Thursday, April 26, 2018

Who Thinks Investing Can Be Responsible? Bankers, Priests, or Unions?

Socially responsible investment is a big buzzword these days, with many new investment funds adding social responsibility as a goal to supplement the usual goal of earning financial returns. Major investment entities such as some European state pension funds now require social responsibility in all their investments. The combination of social and financial goals has long been problematic because various “sin stocks” of firms that manufacture unhealthy products (cigarettes, alcohol, guns) earn high returns, and many other public companies manufacture harmless products but have other socially irresponsible practices. Sweatshops and dangerous factories are often profitable and never responsible.

Investing in a socially responsible fund often means earning lower returns than would be possible with another investment, and managing a socially responsible fund means spending more time checking firms and ending up with lower returns than would be possible. In some ways it is surprising that these funds are so popular, and one wonders what drives them forward. In a new article in Administrative Science Quarterly, Shipeng Yan, Fabrizio Ferraro, and Juan (John) Almandoz looked at exactly this question and paid particular attention to three potential players: financial professionals, priests, and unions.

On the financial side, we have investment fund managers and all others involved in fin
ancial transactions, who are typically seen as pursuing returns only, preferably with no responsibility constraints. The religious side includes many Christian churches that have been strong advocates of responsibility in society generally, including investments. The union side involves those advocating for workers and for consumer safety, including through their investment choices. Among these three, who has the most influence on socially responsible investments?

The answer is that the financing side matters most, but not in the way we might think. Socially responsible investment is not ideal for finance professionals, but it does not happen at all if they are not well established in society. Their expertise and resources are required for socially responsible investment funds to be established and to be successful. The caveat is that if a society is tipped too heavily toward financial concerns, socially responsible funds will have a hard time attracting investors.

What about the influence of religion and unions? Many of the early promoters of socially responsible investment were churches, and many early funds had a religious affiliation, but that does not give religion a strong role in socially responsible investment today – in fact, Yan, Ferraro, and Almandoz found no effect at all. The role of unions is more important, as higher union membership translates into more fund management companies engaging in socially responsible investment. Labor and capital are united, at least in this domain.

People are motivated to invest for many reasons, and figuring out how and when the financial sector responds to those motivations seems key to keeping it on its best behavior.

Yan, Shipeng, Fabrizio Ferraro, and Juan Almandoz. 2018. "The Rise of Socially Responsible Investment Funds: The Paradoxical Role of the Financial Logic." Administrative Science Quarterly, forthcoming.

Friday, April 20, 2018

Cleanse the Temple! Buddhist Monks versus Local Officials in China

Sometimes social science is born from observing simple puzzles. Consider this one: In China, many attractive temples charge admission fees that are obviously higher than is needed for maintenance and the feeding of monks, but other temples do not. What is going on? The fees are for the local government, which sees a famous temple as a way to get revenue without taxing the local people. But what is convenient for the local government is a moral outrage for the monks and many locals, who will sometimes successfully mobilize against the fees. The interesting question is why they can defeat the fee-collecting government officials sometimes but not always. 

In a recent article in Administrative Science Quarterly, Lori Qingyuan Yue, Jue Wang, and Botao Yang look at this question to find out how popular movements based on moral and religious principles contend with pressures from the government and market forces. The battle is unequal because the government has the power of formal authority and markets have the persuasive power of money. The popular movement has none of these, only moral outrage. The contention is particularly unequal in an authoritarian state, where outrage does not translate into power through elections, and illegal forms of protest can be dealt with harshly.

The answer to this question, like many questions about society, lies in how organizations work. The government organization is one side of the story, and there the main issue is that it has many layers – local and central parts of the state. The central state cannot govern locales effectively and prefers to stay away, but it also wants economic development and social peace. Knowing this, the local government officials can ratchet up fees when their areas are economically backward, but they need to reduce them when the protests are loud enough to catch the attention of the central state.

The other side of the story is the organization of protests. Here, the religious leaders did the obvious thing – founded an organization with the specific goal of reducing fees. But protesters don’t just make their own organizations, they also use existing ones. Here, the press was used, though in an authoritarian state the companies that hire journalists and publish newspapers or TV programs are not the most useful. They are too accountable to the state to be able to do much. Instead, the effective organizations are the providers of social media, because they allow the protestors to make themselves heard both by other potential protestors and by the state, which monitors social media protests to understand social unrest and censor its expression. 

