The Value Of A Legally Astute Top Management Team: A Dynamic Capabilities Approach
Yale Law School
March 14, 2016
Oxford Handbook of Dynamic Capabilities (David J. Teece & Sohvi Leih, eds. Mar. 2016). DOI: 10.1093/oxfordhb/9780199678914.013.027
Abstract:
This article, from The Oxford Handbook of Dynamic Capabilities (David J. Teece & Sohvi Leih, eds. 2016), describes the construct of “legal astuteness” and explains why it is a valuable dynamic capability. It also examines the systems approach to law and strategy, which embeds the top management team within the firm’s “ecosystem.” The discussion begins with an overview of the dynamic capabilities approach to competitive advantage and proceeds by identifying the requirements of legal astuteness: a set of value-laden attitudes about the importance of law and ethical behavior to firm success; a proactive approach to management, regulation, and risk; context-specific knowledge of the law and the appropriate use of legal tools; and strategically astute counsel. The article then explains how legally astute top management teams can augment contracts with relational governance; practice strategic compliance management; enhance, combine, protect, and reconfigure tangible and intangible assets; and manage human resources more effectively. Finally, it outlines degrees of legal astuteness.
The Value Of A Legally Astute Top Management Team: A Dynamic Capabilities Approach – Introduction
This chapter presents the construct of “legal astuteness” (Bagley, 2008) and argues that it is a valuable dynamic capability (Teece et al., 1997; Teece, 2007). It also presents the systems approach to law and strategy (Bagley, 2010), which embeds the top management team (TMT) within the firm’s “ecosystem” (Teece, 2011: 4, 6). Like “[t]he element of dynamic capabilities that involves shaping (and not just adapting to) the environment” (Teece, 2007: 1321), the systems approach “is entrepreneurial in nature” (Teece, 2007: 1321) and includes not only the competitive environment, the resources of the firm, its value proposition, and the activities in the value chain but also the regime of public law and the broader societal context within which firms operate.
The dynamic capabilities approach seeks to explain how certain firms build competitive advantage in “a Schumpeterian world of innovation-based competition, price/ performance rivalry, increasing returns, and the ‘creative destruction’ [Schumpeter, 1934] of existing competencies (Teece et al., 1997: 509).” Teece disaggregates dynamic capabilities “into the capacity (1) to sense and shape opportunities and threats, (2) to seize opportunities, and (3) to maintain competitiveness through enhancing, combining, protecting, and, when necessary, reconfiguring the business enterprise’s intangible and tangible assets” (Teece, 2007: 1319). Dynamically capable firms have the ability “to learn and to adjust” (Teece, 2011: ix) and to sense, create, shape, and seize opportunities “while simultaneously [identifying and] managing competitive threats” (Teece, 2011: 4). Dynamic capabilities “also embrace the enterprise’s capacity to shape the ecosystem it occupies” (Teece, 2007: 1320), including the ability to help shape the “rules of the game,” the informal customs and laws governing the conduct of business (North, 1990: 3). They also include “the ability to develop new products and processes, and design and implement viable business models” (Teece, 2007: 1320).
Wernerfelt (1984) and Barney (1991) asserted that firm resources, be they physical capital, human capital, or organizational capital, have the potential of providing sustained competitive advantage if they are valuable, rare, and imperfectly imitable by competitors, and have no strategically equivalent substitutes. Under the resource-based view (RBV) of the firm, “a firm develops competitive advantage by not only acquiring but also developing, combining, and effectively deploying its physical, human, and organizational resources in ways that add unique value and are difficult for competitors to imitate” (Colbert, 2004: 343). Because “competences can provide competitive advantage and generate rents only if they are based on a collection of routines, skills, and complementary assets that are difficult to imitate” (Teece et al., 1997: 524), “that which is distinctive cannot be bought and sold short of buying the firm itself, or one or more of its subunits” (Teece et al., 1997: 518). As discussed in Section 3.3.1 below, it is increasingly difficult to identify significant sources of firm value that do not depend on legal rights for the capture of that value.
Teece et al. (1997: 518) postulated that “the competitive advantage of firms lies with its managerial and organizational process, shaped by its (specific) asset position, and the paths available to it.” A firm’s “managerial and organization process” includes the ways managers coordinate or integrate activity inside the firm, such as the process by which learning occurs and is disseminated and the capacity to reconfigure the firm’s asset structure and to accomplish the necessary internal and external transformation (Teece et al., 1997: 518–521). Position comprises the “current specific endowments of technology, intellectual property, complementary assets, customer base, and its external relations with suppliers and complementors” (Teece et al., 1997: 518). Thus, it includes enforceable rights, such as contracts with customers, suppliers, and complementors; patents, copyrights, customer lists, and other tacit knowledge protectable as trade secrets; reputational assets, which can be impaired by compliance failures; and structural assets, such as distinctive corporate governance and partnership arrangements and the ethical and innovative culture of the firm. “Paths” are “the strategic alternatives available to the firm,” which are affected by “the presence or absence of increasing returns and attendant path dependencies” (Teece et al., 1997: 518).
While recognizing that “competitive advantage can flow at a point in time from the ownership of scarce but relevant and difficult-to-imitate assets, especially know-how,” Teece made it clear that “in fast-moving business environments open to global competition, and characterized by dispersion in the geographical and organizational sources of innovation and manufacturing, sustainable advantage … requires unique and difficult-to-replicate dynamic capabilities” (Teece, 2007: 1319).
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