Business has always had to adapt to new technologies, from the steam engine to the automobile to personal computers. Today, artificial intelligence (AI) and closely related developments like Big Data analytics and machine learning are the technologies transforming business, along with more established advances such as cloud computing and mobile connectivity. Together, these technologies raise a host of questions, including how they affect corporate structures and governance.
In a recent article, I highlight three phenomena, facilitated by the above-mentioned technologies, that are reshaping traditional views of corporate governance: (1) the blurring and perforation of firm boundaries through AI; (2) “reverse access” based on the strategic leveraging of third-party resources by businesses; and (3) the hybrid role of online platforms.
Blurring and Perforation of Firm Boundaries
Firms are commonly seen as separate entities with clear demarcations between their internal operations and the external market. However, the use of third-party provided AI systems (AI-as-a-Service) is challenging this notion. Businesses now frequently rely on external AI tools for various functions, from customer service chatbots to complex data analytics and core business operations. This can make it difficult to distinguish where firms end and the market begins.
Indeed, AI can serve as a two-way bridge between different firms. From the perspective of a business, using third-party AI systems introduces elements of delegated or shared authority and, as a result, perforated firm boundaries. Conversely, AI can extend the AI provider’s firm boundaries. Consider a business that relies on third-party AI services to manage various aspects of its operations. It will have varying degrees of limited or shared authority – and in certain aspects no authority – over the AI, such as its underpinning algorithms and operation. Authority over the AI system therefore lies both within and outside of the firm but for certain aspects only outside the firm.
As for AI providers, they may benefit from knowledge they gain from deploying their AI services at multiple businesses. Currently, there is no straightforward way to fairly distribute the knowledge gains among AI providers and users.
Given these new realities, theories of the firm that assume clear organizational boundaries may no longer be adequate. These theories must adapt to the new dependencies by allowing for more flexibility in defining corporate boundaries, while governance strategies should ensure that critical functions that are outsourced or dependent on third parties remain under effective oversight.
Reverse Access
My article also explores the phenomenon of reverse access. Access is reversed because, rather than the usual situation of consumers accessing business resources, goods, or services, it is businesses that are using and extracting benefits from assets or resources (time, labor, goods, etc.) that are owned or provided by consumers or other individuals. For example, online platforms control and commercially exploit or monetize resources that reside beyond what would traditionally be viewed as their boundaries. As a result, firms can quickly grow with limited investment in tangible assets or employees. This development is novel in terms of the scale on which access takes place, enabled through technology, as well as the importance of the access for a company’s core business.
Like perforated boundaries, reverse access is hard to reconcile with traditional concepts of the firm and its governance. Questions concerning the regulatory consequences of reverse access arise as well.
Hybrid Role of Online Platforms
As a third phenomenon, the article discusses the unusual hybrid role of online “matchmaking” platforms. Companies such as Amazon, Alibaba, Airbnb, Tencent, and Uber focus on connecting buyers and sellers. Their own role and status in doing so, however, is disputed. In their telling, platforms are solely intermediaries, market makers, or facilitators that bring together suppliers of goods and services with prospective customers.
Yet, some online platforms go beyond this role. Technology allows them to erode or eliminate the distinction between the firm and the market by combining aspects of each. Platform companies are able to influence the terms of the exchanges on the platform, much like a central organizing authority. For instance, they may control access of suppliers to the platform, determine the conditions on which contracts are concluded and performed, or require the use of specific payment and fulfillment services.
Some marketplaces are therefore not actually marketplaces. Rather, they are online storefronts that let customers make purchases from just one party, the store operator, rather than contracting with independent market participants. They may mimic the market and exchanges between suppliers and buyers, but the platform, as the sole supplier, is not an actual market.
Again, the unclear distinction between firms and markets does not easily conform to traditional theories of the firm. Further, with powerful platforms controlling access to and terms of exchanges on important markets, they gain gatekeeper status. This, in conjunction with the winner-takes-all and network effects associated with the typical platform model, creates the need to formalize platform responsibilities.
Implications for Corporate Governance and Regulation
As to corporate theory, I argue that the traditional views of firms as isolated units are increasingly out of step with business structures and practices. New technologies weaken the idea of unfettered hierarchy within firms and their status as islands separate from the open waters and other islands surrounding them. Classic transaction-cost economics models remain useful for predicting the emergence and size of firms, but their application is complicated by new interactions between shifting authorities within different businesses, driven by AI and other technological advances. The nexus of contracts theory is better able to accommodate these economic realities, in part because its proponents are more willing to accept fuzzy firm boundaries. The theory’s flexibility, however, makes it also less relevant in terms of implications for the specific impacts of technology on firms described in my article. As an alternative, the view of the firm as a network of various actors’ specific investments, centered around access to critical resources,[1] offers a useful framework for conceptualizing firms in view of perforated boundaries and reverse access.
The “specific investments” framework also provides insights into consequences for corporate governance, especially in conjunction with resource-based accounts of the firm.[2] Given that perforated boundaries, reverse access, and online platforms all imply far-reaching forms of firms’ reliance on third parties and outside resources, a lesson for boards is to focus on guarding and fostering access to resources for the sake of investors and the firm’s own survival. Even where survival is not an issue, doing so may still provide a competitive advantage, boosting the firm’s potential for long-term profits.
Finally, I argue that the three phenomena are relevant to regulation, in particular as they highlight the need to mitigate power imbalances. As firms become more interconnected and reliant on external technologies – in particular AI and online platforms – there is a risk of concentrations that may disadvantage smaller players or create monopolies. Regulators should develop policies that promote fair access to AI and platform resources. Those policies should focus on (1) access and terms, to ensure that firms are not arbitrarily prevented from using AI or forced to accept unreasonable terms, (2) transparency, to allow users to make informed choices about deploying AI and its potential consequences, and (3) distribution of knowledge gains, to support fair outcomes in allocating AI rents.
Conclusion
In my article, I analyze how AI and new technologies are reshaping the corporate landscape. The perforation of firm boundaries, strategic leveraging of third-party resources (reverse access), and the hybrid role of online platforms all present challenges to traditional governance models. To address these challenges, we can tweak or revisit existing corporate theory and governance approaches. Additionally, firms and regulators must adapt their strategies, focusing on resource optimization and regulatory frameworks that promote fairness and transparency. As the digital and AI revolution continues, these adaptations will be crucial in ensuring that corporate governance evolves in a way that supports innovation while safeguarding business and society’s interests.
ENDNOTES
[1] See Raghuram G. Rajan & Luigi Zingales, Power in a Theory of the Firm, 113 Quart. J. Econ. 387 (1998).
[2] A classic contribution is Jeffrey Pfeffer & Gerald Salancik, The External Control of Organizations: A Resource Dependence Perspective (2003, originally published by Row, 1978).
This post comes to us from Professor Martin Petrin at the University of Western Ontario. It is based on his recent article, “The Impact of AI and New Technologies on Corporate Governance and Regulation,” available here.