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 naïve 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.  

Wang, Y., T. Stuart, and J. Li

2020. "Fraud and Innovation." Administrative Science Quarterly, forthcoming.

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.

Ineffective Efficiency: Designing Organizations for Surprises

Those of us who teach management are used to handling a paradox common in firms and other organizations: the most efficient and admired firms are often those that fail most spectacularly when facing unexpected problems. This is, or should be, a reason for modesty for those teach or manage, and it is also be a reason to think about the source of failure.

In research published in Industrial and Corporate Change, I examined this issue with PeterW. Glynn and Hayagreeva Rao. We did not embark on a study of failures in famous firms – it has been done so many times before. Instead, we modeled different ways of designing organizational structures to see how well they performed. The idea behind the model is that, in addition to whatever else it does, any firm faces a sequence of incoming problems that it needs to spend time solving, and it matters how quickly these problems are solved. This is an easy conceptual model that takes some advanced math to solve; and looking at it we got some surprises.

First, problem solution times can vary tremendously, especially when the firm is busy. This is important because efficiency comes from not having too many resources at hand, which means that efficient firms are busy. It is one reason that success and failure are so closely linked.

Second, managers can make the problem worse. Adding any level of approval of a solution multiplies the time it takes to finalize, which is very problematic when the solution time is already long. Large span of control (many subordinates), as we see in many lean organizations, makes this problem worse. It is another reason that success and failure are so closely linked.

Third, teams can solve the problem. If they communicate well, a team will much more rarely have very long solution times than an individual, even if the individual has exactly the same expertise as all team members combined. This sounds surprising, so I should be quick to add that communication slows down teams significantly.

Fourth, smart rule-breaking can help solve the problem. Specifically, a worker who selectively solves some problems without forwarding the to the manager for approval can reduce the number of problems that take a long time to solve. Similarly, a worker who simply tosses out some problems instead of solving them can radically reduce the number of problems that take a long time to solve. Naturally, rule-breaking is only good for the firm if the workers can identify problems that don’t need approval or don’t need a solution.

These are simple facts useful for putting together an organizational structure and its processes. A designer who knows them can make the right choices between efficiency today and resilience tomorrow, because they dictate how much slower reactions to surprises are when a structure is set up for efficiency. Perhaps the main lesson is exactly in understanding that this is a trade-off. Efficiency is great until the day it isn’t, and it instead becomes the source of failure.

Glynn, P.W., H.R. Greve, H. Rao. 2019. Relining the garbage can of organizational decision-making: Modeling the arrival of problems and solutions as queues. Industrial and Corporate Change 29(1)125-142.

Similar but Better: When Product Comparisons Are Traps

One of the oldest forms of advertising innovative products and services is the comparison with existing ones. Whenever a firm can argue that its innovation is similar to an existing product, but better, two things happen. First, the similarity makes acceptance easier. Second, the improvement makes changes to the innovative products easier. What could go wrong?

Research by Greta Hsu and Stine Grodal published in Administrative Science Quarterly gives one answer to how a strategy of comparison can go wrong. They looked at the growth of electronic nicotine delivery products – vape devices – and how the makers of such products took steps to get them quickly accepted. These steps in turn led them into a trap of their own making.

The starting point is that the cigarette industry is large and highly profitable. After all, even taking taxation into account, cigarettes are vastly overpriced wrapped dried leaves. Cigarette customers are addicted customers (at least addicted to the product category), which is even better than having loyal customers. The only problem for cigarette makers is that the health damages are well known, and the industry is shrinking. Smokers do not quit in great numbers – the product is addictive after all – but more old customers die than new customers appear.

Actors outside the cigarette industry invented superior systems for delivering nicotine and other flavored vapors through well-controlled electronic devices. They then faced the dilemma of how to market this innovation. What to name it? How to have it regulated, or try to avoid regulation? How to market it? A series of decisions led them onto the path to “similar but better,” including naming these devices e-cigarettes.

In many ways this was a natural path because cigarettes are also delivery systems for nicotine and other flavored vapors. The new systems were more complex but also much more controllable, so they really were similar but better. But positioning them that way instead of emphasizing distinctiveness was still a choice, and it turned out to have a series of consequences. On the positive side, some of the innovators got acquired by major cigarette makers and earned greatly from that. Also on the positive side, the major cigarette makers added their marketing muscle and made e-cigarettes widespread very quickly.

Then there was the negative side. The e-cigarettes are efficient nicotine delivery systems, which is a problem because the addiction to smoking comes from nicotine, not from other parts of the cigarette. So, these devices were similar in addictive properties and better at delivering nicotine, a point that anti-smoking activists immediately understood. They were also quick to notice that one maker started adding tastes that made e-cigarettes appealing to youth, as a way of recruiting new users. As a result, campaigning against e-cigarettes increased, and public opinion has turned against them. A good thing too, because a while after these products became popular, a wave of deaths from vaping THC additives showed that these products can be dangerous in ways that regular cigarettes are not.

