Venture capital is all about risk. The firms find young ventures, or more often select from many ventures seeking funding. These ventures have in common that they are at such an early stage that their market and offerings are unproven, and they cannot succeed unless they receive the funding, and often also advice and instructions. In other words, they are all risky.
There are still ways of adjusting the risk. Some ventures are more risky than others, and even the same venture has different risk levels depending on whether the venture capital firm participates in the first round of funding or a later round of funding. But if venture capital is essentially about risk, and they need to take this risk to gain the high returns they want, what determines the risk level they take at each funding opportunity? This is what Songcui Hu, Qian (Cecilia) Gu, and Jun Xiac studied in research just published in Organization Science. The answer, or should I say answers, are very informative.
The first part is that venture capitalists chase performance: if their performance has been disappointing, they will take greater risk than if it has been good. This is not just how venture capitalists act – firms make more changes when their executives fall behind their goals, and often these changes are risky. Indeed, the most special thing about venture capitalists is that they control the risk very easily by choosing more first-stage investments when their performance is disappointing. Other firms also try to control risk, but sometimes their risk taking is unplanned.
The second part is that venture capital firms form networks with each other through participating in funding syndicates. These syndicates divide up investments and spread risk, but they also produce collaboration, information exchange, and friendship. They result in networks that look different for each venture capital firm. Some place themselves in the center of spider-web networks that spread out widely. Others find positions between different groups of venture capitalists, becoming brokers of information. And here is the main finding from their research. These networks not only determine the information available; they also influence how venture capitalists think about opportunities available. So, what is the result?
Broker venture capitalists see more investment opportunities, and greater variety of opportunities, giving them practice assessing and experimenting with risk. As a result, they can make big adjustments of risk taking according to performance. Spider-web venture capitalists also get many offers, but they are more similar to each other, and this compromises their ability to adjust risk. The result is clear: All venture capital firms try to adjust risk to reach their performance goals, but the firms that are brokers in their networks are much more able to do so.
So, risk taking is a result of chasing performance goals, and of having the right kind of networks. Some decision makers are half aware of these adjustments, but many do not know that these factors influence risk. If they were, would they more carefully consider how goals are constructed? Would they pay closer attention to how their networks are built? I think the answer to both questions is yes. Gaining and spreading this knowledge is why we do research and teach the results.
Hu S, Gu Q, Xia J. 2021. Problemistic Search of the Embedded Firm: The Joint Effects of Performance Feedback and Network Positions on Venture Capital Firms’ Risk Taking. Organization Science forthcoming.
Researchers have spent some time documenting that political ideology creeps into CEO thinking, and through that, influences firm decision making. This is especially true for decisions that are political to begin with, such as whether to counter economic problems with downsizing or whether to retain staffing and instead let investors take more losses. But we also know that a wide range of decisions are influenced by CEO political ideology, even those that do not look so political.
What we have not known until now is that political ideologies are more complex than the liberal versus conservative spectrum that defines US politics. A paper by M.K. Chin, Stephen X. Zhang, Asghar Afshar Jahanshahi, and Sucheta Nadkarni published in Academy of Management Journal has now given a vivid demonstration of how this complexity influecnes firms. In most other nations, conservative can mean either economically conservative, as in the type of person who values competition as a source of economic strength, or socially conservative, as in the type of person who values traditional judgment and intuition over analytical thinking. And, the same person can be either economically or socially conservative, or both, or none of them.
What does this mean for the decision making? The authors looked at corporate entrepreneurship, which is a strategically important decision that is difficult to justify analytically because the uncertainty is so high. After all, corporate entrepreneurship means diverting resources from the main business of the firm in order to enter a less familiar form of business. Corporate entrepreneurship is sometimes successful, and spectacularly so, but often it leads to losses. So how do firms decide when to engage in corporate entrepreneurship?
This is where CEO ideology comes into play. The economically conservative CEO wants to see analysis that justifies corporate entrepreneurship and wants the corporate entrepreneurship sponsors to win resources through competition with the rest of the firm. But how can they? The rest of the firm already delivers results; they just have ideas and hopes. This swings decision making away from corporate entrepreneurship.
