I know that business schools don’t educate priests, so calling them seminaries is provocative. The provocation is based on facts, and these facts deserve attention. Like any other form of education, business schools teach strongly held beliefs on how the world works and why some actions are better than others. By the way, what I just said is not equally true for all kinds of education. For example, science places more emphasis on how the world works, while engineering places more emphasis on what actions are best. Business schools are even more engineering than engineering departments, because students taking MBA degrees are very interested in knowing what to do to become successful, and they prefer short explanations of why the sources of success are connected with how the world works.
This is important because the actions taken by those few MBAs who become CEOs of major corporations are very consequential, so business schools are also very consequential. What we teach is practiced by firms, both when it is right and when it is wrong. A recent paper in Administrative Science Quarterly by Jiwook Jung and Taekjin Shin looks at how business schools were behind the largest change in firm structure in recent history: the breaking up of diversified corporations into smaller specialist firms.
This change is literally a textbook case of what firms should do. According to finance theory of capital markets, investors are better off diversifying by buying many specialist firms than a single diversified firm. According to the economic theory of managers, firms are more valuable when they are so specialized that it is easy to reward and punish CEOs based on how well they do. The combination of these two theories moved into business schools in the 1970s and has stayed there ever since. Jung and Shin discovered an easy way to measure its effect: In the exact same time period, firms led by CEOs with MBAs from before the 1970s kept diversifying, and firms led by CEOs with MBAs from the 1970s onward were de-diversifying. The CEOs were practicing what their business schools preached.
Does this sound like a good effect of education, or is there anything scary about it? We like people to choose the right actions based on knowledge of how the world works. Business schools have a special responsibility because some of the people we educate become very important for the society and economy. So this seems like a good outcome: for anyone who believes what business schools teach, it was great that businesses became less diversified.
Here is the scary part. Any form of science is wrong or incomplete sometimes, especially if it is a young science like the branches of knowledge that business schools teach. Remember when all the finance professors thought the economy was healthy, just before the financial crisis? It gets even worse when our graduates learn what actions are best but prefer short explanations of how the world works. Remember when all investment advisors loved web businesses, just before the dot-com bust? If we teach too confidently, trouble will follow.
De-diversification sounds like a safe case, because there is pretty good evidence that diversified firms are worth a little less than de-diversified ones. But we should keep in mind that even this case isn’t entirely clear. The de-diversification took place during a time period when changes in competition law enforcement meant that buying competitors and increasing prices became easier and a better use of money than diversifying. Also, for firms heavily engaged in product development, some diversification can be a significant advantage, as another recent ASQ paper has shown. Even the best of our knowledge can be changed as we continue to learn. That’s how science works, and that’s why teaching should be done with some modesty.
PS: For those who wonder about the picture of this blog: Martin Luther was a professor and a priest.