So “similar but better” is a choice, and when the basic product is bad for health or for any other part of life that we value, it is not obvious that it is the best choice. If over time we confirm that these products actually are healthier than regular cigarettes, then calling them e-cigarettes and making other comparisons has been a serious mistake. An alternative name was easily available, after all. Using e-cigarettes is called vaping (a simplification of “vaporizing”), and the devices could have been called vapers. Instead, a vaper is now someone using an e-cigarette. Just words, you may say, but words have consequences.

Hsu, G., S. Grodal. 2020. The Double-edged Sword of Oppositional Category Positioning: A Study of the U.S. E-cigarette Category, 2007–2017. Administrative Science Quarterly, forthcoming.

Are Pandemics Worse than We Think? Adding Loss of Inclusion to Loss of Lives

Now that the world is dealing with the Coronavirus turning from an epidemic to a pandemic, it may be time to talk about something we learnt from the Ebola virus. This is a lesson from research by April Wright, Alan Meyer, Trish Reay,and Jonathan Staggs published in Administrative Science Quarterly, and it concerns the social distancing that many places in the world now practice to mitigate the effects of this disease.

We understand that social distancing is inconvenient. In Singapore, which currently has a mild form of it because the Coronavirus is controlled well here, temperature checks when going into certain buildings are inconvenient, we eat at restaurants less often than we would like, and a shopping center (such as the one housing my gym) is a place to think twice about entering. Other places are much worse off, with people quarantined to their dwellings except for emergencies, and all community meeting places and arrangements canceled.

What this research points out is that places of social inclusion are essential to society. Places of inclusion are where people gather to have their needs provided by society, from private actors, government actors, or voluntary associations. They include the sports stadium of the local team, the unemployment office, the church, and the soup kitchen for the homeless. All these are places that provide practical goods and services, but they also serve a symbolic role of defining the community and affirming people’s inclusion in the community.

The importance of places of social inclusion was shown prominently when their research at a public Emergency Department (ED) in Australia suddenly involved the Ebola epidemic. ED doctors and nurses handle many kinds of risks to patients and themselves, but Ebola was unusual because it was an unknown situation, and one that could lead to exhaustion of ED resources and even temporary closure of the ED. This was a situation that invoked fear and a feeling of threat because the physicians understood that turning away any patients was more than failing to provide medical services; it meant an unmet human need. Although most people rarely interact with EDs, they are places of social inclusion that need to stay available.

To manage the Ebola situation in addition to the regular claims on their resources, the ED rationed resources carefully and enabled resource use whenever possible. Doctors and nurses also went to extraordinary lengths to avoid closing down and to keep the ED safe for both patients and employees. In the end, many ED personnel dealt with the situation by reasoning that the Ebola risk, although new, was not so much greater than the risk posed by violent patients or other infectious diseases, which they already dealt with routinely.

If we tie this research to the Coronavirus situation, we should be aware of some differences. The personnel at this ED were very conscious of its role as a place of social inclusion and did their best to stay open and admit patients. And when all was said and done, they had treated no Ebola patients, only some suspected cases. Is that what we will see in the current situation? I doubt it.

Not all places of social inclusion recognize that they have this role, and few are staffed by individuals who have taken an oath to protect the patient and the community, as many doctors do. The Coronavirus will see many places of social inclusion close, by their own volition or by public policy. Few places of social inclusion will be as safe from infections as the Australian ED studied in this research. Ebola was rare and not very contagious but was feared because it was so grimly deadly. The Coronavirus is now widespread and appears to be more contagious than the flu, and deadlier.

For a while, places of social inclusion will be lost, and this will be a great loss to communities and their inhabitants. A significant measure of community resilience will be how quickly the places of social inclusion can open again and serve their community. In the meantime, let’s hope that communities can improvise safe places of social inclusion, as Italians have done by singing from their balconies.

Wright, A. L., Meyer, A. D., Reay, T., & Staggs, J. 2020. Maintaining Places of Social Inclusion: Ebola and the Emergency Department. Administrative Science Quarterly, forthcoming. 

Emotions in Sync: How Teams Adjust for the Best Performance

Imagine a team of any size doing a task that calls for constant coordination and accurate execution. Sound difficult? It is very difficult, and that is why organizations typically prefer to distribute tasks across specialized roles and over time. The Charlie Chaplin movie Modern Times made fun of this approach in its production line scenes, but they are actually an accurate depiction of how assembly is often done these days, and for good reason – it is the most efficient approach.