The socially conservative CEO relies more on intuition, including the intuition of other decision-makers in the leadership team, and will be less driven by numbers and unaffected by ideas of resource competition. This is exactly the winning formula for a firm to take the risk of entering the uncertain world of corporate entrepreneurship.
These propositions make sense when considering economic and social conservativism separately, and the only problem has been to realize that these are different forms of conservative (versus liberal) ideologies. Both exist, and they have independent effects. Indeed, the research spurred by these ideas found solid support for these effects when examining how firms in Iran made their decisions on corporate entrepreneurship. Using data from Iran, which is rarely studied, is another merit of this research, but it seems fair to guess that many other nations will show exactly this division between different types of political ideology.
Chin MK, Zhang SX, Jahanshahi AA, Nadkarni S. 2021. Unpacking Political Ideology: CEO Social and Economic Ideologies, Strategic Decision-Making Processes, and Corporate Entrepreneurship. Academy of Management Journal 64(4): 1213-1235.
I know that the title abuses the old adage “jack of all trades, master of none,” but it does so for a reason. First, as a small sidenote, the full expression used to be “jack of all trades” and was meant as a compliment. “Master of none” was added to make it less flattering. Second, I want to talk about some old research on how the old version, “jack of all trades,” might be more accurate provided the knowledge of each trade is not superficial.
In research published in Academy of Management Journal, Alva Taylor and I analyzed the collector values of old comic books. You know, the type of products that today don’t come in print, but instead appear as movies based on Marvel or DC characters. I am sure you have seen some of them. Comic books are interesting for research because we can measure the quality and innovativeness easily: high quality means high average value; high innovativeness means great variation in the value. Why the latter? Because anything new and surprising can fall flat but can also become a massive hit.
We had many findings, but I am particularly interested in the effect of creators having worked in multiple genres before making a new comic book. That’s the same as learning multiple trades because each genre has its own styles and conventions, so learning a new genre is difficult. But also, it can give fuel for innovation because knowledge of multiple genres helps the creator make novel combinations. And indeed, experience with multiple genres resulted in more innovative comic books. (It also increased quality, but that’s not the point I want to emphasize today.)
Here is the part I did not tell you yet. Comic books can be created by individuals or by teams, so we can talk about one person’s experience with genres, or the sum of genre experiences by a team. Is there a difference in which one becomes most innovative? Yes. Experience with more than three genres means that an individual will become more innovative than a team although individuals start out being less innovative. Clearly, individual creators have an easier time integrating genres.
Now there is research suggesting something similar happens not with knowledge integration, but with cultural integration in new ventures. This is important because many new ventures seek to combine the organizational cultures known by their founders into something new and unique, but often they end up adhering to an industry standard instead. Recent work by Yeonsin Ahn shows that cultural integration is helped by broader cultural experience, but only if this experience is held by individuals.
I can’t help but think that there is an interesting parallel here. It is so much easier to build up knowledge by sharing the work across individuals and forming a team. But, if the goal is to combine what has been learnt, individuals are better at it.
Taylor A, Greve HR. 2006. Superman or the Fantastic Four? Knowledge combination and experience in innovative teams. Academy of Management Journal 49(4): 723-740.
Have you heard stories or seen TV shows about how surgeons are the bossiest of doctors, ruling operating theatres like emperors, except that everything they do is more urgent than any imperial demands? That’s an exaggerated stereotype, but some surgeons fit it, and some forms of surgery are so exacting in process and speed that surgeons cannot tolerate slack. Many surgeons get away with bossiness because their work requires it—and because doctors are at the peak of the hospital pecking order and surgeons at the peak of the doctor pecking order. Everyone looks up to them.
Except that surgeons who are women are a little less looked up to than surgeons who are men. The usual mechanisms are at work, such as men (and some women) thinking of surgery as an activity that fits manly men better (so much cutting and bleeding...) and women generally having difficulty getting accepted in the top tiers of any occupation that has traditionally been held by men. But research by M. TeresaCardador, Patrick L. Hill, and Arghavan Salles published in Administrative Science Quarterly has found another source of difficulty: nurses.
Why are interactions with nurses problematic for female surgeons? Ironically, the source of the problem is that most nurses are women, and they interact differently with other women than with men. Nurses tend to act according to the script when the surgeon is a man: he orders, they obey. He does not need to chat or be friendly to get precise and timely work done, so the only benefit of being a friendly male surgeon is that he is seen as a nice guy. The same tends to be true when male nurses interact with female surgeons: they act according to the script.