So a battle may look like a contest between a union of markets and local governments on the one side and the moral outrage of individuals on the other, but that is not its true nature. There are organizations on both sides, and this is true for any conflict that each side really wants to win.

As I suggested in the title, the conflict between markets and morality is an old one. Two gospels mention Jesus driving merchants out of the temple and overturning their tables. It is a good story, but it is no longer how conflicts are won. People don’t get results; organizations do.

Thursday, April 12, 2018

Business Schools as Seminaries: Firms Practice the De-diversification We Teach

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.

Jung, Jiwook, and Taekjin Shin. 2018. "Learning Not to Diversify: The Transformation of Graduate Business Education and the Decline of Diversifying Acquisitions." Administrative Science Quarterly, forthcoming.

Sunday, April 8, 2018

Do We Trust the Firefighter Who Finds Fires or Books Exciting?

One of the most studied and least understood aspects of life is how people decide to trust each other. Trust is not much on our minds in daily life, but that is because trust is not needed for most of what we do. When shopping, we know that a credit card payment probably won’t lead to fraud later on and that the change we get when paying with bills is not fake currency. In traffic, trusting others is more important, but we generally trust that other drivers know the rules of the road, except perhaps if we’re on a bike.

In some areas of life, trust is very important, including on the job. Even in occupations that are mostly safe, every now and then there may be dangerous situations in which trust in others is important. Trust matters because danger triggers a fight-or-flee dilemma: you can try to solve the problem, at some risk to yourself, or you can escape and let the problem get worse. When solving a dangerous problem calls for teamwork, it is important that everyone makes the same decision.

This type of trust is the inspiration behind a recent paper in Administrative Science Quarterly by Michael Pratt, Douglas Lepisto, and Erik Dane. They looked at firefighters, whose occupation calls for risky teamwork. They have to trust that others will “have their back” in fighting a fire when the situation gets dangerous, so that each can rely on the other. Firefighting is especially interesting because firefighters don’t actually spend much time fighting fires. The increased fire safety of buildings and the need to have enough firefighters on the payroll in case of large fires means that they spend most of their time waiting for calls or handling emergencies that have nothing to do with firefighting. Helping cats down from trees is mostly a myth, but vehicle accidents, gas leaks, and emergency medical assistance are facts of life – firefighters can often get to a scene before the ambulance.

The problem with having safe buildings is that firefighters have little direct evidence from fighting fires together of whom they can trust – when they’re called to the scene of a fire, they may not have ever seen each other fight fires. That means they have to operate on trust derived from indirect evidence. I started by saying that trust is well studied and little understood. One thing we do know is that when people try to decide whom to trust, they look for signs of trustworthiness. When this happens in occupations, the signs may not make sense to outsiders, but they are very real for the people involved. The firefighters in this research tried to understand where their colleagues were coming from, both in their backgrounds and in their attitudes toward the everyday chores at the firehouse. Based on small or large signs they picked up in their early interactions with a newcomer, they would put the newcomer into a small set of categories. And here is where the interesting part lies, because the categories did not inspire the same amount of trust.

The firefighter who has a college education? That one is the “book-smart” type and is not  a commonsense type whom you can trust to think quickly and do the right thing in a dangerous situation. The firefighter who buys his own scanner and goes to fires even when he’s off duty? That would be a “spark,” who has the right motivation but is too excitable and thus is only warily trusted.  Less trusted is the “paycheck” firefighter, who is there for only one reason and likely won’t take risks to help a fellow firefighter out of a burning building. So who is trusted most? For firefighters it is the “worker” type, who they see as always reliable and careful – someone who combines the professionalism of a (good) plumber with the discipline of a soldier, who checks the equipment, cleans up, or does whatever else needs to be done when there are no calls. So the answer to the question of who do you trust is that if you are a firefighter, you probably don’t fully trust the colleague who is just book smart, the one excited by fires, or the one who’s there for the paycheck.

If you are not a firefighter, the answer to the question is different. You don’t know who to trust, and you can’t tell who is of what type. That’s part of how organizations work, because they contain occupations and jobs that have internal codes understood by few others, including management. That’s one reason why managers should be careful not to judge quickly when they see behaviors they don’t understand. Look inside the thinking of the people responsible, and things make more sense.

Pratt, Michael G., Douglas A. Lepisto, and Erik Dane. "The Hidden Side of Trust: Supporting and Sustaining Leaps of Faith among Firefighters." Administrative Science Quarterly, forthcoming.

Wednesday, April 4, 2018








