Think about basic economics — when you specialize in one skill and your neighbor specializes in another, you’re both better off when you collaborate and trade amongst each other, rather than relying on your own advantages.

Firms are increasingly recognizing this principle holds true when it comes to research and development (R&D) information sharing among firms.

Businesses form research and development alliances when developing new products. An R&D alliance is a formal relationship between two or more firms to pursue mutually beneficial goals. The firms remain independent entities, but enter into an agreement to combine their knowledge bases in order to expand and refine innovations. “It’s simple,” says Lorraine Eden, a management professor at Mays Business School. “Two brains are better than one.”

R. Duane Ireland
Ireland

Michael Hitt
Hitt

Lorraine Eden
Eden

Many industries are involved in R&D alliances, including pharmaceutical, automotive, electronics and chemical companies. When the costs and risks of developing new products are both high, these firms are more likely to enter into an R&D alliance, says Michael Hitt, a University Distinguished Professor in management and Joe B. Foster ’56 Chair in Business Leadership.

Dan Li ’05, now teaching at Indiana University, worked at Texas A&M with Eden, Hitt and R. Duane Ireland, Distinguished Professor in management, Conn Chair in New Ventures Leadership and AMJ Editor, on a recent study to examine which type of governance structure is most effective for these alliances. They focused their research on multilateral alliances (three or more firms) and compared them with bilateral alliances (a joint venture between two firms).

“Very few have studied multilateral alliances,” Hitt said in describing the research’s uniqueness. Eden adds: “People have been researching bilateral firms for the past 20-30 years, but there’s been not much written on multilateral ones.”

Hitt describes information sharing between firms as “a real balancing act.” Individual firms must manage the information they share and the information they protect. “In a joint venture,” says Hitt. “If everyone invests money, there’s an incentive to share information and be fair.” They wanted to learn if this remained true when the number of partners increases.

According to Eden, much of the intended knowledge sharing within the alliances involves “tacit information” — information that must be thoroughly explained and demonstrated by one firm to another. She argues that selecting the type of governance (equity-based or contractual) structure can be critical to the success of the R&D alliance since equity ownership, where one firm owns a piece of the other firms, can help facilitate planned knowledge sharing among them.

At the same time, however, sharing knowledge often leads to “unintended information leakages,” which causes problems among the R&D alliance partners. “There’s a real hesitancy,” Hitt says. “When you’re in an alliance, you have to trust your partners, who are potential competitors, to be fair.”

Their study examined 2,500 alliances — 1,700 bilateral and 750 multilateral. The researchers also compared governance structures in two types of trilateral R&D alliances: chain and net. The study found that 18 percent of trilateral alliances use a chain-based approach, which involves a passing of information from one firm to another, and 82 percent of alliances use net-based approaches, or group sharing.

As the complexity of the alliance increases, the probability of cheating also increases. For example, the alliance between pharmaceutical companies becomes more complex if the companies are from different countries, mainly because intellectual property rights vary internationally. Additionally, the more firms involved in an alliance, the more likely there will be a “free-rider,” or a firm that wants information from other companies without sharing any of its own. This is more likely the case in net than in chain trilateral alliances, notes, Eden, because it is “easier for the cheater to hide.”

The research found that equity governance structures, rather than contractual structures, combat the uncertainty of information-sharing firms face as complexity escalates in multilateral alliances. Equity ownership can help compensate for complexity and free-rider problems, while also helping to facilitate intended knowledge transfers. The greater the emphasis on equity share, the smoother the facilitation and transfer of information, the research notes.

The authors found that, for both knowledge sharing and knowledge protection reasons, firms were more likely to use an equity governance structure in multilateral than in bilateral R&D alliances. Similarly, net trilateral alliances were more likely than chain ones to use equity governance structures.

Eden suggested that the study offers a confirmation for firms interested in governance mechanisms. “Companies will be able to look at the findings and determine what type of governance is best for their alliance.”

Categories: Research Notes

Medical errors account for 98,000 deaths each year in the U.S., according to a 1999 report published by The Institute of Medicine (IOM). In a more recent report, the IOM claims medical errors harm 1.5 million people and cost $3.5 billion every year. Interestingly, the report claims that medical errors are not due to incompetent people, but to bad systems that include the processes and methods used to carry out various functions.