But female nurses want – even demand – to include a female surgeon in the club of womanhood, where friendly chatting is required, members must know each other’s children’s names and ages, and work is rarely done exactly according to script. “After all,” they may think, “the female surgeon is one of us. That means she should also share some of the burden of the nursing tasks in addition to her work as a surgeon. That’s only fair. If she does not accept our requirements for inclusion and instead acts bossy, we can slow down our responses to her needs and make her job more difficult.” This is what precisely happened in the hospital the authors studied.
The result is extra work for the female surgeon and the loss of some of the special position that a surgeon has in the hospital pecking order. Maybe that’s OK because hospitals are too status conscious and hierarchical to begin with. But the problem is that only women surgeons face these demands for inclusion and the extra work accompanying it. It is discrimination against women, by women.
Is this something that women who are not surgeons should worry about? It probably is. What happens in the hospital is that different occupations interact to produce a result, and the higher-status occupation depends on the lower-status occupation for its success. That should sound familiar to many workplaces: higher-status workers are expensive, so organizations become effective by leveraging them through having lower-status workers do supportive tasks. If the supportive tasks are done differently depending on the sex of the lower-status and higher-status workers, this is an important source of workplace discrimination we need to better understand.
Cardador, M. Teresa, Patrick L. Hill, and Arghavan Salles. 2021. Unpacking the Status-Leveling Burden for Women in Male-Dominated Occupations. Administrative Science Quarterly, forthcoming.
Both in research and in practical life we understand why innovations spread gradually, and why firms copy each other. Whenever an innovation is introduced, it could be good or bad, and this uncertainty makes managers hesitant to adopt the innovation until they have seen that others use it and benefit from it. There are many successful innovations in this world, but also many failures.
What about managers assessing the success or failure of their current strategy? That sounds like a much simpler problem because they know the market share, the revenue, the profit – everything they need to know in order to decide whether to stay with the strategy or adopt it. But, in research I published in Administrative Science Quarterly long time ago, I found that it is not quite that easy. Even when assessing their current strategy, managers copy each other, except in that case they are copying abandonments, not adoptions. If you had the same strategy as me and you abandoned it, I might just decide that mine is not good enough either.
How does this even begin to make sense? They have all the information they need, one may think, and do not need to look at each other. But social influence is so powerful that people copy all sorts of things (as anyone who follows fashion in clothes will know), and managers do the same when making decisions that affect the profit of their firms.
There is in fact a justification for copying abandonment. A strategy should not just be assessed based on how good it is right now, but also on how good it will be in the future. If other firms abandon because they think it is failing, then using that information is smart strategizing. Of course, it is unclear whether managers copy abandonment because of sheer social influence or because they are letting other assess the future.
I did research on how radio stations changed their format (what kind of music and other content they broadcast). To understand what was happening, I also interviewed program directors, who make the decisions, and announcers, who actually create the programs. Interestingly, many of them thought that abandoning an old format was a smart thing in general, because its market share was gradually decreasing, but they also named specific radio stations that had abandoned too soon, and without having a good alternative ready. So what managers is a mixture of social influence and smart strategizing.
This research was done a while ago, but the conclusion has become a theme in much of the research I do on managerial decision making. The smartest story of why they make decisions is not true. The dumbest story is not true either. All decision making is a mix of different influences, and managers are simply trying to balance different considerations to end up with decision that makes sense.
Greve HR. 1995. Jumping ship: The diffusion of strategy abandonment. Administrative Science Quarterly 40(September): 444-473.
We spend way too much time focusing on success. How much space in popular press is spent on the centi-billionaires and the firms they founded? How much academic research is drawn from successful enterprises, those who founded and financed them, and the CEOs currently leading them? Let’s talk about failure for a little while.
We understand that entrepreneurship success, the founding of enterprises that survive and grow, in most cases has a big skill component, though luck is needed too. Is the same true for entrepreneurship failure? Probably not, as Diego Zunino, Gary Dushnitsky, and Mirjam van Praag point out in research published in Academy of Management Journal. Skill is so important for success that we can be pretty sure it is present along with some luck. But by the same token, bad luck can sink an enterprise regardless of skill, so failure does not mean that skill is absent. It does, however, raise the possibility that skill is absent.
