Thursday, June 18, 2020

Between Two Chairs: The Power of the Bridging

One of the differences between practice and science is that in management practice, the person with a clear identity, focused expertise, and undivided loyalty is valued greatly. In science, we often find that this person is too narrow to respond to a complex world. Indeed, we regularly publish findings suggesting that more complex people are more useful to their organization.

Is this true also at the highest levels of management? One way to answer this question is to look at boards of directors, as Jiao Luo,Dongjie Chen, and Jia Chen did in research published in Administrative Science Quarterly. They looked at directors who had studied or worked outside China but then returned and became board members. They examined whether these board members helped introduce the novel (in China) practice of donating to corporate social responsibility (CSR) initiatives.

The reason such returnee board members might be less influential than other organizational members with complex backgrounds is simple: power. The board of directors is the most important decision-making body in an organization. It makes decisions through voting because there is no central authority, and board members may not come to agree on the right decision. That is different from what happens further down in the organization, where an idea-rich person can become recognized and promoted by someone higher up, to the benefit of both.

So are returnee board members more effective in promoting CSR than those who stayed in China? The authors found that the answer is yes butas you might expect given boards’power games—under certain conditions. First, they need allies. More returnees in a board help, and interestingly, returnee directors also become stronger when they have strong local political contacts. In an interesting twist, the directors returning from nations in which political contacts would normally be useless are especially influential if they have political contacts.

Second, the returnees are helped by conditions showing a need for CSR. As in any power game, showing that your side is the right one for helping the community, and getting potential allies that way, can help push the opposition into conceding.

The benefits of having a diverse background and seeing a decision from multiple angles are well known. Whether they translate into actually making the right decision is less well known, and it is very useful to learn that allies are necessary. After all, the main reason that the person with clear identity is trusted more is that they are more common, so they more easily form allies with those like themselves. For people with complex backgrounds, this task is harder.

Luo, J., D. Chen, and J. Chen2020. "Coming Back and Giving Back: Transposition, Institutional Actors, and the Paradox of Peripheral Influence." Administrative Science Quarterly, forthcoming.

Friday, June 12, 2020

Shopping for Judges: How Firms Try to Manipulate Legal Decisions

Many people are not aware that the US legal system facing corporations is much like a shopping mall that lets the plaintiff choose jurisdictions just as freely as we choose between the Adidas, Nike, or Puma store. And plaintiffs choose for the same reasons we choose a shoe store – price and fit. They want quick decisions, because they are inexpensive, and they want decisions that fit their wish. Which is to win, of course.

Thanks to research by Maxim Sytch and Yong H. Kim published in Administrative Science Quarterly, we now know more about how plaintiffs choose jurisdictions. The authors find that the choice is often guided by social connections, a way of choosing that sounds odd but is actually very effective. To understand how this works, there are two things we need to know.
The first is that although the law is said to be the same for everyone, it is not. Legal cases involve communication and interpretation, so whoever can tailor their message to the judge has a better chance of winning.

The second is that communication and interpretation are learnt. That matters because sharing law school education means sharing this type of learning, as well as the feeling of coming from the same stock. Sharing work experience matters too, because people who work together practicing law, as newly minted lawyers do when serving as clerks for judges, learn how their colleagues communicate and think.

Knowing these two things, we can start understanding how a patent lawsuit, which is what Sytch and Kim studied, is filed. The law firm (patent lawsuits are not handled by in-house lawyers) looks for judges who attended the same law school as one or more of its lawyers or for whom its lawyers served as clerks. The firm picks a jurisdiction that has such connected judges. If it gets the judge it wants, the firm’s lawyers tailor the language in their filing to match the communication and interpretation of the judge. And then they win – not always, of course, but much more often than they would if there was no connection or no tailoring of the message.

The increase in win likelihood is stunning. Having studied at the same school at the same time as the judge multiplied the likelihood of a win by 4.6, and having been a clerk for the judge multiplied it by 2.8. Tailoring the lawsuit further increased the likelihood. Clearly, we cannot say that “all corporations are equal before the law.” Those who pick law firms that get the judges they want do a lot better.

Is there no risk to this behavior? Well, the way it works is that a law firm chooses the jurisdiction (Federal District Court), but the judge is chosen randomly within the jurisdiction. Because the law firm looks for social connections, it may actually sacrifice some human capital when assigning its lawyers to the case. That, in turn, means that a loss is more likely if the judge they’re hoping for does not get assigned to the case. The downside is not huge, though: the firm is just over 10 percent less likely to win the case. So, we are looking at a one-sided bet.

Clearly the practice of law is in some jeopardy if it is done in such a club-like fashion. This is especially so because under the US legal system, decisions establish precedent, so any decision in favor of the plaintiff that pushes the boundary of what a patent claim can cover has future consequences. These consequences are already seen in the form of “patent trolls,” which are corporations that acquire (buy) patents not to make products and do business but just to file lawsuits against other firms. Patent trolls benefit from the ability to threaten firms into offering settlements (paying without even going to court), which is more likely when law firms skilled in jurisdiction choice keep winning their cases.

Tuesday, June 9, 2020

Are Fraudsters Innovative? Real-life Ocean’s Eleven

Do we admire fraudsters? I know you want to answer negatively, but there is a great deal of admiration of the clever fraudster expressed in popular culture, as seen in novels and in movies such as Ocean’s Eleven. Much of the admiration has to do with how clever and innovative fraudsters are, unlike most of us. From an outsider’s point of view, it is almost as if someone with a known history of deception in business and private life could get sufficient votes to win an election to a public office.