Ramkumar Janakiraman
Janakiraman

These staggering numbers and facts have caught the attention of many researchers, including Ram Janakiraman, assistant professor of marketing at Mays Business School, Shelley and Joe Tortorice ’70 Faculty Research Fellow and Mays Teaching Fellow.

Janakiraman says he has always been interested in several aspects of healthcare. “As a marketing researcher, the context of doctor and patient relationships greatly interests me,” he says.

This interest led him and a group of other researchers from around the nation to explore and analyze the impact of system automation on medical errors.

Janakiraman explains that medical errors are most commonly traced back to the manual transmission of information across different functional units of the hospital, manual calculations of doses and unmonitored clinical interventions. The big question surrounding the research, he says, was, “Can automation really reduce the rate of errors in various hospital wards?”

Janakiraman’s co-researchers on the article in Information Systems Research were Ravi Aron, an assistant professor at the Johns Hopkins Carey Business School; Shantanu Dutta, vice dean for graduate programs and professor of marketing at USC Marshall School of Business; and Praveen Pathak, American economics institutions professor at University of Florida’s Warrington College of Business Administration.

The researchers hypothesized that the “Automation of information capture and transmission between agents and across the different functional units of the hospital can reduce the rate of medical errors, because they enable the automation of the checks and procedures, thereby removing the “human touch.'”

Janakiraman drew insight from the Joint Commission on Accreditation of Healthcare Organization (JCAHO), as well as the Joint Commission International (JCI). The Joint Commission recommends that hospitals adopt three procedural norms:

  1. Observe and record actions of agents (Sensing Function)
  2. Recommend context-specific procedural controls (Control Function)
  3. Undertake periodic managerial review of the extent to which agents are in compliance with norms (Monitoring Function)

The researchers recognized these three functions as having potential for automation. One example that could be automated is logging the time an item is removed from storage. Rather than recording it in a logbook, a technician could swipe a digital card to record the time.

Janakiraman says this research is important for a number of reasons: No study has empirically analyzed the relationship between automation and medical errors using actual hospital data and no study has looked at the differential impact of automating these three functions on the incidence of two types of medical errors (procedural and interpretative errors) in hospitals. Also, no other study has examined the effect of quality training programs and their complementary effect on automation of error prevention functions using actual data.

“Collecting this data was a humongous feat,” Janakiraman says. The researchers used panel data of incremental automation over time of the error prevention functions and actual rates of medical errors at several wards of two large, top-notch hospitals.

With this data, Janakiraman describes the two categories of medical errors the researchers found: procedural errors (deviations from norms irrespective of what the context and circumstances are) and interpretative errors (deviations from norms that are classified as errors based on the underlying circumstances and the context).

Results from the study confirmed Janakiraman’s hypothesis: automation of the three core error prevention functions (sensing, control and monitoring) helps reduce both kinds of medical errors (procedural and interpretative).

In addition, the researchers found evidence of a significant complimentarity between automation of certain functions and the training of clinical and nonclinical workers in quality management.

“The research demonstrates that there are hidden benefits to the automation of manual functions that are often not captured in a cost benefit analysis,” he says.

Janakiraman plans to continue with his research on healthcare — this time focusing on hospitals’ decision to adopt various technologies, rather than just the impact of technology.

Categories: Research Notes

In an era of soaring medical costs, providing health care to employees at or near their workplace is gaining new momentum, according to an article in the Winter 2012 issue of MIT Sloan Management Review.

A 2011 study by the professional-services company Towers Watson and the nonprofit National Business Group on Health found that 23 percent of the mid-sized and large U.S. employers they surveyed had on-site health clinics and that another 12 percent planned to establish an on-site clinic in 2012.

Leonard Berry
Berry

Companies ranging in size from Fortune’s “Best Company to Work For” winner, SAS Institute, to privately held Rosen Hotels & Resorts report that onsite employee healthcare saves millions in health care spending while improving employee health and satisfaction.

Motivated by rising costs and commitment to their staff’s health and productivity, many companies are taking matters into their own hands, according to the article. In this so-called “do-it-yourself” health care, some firms operate clinics with their own employees, including doctors and nurses, while others contract with outside organizations for clinical management and staff.