Why is this important? Well, the successful entrepreneur often does not form any new enterprises because managing growth and ensuring continued success is already plenty of work, and it is rewarding work too. Failed entrepreneurs often wants to form a new enterprise, because they naturally believe that they are highly capable and just got unlucky. After all, entrepreneurship does go along with a high self-image and willingness to risk other people’s money, and these days “serial entrepreneur” is something of a badge of honor.
But what about the investors who are asked to fund enterprises? Do they look at the track record of the entrepreneur? How do they assess it? First, we need to understand that very few investors face the situation of those who were asked to help fund Amazon. Jeff Bezos told them that they had a 70 percent chance of losing their money, which is fairly realistic (actually the percentage is higher). More importantly, he had no past failures because he had never founded an enterprise – he had been an employee. Most entrepreneurs asking for funding will have a short or long track record of dead or moribund enterprises.
One simple and incorrect decision rule is to view any failure as a sign to stay away. Clearly that will exclude many skilled founders and promising enterprise. Another is to ignore past failures. Clearly that means not seeding out some entrepreneurs who really ought to get a job instead. But can potential investors thread a reasonable middle path?
Fortunately, the researchers found that they can. When assessing a potential venture investment, how promising people found it and how much they could be willing to invest was influenced by past failure, but not so much that past failure ruled out investment. Instead, past failure made the potential investors more sensitive to clues about whether they entrepreneur had skills that would help the venture. So, neither of the simple and incorrect decision rules are at work, but instead some form of middle path. This is what we want to see.
So, does that mean all is well? Not quite. We have to remember that the research shows average investor reactions, and averages are usually smarter than individuals when making judgments like this. This means that entrepreneurial failure does not cut off funding for new ventures. It does not mean that all individual investors avoid the simple and incorrect decision rules. Good news for entrepreneurship, less so for investment.
Zunino D, Dushnitsky G, Praag Mv. 2021. How Do Investors Evaluate Past Entrepreneurial Failure? Unpacking Failure Due to Lack of Skill versus Bad Luck. Academy of Management Journal forthcoming.
We know that discrimination is common in organizations, in the economy, and in our social life. People are treated differently depending on a broad range of criteria, starting with race and gender, and there seems to be no form of training, qualification, or accomplishment that can help people escape discrimination. A classic example are Asian-Americans, who are a so-called “model minority” with a well-known taste for higher education. They suffer discrimination first through the accusation that they somehow do not deserve the education they have earned and then, more nastily, through violent attacks following the Covid-19 pandemic.
The fact of discrimination is well known, but the reasons are less clear – in part because there are too many explanations, and they contradict each other. Two well-known ones are taste discrimination and statistical discrimination. Taste discrimination is simple: people discriminate because they dislike, usually because others (parents? friends?) have told them who to dislike. Statistical discrimination is more complicated because the idea here is that some of those who are discriminated against should be assessed negatively, but it is hard to tell who, so the safe option is to discriminate against all. For example, an employer may think that some young women will get pregnant and quit soon and may decide that all young women should be thought of as short-term employees who do not need to be trained for promotion.
To many of us, statistical discrimination sounds like an excuse that may be true occasionally, but we assume most discrimination is based on cultural beliefs. But is that really so? Bryan Stroube has some interesting findings in research published in Administrative Science Quarterly. The findings were based on the discovery of transactions that offered reasons for statistical discrimination in one period, but these were removed later. In a peer-to-peer lending platform, there is always the concern that the loan may not be repaid, so statistical discrimination could be used to fund loans only to the most trusted social group. If the platform issues repayment guarantees, this motive for discrimination goes away. That is exactly what happened in the platform he studied.
So, what happened to the discrimination? This was a platform in China, where discrimination against women is common in economic arenas, even though women are thought to be reliable in paying back loans. You can probably suspect what happened. Women were discriminated against before the loan guarantee. After the loan guarantee, the economic security of women as lenders was no longer an issue, so women were even more strongly discriminated against.
