Institutional Theory

Why do people behave the way they do in any given society? Better yet, why do organizations and the people within them behave the way they do? This is, no doubt, a complicated question, responded to by multiple theories that explore the complexity of human and organizational behaviour. One such theory that has gained tremendous traction in the study of organizational behaviour is institutional theory. Institutional theory draws from constructionism, which suggests that the outside world is not predetermined or objectively set but is instead constructed by the decisions, attitudes and behaviours of actors within it. Over time, what is considered normal and accepted in a given social reality, is largely based on the repeated behaviours over time of a majority of organizations that assign similar meanings to those behaviours. When processes and structures becomes institutionalized, they move beyond instrumental value and earn intrinsic value as actors assign them validity based on the fact that they are taken for granted as the ‘way things are’ and/or ‘the way things are to be done’. When it comes to organizational behaviour, institutional theory offers an alternative explanation to rational decision-making, a view that organizational members make deliberate and calculated decisions that reflect a sound analysis of the merits of a list of alternatives. Similar to how individuals have been shown to behave irrationality, organizations too have succumbed to irrational decisions and institutional theory helps us understand why this happens. Scholars refer to three primary dimensions that govern an institution that together explain how individuals or organizations come to accept a shared definition of reality.

Regulatory

The first is regulatory, which refers to the explicit, formal rules that constrain behaviour and regulate interactions. The regulative dimension works to coercively ensure stability by establishing ‘rules of the game’ by putting forth rewards and punishments and threat of legal sanctions, increased costs or general disruption. The more familiar regulative mechanisms are laws imposed by governments backed by legitimate enforcement and legal processes. Partly through law and order, we’ve come to accept here in Canada that certain behaviors are unacceptable and therefore deemed criminal. At the organizational level, tax law in a given country specifies how much a company would be required to pay as part of their profit levels. Another might be regulations for or against bribery or limits on pollution levels of given industries. A government's support of electric vehicles or green housing retrofits through emission standards and grant programs represent a regulatory force that influence consumer behaviour.

But beyond the baseline nation state rules that organizations must uphold, these organizations can institute their own supplementary rules that influence employee shared reality in the workplace. Incentive and reward structures, for instance, play a large formal role in influencing how employees perceive the social reality of their workplace. This means that what one employee perceives to be reality in one company could be radically different from a similar employee in another organization. Consider a company whose fundamental reward structure is based on sales commissions versus another company whose fundamental reward structure is based on salary and bonus. Other organizational level regulatory mechanisms that define social reality might include the handling of confidential information of a client, the process by which an employee gets promoted or fired, the explicit process of performance evaluation and the associated rewards and punishments that result, job descriptions, and how bonuses are calculated. The regulatory force can also include rules associated with the type of organizational structure a company uses. A cooperative, for example, where owners are customers is a very different structure than a traditional public company where owners are shareholders. Each structure imposes a very different set of rules that influences behaviour of managers significantly.

Normative

The second institutional dimension is normative. Normative aspects of institutions represent rules-of-thumb, standard operating procedures, role expectations, codes of conduct, occupational standards, and educational curricula. Unlike the regulative dimension which influences behaviour based on coercion, this dimension influences behaviour through social obligation and peer pressure. Trade or industry associations (e.g. Mining Association of Canada) can have an immense impact on member organization behaviour not necessarily due to their ability to legally enforce such behaviour but instead as a result of peer pressure and the establishment of norms that reflect what is acceptable or unacceptable behaviour in the industry. Consider the Net Zero Banking Alliance spearheaded by former Bank of Canada Governor Mark Carney in response to climate change.  No doubt, as we started to see some of the large global banks join the alliance, the pressure of other medium and large banks to do so as well increased dramatically. Similarly, the Equator Principles represent a collective effort on the part of international banks to reduce the availability of capital to those projects that produce negative social and ecological externalities in developing country contexts. These governing bodies have no legal recourse in the event that a bank does not comply but it can rely on peer pressure and a bank’s quest for legitimacy that tends to come with conforming to standard operating procedures in an industry. Unlike the regulatory force where actors conform out of fear of legal sanction, actors conform to institutional norms to avoid shaming through social sanction. As a consequence, in those institutions that are largely influenced by normative rules, actors within the institution tend to ask, “what is expected of me?”