The entire article, “Do-It-Yourself” Employee Health Care,” is available on the MIT Sloan Management Review website. The article was authored by:

Ann M. Mirabito, Ph.D., assistant professor of marketing at the Hankamer School of Business at Baylor University in Waco, Texas. Her research focuses on health care, where she has explored ways stakeholders can act to improve outcomes and value. Her work has appeared in Harvard Business Review and medical journals including Annals of Internal Medicine and Mayo Clinic Proceedings. She has extensive executive responsibility in large (Frito-Lay, Time Warner) and small organizations, consumer and business-to- business and nonprofit and government (Federal Reserve Board).

Leonard L. Berry, Ph.D., Distinguished Professor of Marketing, and M.B. Zale Chair in Retailing and Marketing Leadership in the Mays Business School at Texas A&M University. He is also professor of humanities in medicine in the College of Medicine at The Texas A&M University System Health Science Center. He has served as a visiting scientist at Mayo Clinic studying health care service and is a former national president of the American Marketing Association. Berry co-authored the book, “Management Lessons from Mayo Clinic.”

Gale Adcock, M.S.N., R.N., director of corporate health services at SAS Institute Inc., in Cary, N.C. She also serves as a consulting associate faculty member for Duke University and is an adjunct associate professor at the University of North Carolina — Chapel Hill. She received her Diploma in Nursing from Virginia Baptist Hospital, her BSN from East Carolina University, and her MSN & Family Nurse Practitioner Certificate from the University of North Carolina — Chapel Hill.

About Baylor University

Baylor University is a private Christian university and a nationally ranked research institution, classified as such with “high research activity” by the Carnegie Foundation for the Advancement of Teaching. The university provides a vibrant campus community for approximately 15,000 students by blending interdisciplinary research with an international reputation for educational excellence and a faculty commitment to teaching and scholarship. Chartered in 1845 by the Republic of Texas through the efforts of Baptist pioneers, Baylor is the oldest continually operating university in Texas. Located in Waco, Baylor welcomes students from all 50 states and more than 80 countries to study a broad range of degrees among its 11 nationally recognized academic divisions.

About Texas A&M University

Opened in 1876 as Texas’ first public institution of higher learning, Texas A&M University is a research-intensive flagship university with approximately 50,000 students — including 9,000+ graduate students — studying in over 250 degree programs in 10 colleges. Students can join any of 800 student organizations and countless activities ranging from athletics and recreation to professional and community service events.

About SAS

SAS is the leader in business analytics software and services, and the largest independent vendor in the business intelligence market. Through innovative solutions, SAS helps customers at more than 55,000 sites improve performance and deliver value by making better decisions faster. Since 1976 SAS has been giving customers around the world THE POWER TO KNOW®.

Categories: Faculty, Research Notes

As a stockholder, would you prefer a CEO who is strictly rational about her firm’s future prospects, or a CEO who is somewhat overoptimistic? Researchers at Texas A&M University show theoretically that for risk-averse CEOs, being somewhat overoptimistic is a good thing for shareholders.

Most CEOs are undiversified, meaning that a large fraction of their personal wealth is in invested their company. Stockholders, on the other hand, are typically well diversified, with investments across numerous companies. These differences mean that a risk-averse CEO who is strictly rational will turn down some risky investment projects that the stockholders would like the firm to make. If this happens, the result is lower firm value.


“Given a choice between a very rational CEO and a moderately overoptimistic one,” says Mays finance professor Shane Johnson, “the somewhat overoptimistic one is the better choice.”

“We show theoretically that overoptimism can help offset the effect of the CEO’s risk aversion,” Texas A&M finance professor Shane Johnson says. “The result is that a CEO who is moderately overoptimistic will invest the way shareholders would want her to invest—this maximizes firm value.” In contrast, a purely rational CEO turns down too many investment projects relative to the optimal level, whereas a CEO who is too overoptimistic accepts too many investment projects. Both underinvestment and overinvestment produce firm values below what it could be.

“If the theory is correct, CEOs who are somewhat overoptimistic should face a lower probability of termination than rational CEOs or too-overoptimistic CEOs face. A board doesn’t necessarily know a CEO’s level of optimism when it hires her. It learns by watching his decisions over time,” Johnson says. If CEOs who are somewhat overoptimistic maximize firm value, they should be more likely to keep their jobs than would CEOs with too-low or too-high optimism. Using a large sample of CEO terminations, the team finds strong empirical support for the theoretical predictions. The results are consistent with the view that CEOs who are somewhat overoptimistic maximize firm value.