Where does that leave the explanation of discrimination? Clearly people are capable of considering economic consequences and adjusting to them, and this affects the degree of discrimination. But at its core, discrimination is based on distaste and is culturally determined. Money is no excuse.
Stroube, Bryan K. 2021. Economic Consequences and the Motive to Discriminate. Administrative Science Quarterly, forthcoming.
Does knowledge help innovation? This is a simple question that is difficult to answer. In science, training people well enough to build on the knowledge of others is essential for advancing knowledge. But also, knowing too much forces thinking into established streams, making incremental additions easier but radical innovation harder. In business, most firms will place their bets on knowing more, to the extent of locating R&D in places with expertise, such as Los Angeles for video games or Silicon Valley for electronics and software more generally. Some firms even scatter their R&D around to have multiple listening posts to capture local expertise.
It is exactly this practice of multiple R&D teams that has helped us learn more about knowledge and innovation. In a paper published in Administrative Science Quarterly, Alex Vestal and Erwin Danneels analyze breakthrough innovations in the nanotech industry. This industry has multiple places with expertise (“hotspots”), such as San Jose, Boston, and Los Angeles, and firms have a blend of R&D teams that are in these hotspots or in places with less concentrated expertise.
So, does it help to be near expertise? It turns out that being too close to a hotspot with the same expertise as the firm is a drawback, just as scientists believe, but if the hotspot has slightly different expertise, the firm is more likely to produce a technological breakthrough. If the hotspot has expertise that is too different, a breakthrough is much less likely. The insight here is that one learns the most by being near, but not too near, the expertise of others. Maybe this is because being too close to the outside expertise means that there is little outside knowledge that needs to be moved inside the firm?
The explanation is not so simple as that. Instead, a hotspot with the same type of expertise as the firm may generate so much knowledge that it becomes difficult to process internally. But some firms had very close personal networks within their R&D team in the hotspot, which makes processing and integration of knowledge easier. For firms like that, there is no cost to being in a hotspot with the same expertise as the firm, because this makes technological breakthroughs much more likely.
Close networks among the local R&D team are not all good, however. Closely connected R&D teams are prone to ignoring knowledge gained from R&D teams in other locations, so they can fail to move knowledge that is already inside the organization but outside their specific location. As a result, the teams with close networks are less likely to make technological breakthroughs based on knowledge from outside their local hotspot.
This is interesting because it shows how the creative spark leading to innovation depends on how knowledge is moved around and processed. We have long known that hotspots for technology and innovation have knowledge moving quite freely, so firms can locate there to detect interesting knowledge and move it inside. Getting knowledge into the firm is not the same as using it effectively though. It needs to be moved to the right place in the firm, and it needs to be processed effectively.
The key to gaining advantages is the social network inside the firm. Location relative to a hotspot of knowledge looks like an easy solution to the problem of facilitating innovations, but the firm also has to be able to move knowledge internally and process it internally. That means having employees who are willing and able to share knowledge.
Vestal, Alex and Erwin Daneels. 2021. Technological Distance and Breakthrough Inventions in Multi-Cluster Teams: How Intra- and Inter-Location Ties Bridge the Gap. Administrative Science Quarterly, forthcoming.
Here is a piece of conventional wisdom that I and many others firmly believe: Nepotism is the enemy of good management because it places untested and often unqualified people in important positions simply because of who their parents are. Most of us do not work in organizations owned and controlled by families, and even some of us who do are working in organizations owned by families but controlled by professional managers who have been carefully selected. Then there is the rest of us, who worry about the capabilities of the owner family child in an executive role, and who have read the news about scandals such as the Samsung family ownership.
But every now and then some evidence appears that gives us reason to rethink our beliefs. In a paper published in Strategic Management Journal, Guoli Chen, Raveendra Chittoor, and Balagopal Vissa look at CEO pay in family firms in India, comparing those run by CEOs from the family versus those run by non-family CEOs. Their findings contained some surprises.
Here is an unsurprising finding: CEOs from the family get paid more. Sure, we all know about favoritism and about extracting resources from a firm (which also has non-family owners) to put into the family’s pockets. This is an annoying finding, but it is no surprise. Oh and by the way, the increase in pay depending on the firm performance is nearly the same for low and high performance provided the CEO is a family member, but a nonfamily CEO does not benefit from higher performance.