Part of what makes the normative dimension so powerful is that actors in society – including organizations – have a very strong desire to feel part of a group or community, meaning that social sanctions represent a very powerful enforcement tool to shape behaviour and social reality. For instance, the proliferation of sustainability or ESG reporting across public companies was, at least initially, not a legal requirement but instead a normative one. Across many industries, major public companies faced major social sanction by their peers and other stakeholders if they did not report on their non-financial performance. Even ESG tactics can be institutionalized through normative forces as one did in grocery retail where one business after another instituted a reusable bag policy and started to charge $0.05 per plastic bag. This of course was replaced in Canada with a regulatory ban on single use plastics. Initially though, there was no law pressuring companies to adopt this tactic but instead a rite of passage to be part of an exclusive group of “morally sound” companies. Codes of conduct in businesses are normative as well. It is very difficult to impose coercive legal sanctions on employees who do not follow the code of conduct because they are likely very difficult to measure and enforce. As a result, organizations rely on peer pressure and social obligation to enforce employee conformance to these codes.

Cognitive

The third institutional dimension is cognitive. Individuals and organizations will often adhere to the cognitive dimension of institutions without any conscious thought of doing so. That is, unlike its normative and regulative counterparts, cognitive aspects of institutions are subconscious. For instance, it might feel natural to commute to and from work in a motorized vehicle in one context but natural to commute to and from work using public transit in another. In either of these two contexts, individuals abide by this action because it is culturally supported to do so. Customers entering a grocery store find it natural to begin on the right hand side of the store and move left while the consumption of breakfast cereals in western markets has become a highly unquestioned breakfast tradition in the last several decades. These are not rational decisions, nor do they represent legal or even social obligations. They are highly unconscious traditions, the resistance to which would be deemed unfathomable. Sources of cognitive influences tend to originate from an individual’s background, ethnicity, upbringing, education, and life experiences. At the organizational level, culture has an important impact on the cognitive dimension. For instance, one company might have a strong culture of cooperation while another might have a strong culture of adversity and competition. The ensuing behaviour of employees is often so automatic that it feels very out of place not to cooperate and share information as opposed to competitively withhold such information.

Decision makers are particularly vulnerable to the cognitive dimension because they are boundedly rational. That is, their ability to process all information from the external environment in a rational way is severely limited. As a result, they rely on schemas, frames, cognitive heuristics or even belief systems to select and process information. This means that social reality is largely influenced by the cognitive frames actors use to make sense of the outside world. For instance, individuals belong to particular social groups whether that be a student, a parent, a grandparent, an employee, a community member. Within each social group are certain culturally acceptable behaviours that are highly taken for granted yet might not be the same behaviours these individuals would enact had they not been part of the social group. Studies show, for instance, that when in a high pressured managerial role, individuals will behave in certain ways that contradict their behaviour in their personal lives. This is not a result of normative obligations as much as they are of cognitive heuristics individuals use in their cultural understanding of a manager in a particular industry to guide their behaviour in particular roles.

