG extends DCV to the board level. More importantly, by adopting a free energy principle-powered perspective—i.e., redefining the firm as an enactive inference machine—DCV’s triplet of ‘sensing, seizing, and reconfiguring assets’ is operationalized such that the firm is engaged as a ‘whole’. ANNP is established and applied as the neuroscientific basis for duality management: managing the existing while contradicting the present to develop the future. This TPN/DMN antagonism—between exploitative task execution (TPN) and explorative (abductive) thinking (DMN)—is a neurological representation of the contradictory demands that challenges companies’ sustainable outperformance and survival. The board’s traditional monitoring and advisory roles must be explicitly complemented with a duality (TPN/DMN) management mandate. More specifically, the board’s dynamic capability of duality management lays the foundation for the board’s newly established governance purpose in discontinuous and distributed markets: ‘duality stewardship’.
Bijan Khezri
Chapter 9. Laying the Foundation for a Self-Organizing (Autopoietic) Governance Logic
Abstract
Beneath all chaos is an underlying structure. Our challenge is to exploit disorder’s underlying order. To survive, living organisms are encoded to resist disorder, i.e., entropy, by way of self-organization. Firms are nothing more than molecules and are subject to obeying the very same laws of thermodynamics: entropy will eventually rise. Three specific propositions, previously developed as part of this book’s underlying dissertational research, are outlined: (1) STRUCTURE: The stronger a firm’s cross-hierarchical top-down/bottom-up cognitive (throughput) coupling between and within governance and operational channels, the less dominant a firm’s top-down approach cultivating a form of CEO-centrism in strategy ownership. (2) COGNITION: The stronger a firm’s cognitive disposition toward environmental enactment and innovative abduction as opposed to adaptation, the stronger the firm’s strategic control, and the smaller the risk of falling for the financial control trap. (3) CAPABILITIES: The stronger the board’s DMN-centric ‘duality stewardship’ empowering Upper Echelon to sustainably balance exploitation vs. exploration as well as financial vs. strategic control, the stronger the sustainability of successful and continuous strategic renewal and, hence, the firm’s prospects for survival. Strategy is less macroscopic but more subatomic, less linear and determnistic, but more quantum and discontinuous. There is a dominant tendency of glorifying the ‘realist’ beauty of top-down linear cause-effect relationships to the very detriment of (quantum) self-organization.
Bijan Khezri

