Monday, 28 February 2011

Wage differences between men and women – sexist or functional?

There is no denying that women get paid less for doing the exact same jobs as men. Ample research has persistently shown that the wages of women, irrespective of qualifications and experience, are lower for the same kind of work. The only thing to be debated is “why?”

Some researchers have suggested that people who conclude from this finding that women are discriminated against jump too hastily to that conclusion, because the underlying reasons could be more complex and subtle than that. We should be more cheerful, and not immediately make such sinister inferences.

The story of firm specific skills

Instead, their explanation hinges on “firm specific skills”. With firm specific skills we mean the experiences and qualifications that employees may build up over time that are particularly valuable to the person’s employer, because it concerns knowledge about its specific product portfolio, a technology particularly crucial for the firm, relationships with its most important customers, etc. These firm specific skills are very important and pivotal because if this person (who has accumulated this knowledge over the course of his or her tenure at the firm) were to leave, the firm could not just find a replacement somewhere on the job market, because they are by definition not skills anyone can pick up at school or at some other employer. Firms, who are afraid that women are more likely than men to resign from their job at some point (to give birth and take care of children) are more reluctant to assign jobs that lead to such firm specific skills to women. Therefore, on average, women build up less of those crucial firm specific skills. Therefore, they earn less money for what seems to be the same job.

I found this an appealing explanation. Because I guess it might be true that employers make the assumption that women are more likely than men to drop out of employment at some point. It also seems quite possible that two people having the same function might not get paid the same salary because – although we cannot observe this directly from their resumes – one of them might have built up more of those important firm specific skills, which employers reward in the form of a higher salary (because they are more afraid to lose them). So, intuitively appealing indeed, I thought.

Clever research: Temporary employees

But, in spite of its intuitive appeal, no-one has actually provided any evidence for it… And that is because it is incredibly difficult to research; it is just very difficult to measure such firm specific skills, whether certain jobs are associated with more of them than others, etc. Basically, all we can measure is someone’s sex, their job status, and their salary – and not much more.

But sometimes that is enough, if you choose your research setting in a clever way. And clever is exactly what Isabel Fernandez – my colleague at the London Business School – is. She decided to examine and measure wage differences between men and women in the temporary employment sector. And why is this so clever? Well, because by definition, firm specific skills do not matter much in this industry. Temporary employees, employed by staffing firms, are meant to be transcient and hopping between jobs. Firm specific skills are all but irrelevant for the kind of work they do. If Isabel were to find equal wages between men and women in this sector, it would be strong evidence that gender pay differences in other sectors are likely due to firm specific skills, and not some evil discriminatory attitudes amongst employers. On the other hand, if she’d even find wage gaps here, it would be convincing proof that we cannot simply attribute gender differences to firm specific skills (which men might have more off) and justify them in that sense. Then, something else (perhaps more sinister) must be going on...

Thus, Isabel talked a staffing firm – specialized in high skilled IT related contractors – into providing her with their internal databases: resumes, client information, demographic data, project characteristics, prices, and so on. Subsequently she compiled an extensive and detailed database on 250 of its temporary employees who, over a period of several years, jointly were involved in 1462 projects across 462 different companies. She measured their hourly pay rate and statistically corrected the differences between them for things such as years of education, specialist training, experience, project characteristics, and so on. Until there was only one variable left to examine: gender.

And she found that, even in temporary jobs, women get paid substantially less than men, for the same type of work. Women earned an average of $25.08 per hour while men, for the exact same job with the same qualifications, would earn an average of $29.66. And we can’t blame that on firm specific skills.

Hence, “firm specific skills” are a nice story – but not much more than that. They belong to the greater works of fiction. Because, as Isabel showed, they do not explain the difference between male and female wages. And that is rather unfortunate, because it leaves us with the nasty but inevitable conclusion that the world of business does on average still discriminate against female employees. And surely we cannot be cheerful about that.

Wednesday, 16 February 2011

Equity analysts (and their lunch breaks) force firms to look and act alike

The inclination to imitate others is part of human nature. We imitation our peers’ habits, speech, behaviour, taste in clothing and music, and so on. Top executives, making decisions on the strategies of their corporations, are no different. There is evidence from research that companies imitate each other when it comes to the choice of organizational structure, CEO remuneration, acquisition premiums, plant location, foreign market entry decisions, and so on.