An Example: Business School Classrooms

To demonstrate how these three forces (regulative, normative, cognitive) are complementary, consider the business classroom environment, which one could argue is very institutionalized. The professor imposes certain regulatory tools to influence student behaviour. For instance, grading participation and imposing penalties for improper or disrespectful behaviour. On the normative side, students behave in certain ways based on the social penalty that might come with talking for too long in a discussion, dominating the discussion, challenging other students in a way that is disrespectful, etc. Regardless of whether the instructor has regulatory mechanisms in place, the student would be discouraged to engage in this behaviour due to the social sanctions of being ostracized from the class. In fact, some instructors find the regulatory mechanism unnecessary due to the normative enforcement of student behaviour. Finally, each student comes to class with a unique background that defines their personality and demeanor in a classroom setting. Regardless of the rules or what is deemed acceptable by the class, there are important subconscious influences that affect student behaviour that consequently have an impact on class atmosphere. For instance, instructors oftentimes find that one or two students can have a dramatic impact on the culture of the class. These students, for instance, might have a personality that is particularly hostile and combative that is not necessarily balanced by a contrasting personality in the classroom, which results in a particular culture. Studies show that students attracted to business schools possess unique personal characteristics that are not present in students of non-business programs. For instance, it is likely no surprise that classroom environments of top business schools are quite competitive due to the fact that the personality traits of students entering the programs possess high levels of competitiveness and independence.

Dynamism

While the above institutional forces are introduced separately, they are highly interrelated. That is, the proliferation of one force, can have a significant impact on the other forces. This is probably most evident when considering how the proliferation of certain norms, once accepted as given, inform regulation and become enshrined into law. At the same time, norms can become so accepted that individuals might not recall a time when alternative behaviours were available. In this situation, the normative forces lead to a cognitive force. Consider the proliferation of news on social media. It became increasingly common for people to turn to social media to get their news. It became a norm. But studies have shown that a growing number of people, youth in particular, do not even consider alternative media outlets when getting their news.

Legitimacy

The strength of any institution is dependent on how well these three forces reinforce one another in such a way that attitudes and behaviours become highly taken for granted. In such a context, actors face immense pressure to conform to these forces as a means to gain legitimacy by the social group it seeks to be a part of. Back to our classroom example, students gain legitimacy within their peer group when s/he receives good grades from the instructor (regulative), participates in class discussion in a way that is deemed acceptable by the rest of the class, (normative), and uses appropriate business vocabulary and business professionalism (cognitive). New members of the class will often refer to these forces to earn legitimacy just as small businesses aiming to compete effectively with large businesses in a given industry will seek to conform to these forces. Just as we want to be legitimate in our social circles, organizations too want to be perceived legitimate by its competitors, consumers, suppliers, and (soon to be) shareholders.

Interestingly though, the notion of legitimacy tempers the view above that organizations conform to certain beliefs only because they constitute reality or are taken for granted. Legitimacy suggests that organizations also conform because they are rewarded for doing so through access to markets and resources. Yet notice that this is opposite to what strategic decision-making frameworks would suggest, which is to find ways to remain differentiated from larger competitors. Here, institutional forces leads to isomorphism, which suggests that organizations end up looking very similar as they adopt the institutionally prescribed practices. But solid empirical evidence shows that when organizations conform to the normative, cognitive, and regulatory forces that define social reality, they perform better. That said, the search for legitimacy does reinsert the role of pragmatism and instrumental value back into institutionalization.

Organizational Fields and Institutional Logics

Although institutions can be a powerful source of influence on actors, in many cases their reach can only go so far. In the example above, the competitive classroom is really only evident in certain university and college programs and is not evident in other programs. This is important for two reasons. First, institutional power has a boundary. In some cases, a particular institutionalized behaviour may be restricted to a small number of highly similar actors (e.g. Canada’s big banks) while in other cases institutionalized behaviour may apply to a group of diverse actors (e.g. Fair Labour Association). Organizations influenced by a given institution are said to exist in an organizational field. An organizational field represents a community of organizations “that partakes of a common meaning system and whose participants interact more frequently and fatefully with one another than with actors outside the field” (Scott, 1995: 56). Examples might include businesses that define a supply chain, businesses in an industry, a group of NGOs, a trade association, a collection of diverse organizations within a small community, or a selected group of governments (e.g. G20). As each actor in the field makes decisions and behaves, they impose and reinforce the coercive, normative, and cognitive forces on other organizations in the field. More specific to sustainability or ESG, scholars have suggested that organizational fields are formed around "the issues that become important to the interests and objectives of a specific collective of organizations" (Hoffman, 1999: 352). This implies that it is an issue like poverty or climate change that make links among organizations that may not have previously been present.