Before this research was conducted, the common belief was that any level of over-optimism was bad, says Johnson. “Our paper is one of a series that argues that some level of over-optimism is good for CEOs,” he says. “Given a choice between a very rational CEO and a moderately overoptimistic one, the somewhat overoptimistic one is the better choice.”

The research was conducted by Texas A&M finance professor Shane Johnson; doctoral students T. Colin Campbell, Jessica Rutherford and Brooke Stanley; and former Texas A&M professor Michael Gallmeyer, who is at the University of Virginia.

For more information, contact Johnson at shaneajohnson@tamu.edu.

“CEO Optimism and Forced Turnover” by T. Colin Campbell, Michael Gallmeyer, Shane A. Johnson, Jessica Rutherford and Brooke W. Stanley was published in Journal of Financial Economics.

Categories: Research Notes

Intuitively, it is clear that changes in a service environment can reduce the quality of a service at least temporarily. But what is not clear is how deeply, and for how long, major changes affect operating performance – that is, until Texas A&M University business professors Gregory Heim and Michael Ketzenberg decided to answer those questions. They chose a dramatic example of redesign and decided to focus on experience-based service companies, in general, and an area that had not been previously studied in depth: golf courses.


“The argument for improving a course is to make it better, but we wanted to find out if people really thought that was true,” said Mays professor Gregory Heim. “Some people embrace change, while others don’t.”

Many service managers redesign their services periodically to keep their offerings fresh, competitive and desirable to customers. Prior research has shown that it could increase repeat business. What Heim and Ketzenberg wondered was how service firm managers and employees relearn to improve their performance after these major redesigns.

That was the extent of Heim’s golf knowledge at the start of this project. He sought out a colleague to fill the gaps. He did not have to search far to find someone to fit the bill. In fact, Ketzenberg was just down the hall. Ketzenberbg has two passions: research and golf, and he considers the opportunity to combine both a godsend. Heim says he focused on the data analysis, while Ketzenberg provided golfing expertise. “It was an ideal pairing for this project,” Heim says.

Heim says a major research challenge is obtaining real-world operating data from companies upon which to base the research. Most companies are reluctant to share their data. For this study, the authors were looking for data from multiple companies over multiple years. Golf courses posed less of a problem, since the data were publicly reported.

Gregory Heim
Heim

The data came in the form of “panel data” from The Dallas Morning News. The News tracks the top Texas golf courses annually through ratings and evaluations of top courses by golf professionals, as well as information on when the courses were designed and redesigned. Heim and Ketzenberg chose to study the data from 1989 to 2009. Their study provides managerial insight by demonstrating the extent of learning, illustrating how redesigns can negatively affect service outcomes, showing how relearning occurs and discussing tactics for success when redesigning services.

Major redesigns, intended to improve products and services, tend to throw the quality of service off track, the researchers found. The question was how long the service suffers, which they studied through learning effect patterns during routine operation periods as well as “window of opportunity” effects the local service crews felt after outside firms had completed the major redesigns.

“We wanted to see what we could learn about what happens when you destroy the course to redesign it; how age affects the long-term experience; and whether the quality of service gets better with time,” says Heim. “When you redesign it, there’s a period of time when the customers miss the familiar old course and they have to re-learn to navigate the course — the hazards, slope of the course, shape of the greens, and so forth. The argument for improving a course is to make it better, but we wanted to find out if people really thought that was true. Some people embrace change, while others don’t.”

Michael Ketzenberg
Ketzenberg

The topic is a nontraditional one for the field of information and operations management, but both of them say it was fun to do. The lessons learned were to carefully consider changes, communicate about them with stakeholders and make the investment in training staff for the transition. “Discontinuous events that lead to dissatisfaction on the customer’s part are not going to pan out to be good investments,” Heim says.

Both Texas A&M researchers plan to continue golf-related research: Heim intends to update the golf data for new studies while Ketzenberg is working with Rogelio Oliva and a colleague from Europe, Mozart Menezes, on a paper titled “Optimal Scheduling of Golf Beverage Carts.” Ketzenberg explains, “We are trying to answer the often-heard golfer’s lament of why there is never a beverage cart around when you want one. Fun stuff.”