As a consequence, in many industries, we end up with a large number of firms doing pretty much the same things, and in the same way. However, this inclination to imitate does not only stem from top executives’ personal propensities and uncertainties; sometimes companies are forced to do similar things and act in similar ways, even if these ways are detrimental.

Forced to act alike

For example, research by professors Benner from the University of Minnesota and Tushman from the Harvard Business School showed that the implementation of ISO9000 (a quality management system) could be detrimental to firms (because, in the long run, it killed off innovation) but even if a firm did not want to implement the system, it was often pretty much forced to do so by various external constituents.

That is because not implementing the popular practice would make a firm look “illegitimate”. As a consequence the company will be likely to get downgraded by analysts, may find it harder to find customers or financiers, and even the firm’s own employees might start to ask questions why the firm is “lagging behind” and not doing what others do. Eventually, top management may decide to implement the practice after all, even if they have doubts it is actually effective.

One powerful group of external constituents in our society who often force firms to act alike (even if it is to their detriment) are equity analysts. The influence of equity analysts in our business society is very substantial. That is because – as research has confirmed – the impact of their stock price recommendation is very real and significant. Thus, they determine the amount of financial resources available to a firm. However, their impact actually goes quite a bit further than that; because of their power to determine a company’s access to financial means, they also have a substantial influence on what sort of strategy the firm is pursuing in the first place. A good setting to illustrate this is firms’ strategic decision regarding corporate diversification and their choice of in what combination of businesses to operate.

The influence of analysts (and their lunch breaks)

In general, where in the 1960s many firms operated in a diversity of businesses, since the 1990s we have witnessed a reversal in that trend towards de-diversification. There might be good economic reasons for that – shareholders are not fond of diversification because they can diversify their stock portfolios themselves; they don’t need companies to do that for them – but sometimes it does make sense for a firm from a strategic, value-creation perspective.

For example, a company like Monsanto sort of had to operate in pharmaceuticals, agricultural chemicals and agricultural biotechnology because their expertise bridged these different areas and therefore it was advantageous to operate in all of them. Hence, sometimes diversification might make sense. But that something makes sense from a strategy perspective doesn’t mean it makes sense in light of an analyst’s lunch break. What do analysts’ lunch breaks have to do with any of this, you might wonder? Well, it is very important for listed firms to be covered by analysts. We know from ample research that firms who receive less coverage usually trade at a significantly lower share price. Now consider this quote, from an analyst report by PaineWebber in 1999:

“The life sciences experiment is not working with respect to our analysis or in reality. Proper analysis of Monsanto requires expertise in three industries: pharmaceutical, agricultural chemicals and agricultural biotechnology. Unfortunately, on Wall Street, these separate industries are analyzed individually because of the complexity of each. At PaineWebber, collaboration among analysts brings together expertise in each area. We can attest to the challenges of making this effort pay off: just coordinating a simple thing like work schedules requires lots of effort. While we are wiling to pay the price that will make the process work, it is a process not likely to be adopted by Wall Street on a widespread basis. Therefore, Monsanto will probably have to change its structure to be more properly analyzed and valued”. (Adopted from Tod Zenger, Professor of Strategy at Washington University.)

Wait a second, you might think, did they just suggest that Monsanto should split up because it requires three (industry-specific) analysts to cover them and these three guys cannot find a mutually convenient time to meet?! Yes, I am afraid they did. Analysts prefer firms who follow their own internal division of labour and if firms do not conform to this requirement, they will downgrade them or stop covering them altogether.Along similar lines, in a large research project, Ezra Zuckerman, professor at MIT, found that firms divested businesses, split up or demerged in order to make themselves easier to understand for analysts. Those firms who, for one reason or another, comprised an unusual combination of businesses in their corporation and therefore were “more difficult to understand” for equity analysts traded at a significantly lower price.

They could try to explain their strategy at length but after a while the only thing left for them to do was to split it. Arthur Stromberg, then CEO of URS Corporation, who initiated its spin-off, declared: “I realized that analysts are like the rest of us. Give them something easy to understand, and they will go with it. [Before the spin-off,] we had made it tough for them to figure us out”. Security analysts usually specialise in one or a specific combination of industries. If a firm does not conform to that division of analyst labour, they are more difficult to understand and analyse, which is why they will trade at a lower price. It then makes sense to give in to the analysts’ whims, and focus and simplify, even if that would make you weaker in a strictly business sense.