Second, given that the influence of an institution is restricted to a particular organizational field, it is useful to consider how different sets of regulative, normative, and cognitive forces can be associated with one organizational field and how a different set of these forces can be associated with an alternative organizational field. In other words, despite facing a similar problem, organizational fields, each with their own meaning systems tied to regulative, normative, and cognitive forces, will have a dramatically different interpretation of the problem and of the solution. Scholars refer to the institution that governs a particular organizational field as an institutional logic. Logics regulate behaviour within an organizational field because they represent a particular combination of regulative, normative, and cognitive forces. More specifically, they are taken-for-granted, resilient social prescriptions, often encoded in laws and norms, specifying the boundaries of the field, its rules of membership, and the role identities and appropriate organizational forms of its constituent communities.

As an example, consider how three different logics interpret human activity. The institutional logic of capitalism is based on accumulation and the commodification of human activity. But the logic of the state is of rationalization and regulation of human activity by legal and bureaucratic hierarchies. The logic of the family is community and the motivation of human activity by unconditional loyalty to its members and welfare. As another example, scholars have shown a dramatic difference in the cognitive, regulative, and normative forces that characterize a professional logic (i.e. medical practitioners) versus those that characterize a management logic (i.e. administrators). Although these two groups of actors work side by side within a health care setting, they both bring with them highly distinct institutional practices and beliefs that clash when these actors interact with one another. While medical practitioners prioritize high level quality care often at whatever cost, for instance, hospital administrators prioritize efficiencies and cost savings. The point here is that logics provide an important meaning system for actors in an organizational field and help to differentiate one organizational field from another. The strength, stability and maturity of an institutional logic is based on the extent to which actors in the organizational field adhere to the rules, norms, and practices that define that field.

But increasingly, organizational fields are becoming characterized by multiple and often conflicting logics. That is, fields are no longer made up of like-minded organizations but instead are made up of highly diverse actors who bring with them their own logic. This is because unlike traditional definitions of fields that were based on membership homogeneity, more recent definitions of fields suggest that they represent a congregation of actors that gravitate to particular issues. This means that actors making up a field can originate from divergent and often contradictory logics. For instance, although environmental groups and chemical companies may share a similar organizational field because they influence one another, they do not share the same regulative, normative, and cognitive forces that influence attitudes and behaviour towards the environment. Microfinance institutions, as another example, face highly contradictory logics when they attempt to simultaneously adhere to the market or business logic of profit maximization and the development or NGO logic. Consequently, some organizational fields may be guided by one overarching logic while other more diverse organizational fields may face conflicting logics.