For more information, contact Heim at gheim@mays.tamu.edu or Ketzenberg at mketzenberg@mays.tamu.edu.

The paper “Learning and Relearning Effects with Innovative Service Designs: An Analysis of Top Golf Courses” by Heim and Ketzenberg was released in July 2011 in Journal of Operations Management.

Categories: Research Notes

It’s complicated, an employee’s decision to leave a job — even more complicated than previously believed, Texas A&M University researchers conclude after conducting research on when job searches result in turnover.

As expected, turnover was higher when employees had lower levels of embeddedness and job satisfaction and higher levels of available alternatives. What wasn’t expected, or previously explained, was that there is more complexity to the process than believed, and specifically, that these factors play a key role in whether search behavior actually results in the decision to quit.

Wendy Boswell
Boswell

Embeddedness means how attached someone is to his current environment, says Mays Business School faculty member Wendy Boswell, who collaborated on the research with fellow faculty member Ryan Zimmerman and doctoral candidate Brian Swider. The trio examined factors that may help explain under what conditions employee job search effort may most strongly (or weakly) predict subsequent turnover.

“How tied you are to not only the place but also the community — if you own a home, your spouse has a job there, you belong to a church or are involved in schools, determines how much incentive it takes to get you to leave,” Boswell explains.

“Fit” is also important — whether the values of a community (as well as the organization) align with the individual’s — and characteristics such as metropolitan versus small-town, or urban versus industrial. “The practical implication for an employer is to know who is really vulnerable to leaving, then going and intercepting those high performers — retention isn’t “one size fits all,'” explains Boswell.

Ryan Zimmerman
Zimmerman

The culture of the organization and community also carry great weight in the decision, Swider says. “Say I’m working in New York City and a job opens in a small southern suburb. Whether I pursue that opportunity depends on my personal preferences,” Swider says. “It could be the opportunity I’ve been waiting for or it could sound like a nightmare.”

Employers do a poor job of predicting impending turnover, Swider says. These findings suggest that there may be a number of factors interacting to influence employees’ turnover decisions, indicating greater complexity to the process than described in previous prominent sequential turnover models.

Boswell explains the assumed process: An employee experiencing job dissatisfaction searches for alternatives, evaluates them against his current position, then either quits or stays put. But, often times, employees search and don’t leave. Online applications make it easier to search and even apply for positions, but the likelihood of an employee actually accepting another position depends on his level of enmeshment or “stuckness” as well as how important it is for the person to leave and whether he or she even has the opportunity.

Brian Swider
Swider

“The more of these attachments you have, the more likely you are to want to stay somewhere,” Boswell explains. “It used to be the defined benefit plan, but now it is all these other factors that you might have to sacrifice if you were to leave.”

The key for an employer to stay ahead of the turnover, Boswell says, is to know his or her employees. “Are they satisfied, embedded, on the fence?” she says. “Are they flight risks? If so, and if they are top employees, you might be wise to invest in trying to retain them.”

For more information, contact Swider at bswider@mays.tamu.edu or Boswell at wboswell@mays.tamu.edu.

“Examining the job search – turnover link: The role of embeddedness, job satisfaction, and available alternatives,” by Brian W. Swider, Wendy R. Boswell, and Ryan D. Zimmerman, was published in the March 2011 issue of the Journal of Applied Psychology.

Categories: Research Notes

Imagine borrowing from someone else’s stockpile of corporate stocks, then selling shares, later buying them back and returning them, keeping any profit. That’s what short sellers do on a regular basis, and they tend to out-perform the analysts.

The practice is called short selling, and research by two Texas A&M University business professors and a former PhD student shows that ordinary investors can profit by trading with the short sellers.

Lynn Rees
Rees

Their research investigated whether short sellers and analysts differ in how they use information that predicts future returns. It appears short interest significantly anticipates the expected direction, while analysts tend to positively recommend stocks with high growth, high accruals, and low book-to-market ratios, despite these variables having a negative association with future returns.

“Investors frequently observe and use recommendations from analysts on whether to buy or sell a stock,” says accounting Professor Lynn Rees. “But, our research suggests that analysts do not always use accounting information, such as accounting accruals and cash flows, in forming their recommendations; whereas, short sellers appear to do much better in using these signals.”