Part III

Frontmatter
Chapter 10. Free Energy Governance vs. Traditional Corporate Governance
Abstract
Through the lens of the theoretical concepts developed in this book, FEG and traditional corporate governance (TCG) are assessed in comparative perspective. TCG models are predominantly characterized by a compliance mentality centered around board effectiveness as a matter of managing (agency) conflicts of interests through optimizing stereotypical board diversity and enforcing director independence. FEG introduces a radically new logic exercising the ‘corporate wholesale reinvention’ that strategic renewal is now imposing. Indeed, any such juxtaposition of two governance logics can hardly escape the accusation of oversimplification. However, once we embrace the world as discontinuous and distributed, we start understanding that today’s entrenched corporate governance approaches are a ‘low-scale, low-leverage legacy business’, breeding inertia. Public policy prescribed ‘best practices’ guiding corporate governance is an anachronism of modern business, reinforcing Upper Echelon’s risk-averseness (i.e., compromising epistemic foraging) and, consequently, entrapment in the incapacitating perception of the world as VUCA (volatile, uncertain, complex, and ambiguous). FEG embraces any dimension of VUCA as information-rich input for top-down/bottom-up prediction error minimization in pursuit of minimizing surprise. An overreliance on CEO-framed information flows and analysis, which is so characteristic of TCG, is as good as flipping a coin: the very processes that explain success equally breed failure.
Bijan Khezri
Chapter 11. Implications for Management Practice
Abstract
‘How can one possibly redefine the board’s strategic meta-role when traditional governance modes are so ubiquitously entrenched and cognitive capabilities so poorly developed or non-manifest?’ To be practice-relevant, theory must be intuitive and inspire Upper Echelon questioning its very Habits of Mind. To conceive strategic renewal as a continuous and generative process of top-down predictions/bottom-up stimuli surprise minimization urges Upper Echelon to consequently optimize the multi-intelligent sources of stimuli, redesign processes as well as incentive structures, and develop a new language to empower enactive inference. Indeed, to date, corporate governance research and practice are more concerned with defining behavioral responsibilities rather than addressing its very capability needs. There is no ‘one size fits all’ best-practices-catalogue, but FEG’s nexus of structure, cognition, and capabilities provides the building blocks for a fundamentally new governance logic. In a discontinuous world, the essential governance challenge is to ensure the self-organizing optimization of top-down/bottom-up prediction error minimization: learning to infer. Once we embrace FEG as a novel organizational framework and early detector of a firm’s impending entropic decay, we must reckon that unless replaced with a FEG-inspired logic, TCG is likely to continue relegating the board of directors to strategic irrelevance, reinforce financial control at the expense of strategic control, prioritize top-down content over top-down/bottom-up process, cultivate inertia, and inhibit the full growth and survival potential of firms as self-organizing systems.
Bijan Khezri
Chapter 12. Future Research Agenda
Abstract
FEG is the product of a multidisciplinary research project connecting the dots among strategy, governance, and neuroscience research opening a new conversation headlined ‘introducing the free energy principle to strategy management’. FEG redefines the nexus of structure and cognition (ABV), advances the dynamic capability view (DCV) from the managerial to the board level, and establishes strategy as an enactive (Bayesian) inference challenge. In terms of future research, four areas should advance the optimization of FEG: (1) language and communication, in particular explainability of corporate purpose, prediction models, and predictions; (2) embodied cognition, in terms of a deeper understanding around the neurobiology underlying leadership’s world engagement as well as false inference; (3) artificial intelligence, in particular the strategy application of Ai-powered machine algorithms; and (4) board capabilities’ developmental paths, in particular the board’s ability to collectively develop meta-capabilities. FEG as a framework provides the fundamental building blocks that empower a firm to implement free energy minimization as a self-organizing principle: structure (top-down/bottom-up connectivity), cognition (environmental enactment), and capabilities (duality management). Within the FEG framework, many vibrant strategy research topics lend themselves to be repurposed as a matter of optimizing free-energy minimization. More specifically, survival rather than just performance is the critical dependent variable.
Bijan Khezri
Chapter 13. Outperformance and Survival as a Matter of Self-Organization
Abstract
The classical cause-effect determinism upon which the paradigm of strategy management as well as corporate governance research has been built is uprooted. Popperian academics’ relentless pursuit of empirically establishing, qualifying, and then falsifying mechanistic cause-effect relationships is struggling to inspire the business community, which itself is wriggling too often with the (self-inflicted) limitations of its very world models. Together—academia and practice—are challenged to reconnect organizing to that self-evidencing dimension of the universe’s information system. FEG is as valid for business organizations as it is for political constructs or, for that matter, navigating geopolitical dislocations and debt cycle disruptions. Any organism that suffers from (1) top-down/bottom-up hierarchical dysconnectivity and a top-down dominance of supervised content prescriptions, (2) an urge to adapt to the outer world amid an incapacity for enactive inference, and (3) the non-existence of both a timeless (deep) purpose as well as meta-capabilities, is naturally entropy-bound. In the absence of a generative (Bayesian) model, we become incapacitated. Indeed, ‘camping on seesaws’ is the categorical imperative of survival-pursuing self-organization: organization as a means, not an end. It is right here where the fundamental difference between Traditional (TCG) and Free Energy governance models lies. FEG sees through formal organization as organizing manifests itself as a self-organizing generative model ‘operating as a whole’—within and without the firm—embracing self-organization as a self-evidencing (universal) information system.
Bijan Khezri

Part IV

Frontmatter
Chapter 14. Steve Case
Abstract
Case’s governance experience encompasses private and publicly listed companies as well as public institutions. Five key interview statements are worth highlighting: (1) “there is a need to take a fresh look at governance models”; (2) “governance cannot be viewed in a vacuum – what is appropriate really depends on the context”; hence, “a ‘one size fits all’ approach will likely be flawed”; (3) “where the organization is in the lifecycle will likely lead to a sense of how ‘top down’ vs ‘bottoms up’ the governance should be”; (4) “sometimes the best way to expand and grow is to not just rely on internal innovation, but to acquire […] be careful to not let M&A become the only source of innovation and growth, as that too can stifle innovation in other parts of the company”; (5) “Signals for transformative changes can often start at the bottom, because younger people may be more attuned to this. But in other instances, the leadership needs to come from the top, as people at lower levels may be too task-specific and miss the relevant signals.”
Bijan Khezri
Chapter 15. Jan Ståhlberg
Abstract
Jan Ståhlberg is one of Europe’s private equity veterans who has consistently embraced governance as a critical driver of performance and value creation. Five key interview statements are worth highlighting: (1) “private equity should outperform public companies […] PE practitioners constantly question the status quo.” (2) “Public boards are more dedicated to what they have. They rarely question the existing business.” (3) “Everyone is informed in real-time about everything. Indeed, this may lead to an overload of information, but overall, this is still more preferable than top-down filtering that may risk excluding potentially insightful stimuli and feedback […] this is Free Energy Governance: connecting top and bottom in circular causality of sensemaking with the least friction and optimal response time.” (4) “Create a culture that empowers and encourages people to contribute, to take decisions, and not to be risk averse.” (5) “You cannot expect bottom-up stimuli reaching the top when the top is not reaching out to the bottom. And sometimes a simple walk through the office can make all the difference. Listen humble and with respect. In summary, it really comes down to three things: communication, transparency, and respect.”
Bijan Khezri
Backmatter
Metadata
Title
Governing Continuous Transformation
Author
Dr. Bijan Khezri
Copyright Year
2022
Electronic ISBN
978-3-030-95473-4
Print ISBN
978-3-030-95472-7
DOI
https://doi.org/10.1007/978-3-030-95473-4

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