Institutional Change and Institutional Entrepreneurship

So far, our discussion here has centered around the stability and strength of institutions in influencing behaviour. But history shows that institutions do change. That is, alternative logics can replace prevailing logics governing organizational fields. The best way to think about institutional change is to consider how what was once deemed subconscious and taken-for-granted undergoes a dramatic change. A relatively recent example of institutional change is how Uber challenged the conventional normative, regulative, and cognitive forces that govern paid transportation. The taxi industry benefited for quite some time from a highly stable institution where behaviours of actors in the field (i.e. taxi-drivers, municipalities, consumers) were highly taken-for-granted. But the very notion that paid transportation doesn’t necessarily have to reside with specifically marked vehicles but could include the thousands of non-marked vehicles otherwise sitting parked and unused, while completely logical for many now, radically challenged (if not yet changed) the logic of paid transportation. Another example of institutional change emerged in the organizational field of Chartered Professional Accountants in Canada. Once a highly institutionalized set of behaviours by the big five (at the time) accounting firms, the standard service of auditing and assurance was challenged to include management consulting, a service unheard of prior to this change. CPA Canada had to scramble to develop the regulatory mechanisms to govern this service and the large firms, through their repeated behaviours, began to establish the cognitive and normative behaviours that slowly became institutionalized. Finally, fueled by neoliberal tendencies of the 1980s and subsequent budget constraints by all levels of government, there has been a shift in the logic that governs how public services (e.g. schools, health facilities, public works) are administered. What was once a public commons logic that saw decisions, attitudes and behaviours reflect the needs and interests of the commons, has now turned into a business logic that views cost efficiency and revenue generation as the primary belief system that governs how and why particular decisions are made. As a consequence, two logics clash when community members balk at the increased reliance on corporate sponsorship in schools on the one hand and school administrators refer to the need for financial sustainability as the way forward on the other. Another more familiar example might be the Canadian diet. There is no doubt that regulative, normative, and cognitive forces play an important role in what constitutes a Canadian diet. Cognitive desires for salt, sugar, and fat overruled any rational effort by consumers to eat well while growing norms associated with eating on the go, in the car, and at your desk facilitated fast food that carried with it particular harmful effects. Finally, and perhaps less intuitively, regulatory forces have played a substantial role in facilitating a particular Canadian diet. Government subsidies of the meat and poultry industries in the 1900s meant that these products were priced lower in real dollars next to healthier alternatives. We’re only now starting to see a challenge to this institution as a result of small changes to these three forces.

So then what causes institutional change? In the case of Uber, and many examples like it, technological innovation can be the source of change. The Internet itself has questioned many taken for granted practices in society including the whole concept of retail. Other causes might originate from particular individuals or organizations. Scholars call these actors institutional entrepreneurs. Institutional entrepreneurs can be defined as actors (whether it be individuals, groups, or organizations) who envision new combinations of regulative, normative, and cognitive forces as a means of advancing interests they value highly yet that are highly suppressed by the strength of existing institutional logics. Actors, according to Battilana and colleagues (2009: 68), “must fulfill two conditions to be regarded as institutional entrepreneurs 1) initiate divergent changes; and 2) actively participate in the implementation of these changes.” Often, institutional entrepreneurs "spearhead collective attempts to infuse new beliefs, norms, and values into social structures, thus creating discontinuities in the world of organizations" (Rao & Giorgi, 2006: 271). Despite what you might say about Elon Musk, he does embody some of the characteristics of an institutional entrepreneur given that he is challenging the highly taken from granted institutional context that supported the internal combustion engine. Institutional entrepreneurs face an immense challenge because they are trying to change or at least challenge the very social reality that, by definition, is meant to suppress the motivation and/or awareness of alternative realities. Another example of an institutional entrepreneur might be Muhammad Yunus, who sought to challenge the highly taken for granted institutional logic of banking. Yunus needed to challenge the regulations that determined who was eligible for financing. He needed to stand up against the highly entrenched norms in the industry of ignoring the poor because they didn’t meet industry standards of what constitutes an eligible loan. Most importantly, he needed to challenge the highly taken-for-granted cognitive notion that the poor are less reliable in their ability to repay debt. While Yunus did not changing the logic governing banking, he strongly challenged it by demonstrating that the many institutional forces that dictated a social reality were not necessarily optimal.

Summary

In summary, institutional theory is meant to provide a lens through which to understand behaviour. It is a particularly important theory for understanding organizational behaviour because it suggests that, as part of an organizational field, organizations struggle to behave rationality in the backdrop of strong regulative, normative, and cognitive forces that define a taken-for-granted reality. This has fundamental implications for sustainability because it provides a partial explanation for why organizations struggle to break from the pack of unsustainable behaviour. It also suggests that organizations that take sustainability seriously can only do so if they understand the institutional forces that make such an endeavor difficult if not impossible. These institutional entrepreneurs are climbing the proverbial waterfall as they work to advance more sustainable outcomes through changing regulatory, normative, and cognitive forces to which they are also vulnerable.