But some teams need to coordinate quickly. A soccer team does so in response to the other team. An emergency unit team does so in response to the patient condition. Even teams that rehearse in advance to gain perfect execution may need coordination to avoid small mistakes accumulating and getting out of hand. A concert performance by a band, orchestra, or choir would be an example of this. A planned surgical operation or construction of a building is another. Thanks to research by John Paul Stephens published in Administrative Science Quarterly, we now know more about how such coordination is done. He studied a special kind of large team: a choir performing classical music.

The starting point is that each member of the team is heedful of the others, especially those nearby. They adjust to others’ pitch, volume, and tempo, and they influence others as well, helping them pick the right pitch, volume, and tempo. When a team comes together, these mutual influences and members’ knowledge of the ideal output mean that their efforts are in sync, and their emotions are too.

Emotions matter greatly for quick coordination because they adjust what happens when the team is falling apart. And any kind of quick coordination could lead to a team falling apart, with each member being anxious about their part of the task performance or upset about others appearing to do their part incorrectly. The feeling of being out of sync triggers adjustments, because each member will pay special attention to any and all cues that can improve the performance. They use their knowledge of the output, their knowledge of the skill set and current output of each other member, and their knowledge of their own skill set and current output. Once the team knows they are no longer in sync, there is mutual effort to recover.

This is where leadership counts the most. For a chorus, the conductor is always up front directing, but this person is actually not so important if they have rehearsed well and are in sync. If their performance is falling apart, however, increasing the attention to the conductor is a major cue that helps recovery. One sign of greatness in a conductor is exactly this ability to put a performance back in sync, to reunite the team. Much of a conductor’s leadership occurs when composing the performance through the variations rehearsed in practice sessions, but an essential part of such leadership emerges when recovery is needed during a concert.

The same process is found in more extreme versions in smaller teams with distributed leadership, such as those that combine different forms of specialists who engage in a single production. To continue with the musical performance comparison, a string ensemble has first and second violin (and sometimes more), viola, cello, and sometimes bass too. There is no conductor. Instead, a team like this has skilled members who each knows their specialty and the ideal final performance. The team usually comes together in sync during a performance, but when they fall apart, they turn their attention to their leader—the first violinist, who sits front and center and is easily visible by all ensemble members.

True leadership emerges when teams need to reunite.

Stephens, J. P. 2020. How the Show Goes On: Using the Aesthetic Experience of Collective Performance to Adapt while Coordinating. Administrative Science Quarterly, forthcoming.

Friends in Low Places: Independent Regulators Help Entrepreneurs

Here is something that is so well known in business, and so contrary to norms of fair competition, that we prefer not to teach it in business schools: For a large established firm, one of the best hammers for beating down competition from new ventures is influence over legislators. One of the best ways of wielding this hammer is to help them create cumbersome, expensive, and demanding legislation for new firms entering the business. Any kind of excuse will do. For example, societal concerns for safety and the environment can be twisted in ways that generate legislation with the main purpose of making it harder to establish new ventures.

How can that be good for the large firm? After all, they need to expand their business now and then, and they will face the same legislation. That’s true, but unlike entrepreneurs, they have friends in the legislature who can create exceptions when needed. So, is there any way for the entrepreneur to enter a heavily regulated industry? Research by Jake B. Grandy and Shon R. Hiatt published in Administrative Science Quarterly shows one way this can happen: by receiving help from regulators.

Why would regulators help entrepreneurs when legislators help established firms? This is a question that has two answers. The first answer is because they can: Legislation is usually written with some leeway, and regulators can interpret it to allow new entrants. Often, they will do so because strict interpretations can be challenged through appeals. The second answer is because they can: Legislators have many issues on their agendas, and they often grant regulators freedom to act on their own either by legislating some independence or by supervising regulators only loosely.

Grandy and Hiatt tested this effect by examining delays in granting permissions for hydroelectric power plants. For such permissions, the independence of the regulator has no consequence for established firms – but for entrepreneurs, an independent regulator makes all the difference. The timing matters because the application and approval process can take many years. If the regulator is fairly independent, that period can be reduced by a year or more. But if legislators have reason to curtail the regulator’s independence, the application period can instead increase by many months.

These accelerations and delays are important because they are where costs and benefits are found in this industry. The regulator can impose conditions that slow down a project and make it costly, but in the end, nearly all the applications are granted. Granting an application does not mean that the power plant will be built, however: The entrepreneur may have exhausted their financial resources by the time a project is approved, or required modifications may have made the project unprofitable. All of this means that help from regulators is necessary for entrepreneurs – and for a healthy level of competition in regulated industries. 

Grandy, J. B., & Hiatt, S. R. 2020. State Agency Discretion and Entrepreneurship in Regulated Markets. Administrative Science Quarterly, forthcoming.