Co-authors are Edward P. Swanson, holder of the Durst Chair in Accounting; and Mays doctoral graduate Michael Drake of BYU. The researchers have presented the paper to professionals, as well as academic audiences, and a NYC capital management company that uses short interest as an input in an investment model.

Edward Swanson
Swanson

A low percentage of investors do short selling, but a very high percentage of investors would be interested in what they are doing, Rees says, because the short sellers tend to do better than the market. “Our evidence suggests that using the level of short interest combined with analysts’ forecasts allows investors to make more profitable investment decisions,” he says.

For more information about this research, contact Rees at lrees@mays.tamu.edu, or Swanson at eswanson@mays.tamu.edu.

“Trading against the prophets: Using short interest to profit from analyst recommendations,” by Michael Drake, Lynn Rees and Edward P. Swanson, was published in The Accounting Review.

Categories: Research Notes

Businesses competing with larger companies — particularly those that enter a market by acquiring an established business — will fare better if they differentiate themselves from the “behemoths” rather than imitate them or take them head-on, suggests research on the topic.

The researchers found that competitors who imitated the large newcomer had poorer performance, which was counter to prior research.

Alina Sorescu
Sorescu

The phenomenon of acquiring a company to enter a marketplace — common in banking, pharmaceuticals and technology — hasn’t been studied as thoroughly as the path companies take to enter a market through other means, such as introducing a new product, says Alina Sorescu, an associate professor of marketing and Mays Research Fellow.

She and several other researchers tackled the topic in the paper “Behemoths at the Gate: How Incumbents Take On Acquisitive Entrants (And Why Some Do Better Than Others),” which has been accepted for publication in Journal of Marketing.

The research was centered on the banking industry because firms and the actions they take in this industry are well documented, Sorescu says. The researchers looked at 1995-2003 bank data from the FDIC, such as deposit summaries, and interviewed banking officials. The data covers 839 acquisitions in 583 Metropolitan Statistical Areas in the U.S. banking industry. The research specifically focuses on how banks modify their product mix when a large bank enters their market through an acquisition. In this context, the product mix of banks includes various types of loans such as, for instance, commercial and industrial loans and loans secured by real estate. Changes in product mix were assessed at the two-year and three-year marks after the acquisitions.

Results indicate that incumbents are more likely to align their product mix strategy with that of the behemoth if: (1) the incumbent is large; (2) the behemoth’s past performance has been strong; and (3) the market served by the incumbent is small. The size of the market tends to set the tone of the competition, Sorescu says. “The smaller the market, the more likely the incumbent is to imitate the acquirer,” she observes. “It’s like a big fish in a small pond making a big splash — they compete with the same small base of customers.”

Sorescu concludes it’s a bad idea to go head-on with the acquirer.

“It’s best to try to diverge from the acquiring company, even though it is a threatening presence and it is tempting to try to mimic what it is doing,” she says. “You assume the larger corporations have identified a strong path and an advisable product mix, but you must differentiate yourself from it in order to survive. The small firms that imitate the large firms may not be able to offer the same products and services as efficiently as large firms do, and they could suffer more harm than if they focused on what they already do well.”

For more information, contact Sorescu at asorescu@tamu.edu.

The research paper, “Behemoths at the Gate: How Incumbents Take On Acquisitive Entrants (And Why Some Do Better Than Others),” was in press in late 2011 at Journal of Marketing.

It is a collaboration among Alina Sorescu, Prokriti Mukherji, Jaideep Prabhu and Rajesh Chandy. Prokriti Mukherji is senior research associate at the Carlson School of Management, University of Minnesota. Jaideep Prabhu is Jawaharlal Nehru Professor of Indian Business at Judge Business School, University of Cambridge. Rajesh Chandy is Professor of Marketing and Tony and Maureen Wheeler Chair in Entrepreneurship at London Business School.

Categories: Research Notes

Bootlegged concert recordings, undocumented immigrants building houses in the U.S., New York City street vendors selling designer knock-offs—these are examples of a largely unexamined economic activity, the informal economy. These economic activities are considered illegal yet still viewed as socially acceptable or legitimate by some substantial segment of society.