Hence, analysts rule the (diversification) waves. And their lunch break will determine your stock price. But is this influence really beneficial for companies and society as a whole? I guess one could speculate whether the unifying influence of external constituents on firm strategy in general is a healthy thing; after all, they help both the spread of good and bad management practices.

However, it seems evident and beyond debate that the barriers erected by equity analysts for firms to follow original, contrarian strategies – because it does not suit their lunch schedule and division of labour – is less than positive. That is because such contrarian strategies that cut across different businesses are often the most innovative ones, creating most value for companies, shareholders and society as a whole. Hence, figuring out a way to restrict this detrimental influence of equity analysts seems to anyone’s benefit.

Monday, 7 February 2011

People always finish projects behind schedule and over budget - but here is some help

The United Kingdom has a proud tradition of delivering projects way behind schedule and way over budget. For example, the new Wembley stadium in London, which opened in 2007, was originally scheduled to open in 2003. It was also about $450 million over budget. Similarly, the Jubilee Line extension to the London Underground system cost $5.3 billion instead of the estimated $3.2 billion, and was almost two years late; likewise for the prestigious Millennium Bridge covering the Thames; Sadler’s Wells theatre in Islington; the list goes on and on.
But at least it is not as bad as the (in)famous mother of all planning disasters: The Sydney Opera House. This was scheduled to open in 1963 at a cost of $7 million. Eventually, it opened in 1973 and cost $102 million. But I guess that’s simply because all Australians are really British descendants with a gene for criminality.

Anyway… of course there is nothing British about all this. The same happens in many countries, and to most individuals. We all tend to be rather unrealistic in our project planning and for instance consistently underestimate our completion times. Strangely enough, research shows that we only display this so-called “planning fallacy” for our own work. When it comes to estimating the completion time of someone else’s project, we are actually quite accurate. That is why we all snigger at our friends’ project plannings, declaring “they will never make that”, to subsequently make the exact same planning errors for our own work.

Aiding accuracy?

Professors Roger Buehler from Simon Fraser University and colleagues designed a series of experiments to see if he could help people to improve their planning ability. He enlisted a bunch of psychology students and asked them to estimate their completion time as accurately as possible for a particular thesis. At the end, he checked how many of them had been late. Perhaps not surprisingly (if you are also human) more than 70 percent were late. He then ran an experiment in which he asked people to make two plannings: one “if everything went as well as it possibly could” and one “if everything went as poorly as possibly could”, to see if that would make them a bit more realistic. Unfortunately, it didn’t. The majority of people still were way late, even in comparison to their most pessimistic forecast!


Roger then designed another study. He thought, “perhaps giving them a deadline will help?” He asked a large number of respondents to think of a project they were going to undertake in the near future – the projects ranged from all sorts of academic assignments to fixing one’s bicycle or clean their apartment. Then he checked whether there was a real deadline for their project (which was true for about half of them) and asked them for their estimate of their completion time. At the end, he checked how many of them had finished their project before their estimated time of completion. As before, about two thirds of people had been overly optimistic, and finished their project late, regardless of the nature of the project. And there was no difference between the groups with or without a deadline. Apparently, setting a deadline does not help a single bit; we do not become more accurate in our planning forecasts.

Recalling past experience

Then Roger thought of yet another experiment. He had noticed that when people explained the logic for their planning, they almost always only referred to what might happen in the future, during their project; they never seemed to think about relevant past experiences with similar projects, where surely they had experienced that they tended to be overly optimistic and usually finished late. So he thought, “perhaps that might help; asking them to think about similar past experiences before making their project planning?” And so he did. He ran a similar experiment but first asked people to remember their relevant past experiences. Didn’t help a single bit… His bemused respondents first told him at length about their past planning errors and then, during the subsequent minute, made the exact same planning errors all over again.

Then Roger took a deep breath, and designed one final experiment. Now he did not only ask participants to recall their past experiences before making their project planning but now he also asked them explicitly to actually incorporate these past experiences in their planning. And – beware and behold – that helped. When Roger explicitly forced people to connect their past experiences to their new planning, they finally came up with some quite realistic forecasts.
Hence, the planning fallacy is a pervasive and persistent phenomenon that is not easy to tackle. We are quite good at forecasting someone else’s project, but we are stubbornly overoptimistic about our own. The only way to make us see some sense is to be grabbed by the ear by someone like Roger, and be forced to explicitly take into account the past errors of our ways. Then there is no denying it anymore, not even to ourselves.