An important premise of the admiration is that fraud and innovation are found in the same people and the same firms. So, maybe those who fraudulently get money are the ones who will use it most innovatively? Whether that is true is the topic of research by Yanbo Wang, Toby Stuart, and Jizhen Li recently published in Administrative Science Quarterly. Their idea was simple and powerful. One of the main ways that firms do fraud is by misstating their financial statements. For example, a fraudster might report huge losses and no wealth to the tax authorities and tell everyone else that he is a billionaire. The benefit of the fraud is to get something valuable – paying less taxes while getting trust and resources from others.

Wang, Stuart, and Li were able to find data proving that such fraud took place because they could compare Chinese firms’ regular financial statements with those they reported when applying for innovation grants. Obviously, reporting success can help a firm get innovation grants, even if the report is false. After all, when the state grants innovation funds it acts like an angel investor or a venture capital firm – it chases success.

For those of you who value honesty, I should start with the authors’ finding that half the firms were honest. How you react to this finding depends on what you thought was true, of course, but it can be either relief or disappointment.

What follows is worse. Fraud pays. Exaggerating success helped firms get money, so the final pool of firms getting innovation grants was less honest than the initial pool of applicants. Also, fraud leads to waste. Honest firms winning grants increased their hiring overall, including R&D hiring, whereas fraudulent firms winning grants only increased non-R&D hiring. It is unclear what exactly the fraudulent firms were using their innovation grants for, but it clearly was not pursuit of innovation. Logically, they would succeed in innovating only if they were smarter than the honest firms to begin with. Were they?

What follows is even worse. Fraud produces smoke and mirrors only. Honest firms winning grants produced more innovations that they patented, whereas fraudulent firms winning grants did not. However, the fraudulent firms excelled at producing utility patents, which is a form of patent that establishes legal claim over a non-innovative feature of a product. Utility patents can be ways of claiming progress when there is none, but they can also be a way to get the legal means to become a patent troll.

Clearly this is one type of fraud that did nothing good for society and in fact produced significant waste of resources. And why should we expect otherwise? The brilliant (and good-looking) fraudsters in Ocean’s Eleven are fiction, and the fun of fiction often lies in that it is very different from reality.

People still have illusions that invite fraud, because success looks so wonderful that even those who should have better judgment often do not stop to ask whether what they are seeing is true. For example, in retrospect it seems strange that the bold claims of innovative blood testing by Theranos could seem true. They were still able to recruit a stellar board of directors including people like Riley Bechtel of the famous Bechtel Corporation, William Foege, who had been with the CDC (yes, the people trying to save the U.S. from Covid-19), Fabrizio Bonanni who had been with the biotech firm Amgen, and James Mattis, Marine Corps general. Of course, it ended well for James Mattis, who was awarded for his good judgment in Theranos by being picked as President Trump’s Secretary of Defense.

Fraudsters win because others are na├»ve and optimistic. They win especially easily when lack of transparency enables fraudsters to tell different things to different people. So when we know that information is being concealed, we should pay even closer attention.  

Thursday, June 4, 2020

I Did It My Way: Finding Allies When Solving Problems

Firms often run into problems. The most common one is that low performance causes unrest in the board of directors and shareholders. More unusual ones (but still too often) are safety problems with the product, pollution from the production, disputes with the employees, and so on. When there is a problem, managers and board members look for a solution, and the question is, which one to pick?

The question is important for the firm because different solutions have different merit. It also reveals a lot about power and politics in the firm, and especially when the board of directors makes the decision. This is because each board member has learnt from their experience and knows some ways of solving problems well, other ways less well. That sets up a power play between different fractions of the board with different experience and different solutions to the problem. Finding out which side wins is the topic of research by Cindy Man Zhang and myself published in Academy of Management Journal.

The context was acquisitions of other firms in China. Globally, acquisitions are a frequent solution for firms trying to improve their performance -- paradoxically so, because most acquisitions are bad for performance. Still, it is hard to find a board that is not confident enough to think they can do better than most others, so acquisitions happen a lot. The key feature of acquisitions in China’s market economy with many regular firms (not state-owned firms) is that many acquisition targets were available, and these came in two types: regular market-based targets and the more unusual state-guided acquisitions, which were firms that the state very much wanted to see acquired by another (wealthier, more capable, or better managed) firm.

Now the power play is clear, right? Market-based acquisitions are identified by the acquirer and are firms that promise economic benefit in some way, such as synergies or opportunities to downsize. State-guided acquisitions can also bring economic benefit, but probably less, though they earn political capital with the state. A director with experience in the private sector, especially outside China, wants nothing to do with the state-guided acquisition and prefers the market-based one. A director with experience working for the state is comfortable following state directives and suspicious of methods for assessing the economic benefit of market-based acquisitions. Game on: there are two potential solutions, each with supporting board members.

It looks like we could determine what solution is chosen just by counting votes in each direction and seeing which one wins, but it is not that simple. What about the director with no state or market experience? What about the director with both? What if the state-directed alternative is economically very attractive (or the opposite, very unattractive)? We cannot treat board members as robots who do one thing only, regardless of circumstances. What we need to consider is that each side tries to build a coalition of like-minded directors, but also draws in all others who might join because they start out in a neutral position.

What we found was more interesting and also more intuitive. Counting votes does predict the type of solution provided we take into account the in-between directors – those with no clear loyalty to the state or market, or those with split loyalty. These in-between directors are very influential on acquisition decisions because they can join either one of the coalitions and can change sides depending on how good each alternative acquisition target is. Experience matters in firms because each decision makers wants to “do it my way.” Power and politics matter because there is more than one way, and decision makers need to build coalitions.

Zhang,C.M., H.R. Greve. 2019. Dominant Coalitions Directing Acquisitions: Different Decision Makers, Different Decisions. Academy of Management Journal 62(1)44-65.