Here is a surprising finding: When they checked the data more carefully, they found that the family CEOs actually got rewarded very much when the firm had very high performance, less so when it had average or low performance. This is exactly how one would design an incentive scheme for CEOs, because disproportionate rewards at the high end are necessary to compensate for their reluctance to take risk. But why is the incentive scheme especially well designed for family member CEOs?
One more interesting surprise that might be telling: The relation between high performance and higher pay is particularly strong if the firm is named after the family. So, exactly the kind of firm that would embarrass the family if the performance were low has a family CEO with good incentive pay. Interesting way for the family to control their (younger) CEO member, right?
You have probably read through this and concluded that it does not matter. Having a good incentive scheme is not the same as getting high performance. After all, poorly qualified spoiled brats are not going to accomplish much regardless of how they are rewarded. True, except for one thing. The firms managed by family CEOs had higher performance on average than those managed by nonfamily CEOs. This is certainly a paper to make us reconsider our beliefs.
Chen, G.,R. Chittoor, B. Vissa. 2021. Does nepotism run in the family? CEO pay and pay-performance sensitivity in Indian family firms. Strategic Management Journal 42(7) 1326-1343.
People dislike fraud, so much in fact that they see it as immoral and are willing to make some sacrifices to punish the fraudsters. This is even true when they are trying to earn money through investments. The best evidence on this is from research on individual people managing their personal money, but in today’s stock market most of the money is moved around by professional fund managers who are simply looking for returns. Does the market still have any morals?
Research by Ivana Naumovska and Dovev Lavie published in Administrative Science Quarterly suggests there are some morals left, but they are… selective. They looked at firms involved in financial misconduct, which is the kind of misconduct that investors care the most about because it hurts them directly. (They might be more forgiving of pollution.) It is already known that investors react by withdrawing money held in the firm accused of misconduct—and also from similar firms, because the stigma of misconduct places similar firms under suspicion.
This research goes one step further by asking whether investors are not just reacting to stigmatization but are also strategic in how they respond. An interesting feature of similar firms is that many of them don’t just resemble each other; they also compete with each other. A firm engaged in misconduct is weakened by money withdrawals and other punishments, so shouldn’t that strengthen its competitors? If it does, then that could be a reason to bet money on the competition, even if it is similar. Again, a selective form of morals.
In fact, the research went even further. Recognizing that investors differ in how well they understand how firms compete, Naumovska and Lavie distinguished between the detailed analysis of firms done by mutual funds and hedge funds and the coarser understanding of other investors. All investors will react to stigmatization and competition, but the more sophisticated investors will be less sensitive to stigmatization and more sensitive to competition. More forgiving and more strategic, in other words.
Were they? Absolutely. Measuring stock market returns, it was easy to show that both stigmatization and strategic investment took place. The authors found a U-curved relation between stock market returns and the product market overlap of each firm with the firm accused of misconduct, such that intermediate levels of similarity were the worst. Importantly, less sophisticated investors punished firms more if they were more similar to the firm accused of misconduct, showing no strategic investment. The more sophisticated investors also reacted negatively to any level of misconduct but were significantly more forgiving if the two firms were so similar that the damage suffered by the accused firm might turn out to be profitable for the other firm.
So does the stock market still have morals? Some morals, and selective morals. A somewhat disturbing conclusion is that those of us who prefer to let others invest our money through mutual funds and ETFs (not hedge funds, I hope) actually make the market less of a moral place, because those who manage our money are less willing to deal out punishment for misconduct.
How much of a problem is that? Arguably punishing firms that are similar to one that commits any form of misconduct may be unfair because one should be presumed innocent until found guilty. But that overlooks some important details. First, people are presumed innocent, but we don’t need to hold firms to the same standard. Second, the stock market is not a court, and it is perfectly acceptable to move money away from the possibility of future misconduct. I am perfectly comfortable with stock market morals through stigmatization, and I am uneasy about the implications of this research.
Naumovska, Ivana and Dovev Lavie. 2021. When an Industry Peer is Accused of Financial Misconduct: Stigma versus Competition on Non-accused Firms. Administrative Science Quarterly, forthcoming.
This blog is devoted to discussions of how events in the news illustrate organizational research and can be explained by organizational theory. It is only updated when I have time to spare.