Because nearly nine percent of the GDP of the United States (and perhaps more than 60 percent in some African and South American countries) is involved in the informal economy, it is a topic worth exploring, says Duane Ireland, Distinguished Professor of Management and Conn Chair in New Ventures Leadership. He and two Mays colleagues (David Sirmon and Laszlo Tihanyi) and Justin Webb (a recent graduate of the Mays Ph.D. program who is now at Oklahoma State University) have examined how the informal economy works and the reasons some ventures thrive, despite barriers of legality and legitimacy.

The illegality of bootleg DVDs in most countries has not prevented them from becoming a significant source of income for many entrepreneurs willing to take the risk of operating in an informal economy.
The illegality of bootleg DVDs in most countries has not prevented them from becoming a significant source of income for many entrepreneurs willing to take the risk of operating in an informal economy.

The cornerstone of their research is a matrix for categorizing entrepreneurial activities based upon legality and legitimacy. While some entrepreneurial activities in the informal economy are considered illegal yet legitimate (e.g., the sale of counterfeit products or use of undocumented workers as labor to build a home), other entrepreneurial activities fit different classifications of legality and legitimacy. For example, tobacco-based and adult-oriented products in the United States are legal yet considered illegitimate by large societal groups.

In contrast, illegal drugs and human trafficking are considered illegitimate by the overarching society. Distinguishing among different classifications of legality and legitimacy is important to understanding the mechanisms through which these entrepreneurial activities are able to exist, grow, and be sustained even while occurring outside of the law.

Ireland says one aspect that he finds fascinating is how a business can move between categories over time, due to the intentional actions of the business or due to shifts in the definitions of legality and legitimacy. Take for instance, alcohol sales in the United States in the 1920s during prohibition. Though it was illegal, speakeasies and bootlegged liquor became quite commonplace and legitimate. Then in 1933, the industry once again was legalized. This is a great example of the fluid nature of the boundaries in this area.

In a similar vein, the production of marijuana is an example of the porous nature of the matrix, as it is moving from illegal and illegitimate in the United States to illegal but legitimate, or legal but illegitimate, depending on some groups’ norms, values, and beliefs and various state and local laws.

Another example is Napster ten years ago and Youtube.com during its initial operations. It was alleged that Napster allowed users to violate copyright laws by sharing audio files freely. The online service was hugely successful from 1999 to 2001 when it was shut down due to issues of legality. At least initially, similar allegations suggest that Youtube violated copyright laws by not removing items from its site that were posted by individuals who did not have permission from the owners of the postings. However, for some large groups and with an increasing expectation of free content on the Internet, Youtube is still seen as legitimate, despite the fact that some postings may not be legal with respect to copyright laws.

The paper “You say illegal, I say legitimate: entrepreneurship in the informal economy,” appeared in Academy of Management Review in 2009 and was a finalist for best paper that year.

Categories: Research Notes

Toward the end of their relationship, Enron was paying nearly $50 million each year to Arthur Andersen for services, including both internal and external audit functions. Did the risk of losing such a large client lead to the ethical compromises that Andersen was willing to make in colluding in the enormous fraud scandal that eventually brought down both firms?

Nathan Sharp
Sharp

Yes, said analysts, who recommended internal and external audit functions in public companies be split between firms to prevent economic bonding and cooperation in fraud. Created soon after, the Sarbanes-Oxley Act prohibited external audit firms of public companies from having any involvement in the internal audit function. However, research from Nathan Sharp, assistant professor of accounting, suggests this move may have been a mistake.

Sharp and colleagues investigated companies in the pre-SOX era to determine if companies that outsourced or co-sourced internal audit work to their external auditor had a higher risk of misleading or fraudulent external financial reporting. The result? This relationship actually lowered accounting risk.

The reason is simple. When a single firm is involved in both audits, it’s harder for fraud to go undetected, as there is greater communication between both audit teams. Knowledge spillover occurs because the internal audit team provides insights into the company that an external audit team might miss. This information sharing is less likely to happen when the teams are from competing firms or when the internal audit function is kept entirely in-house.

There is much debate about this topic says Sharp, and he and his colleagues are not suggesting SOX be changed. However, if you talk to public accounting firms, the opinions are clear: It’s good sense to make it easier to share information between internal and external audit teams to create the most complete financial snapshot of a company.

Sharp’s article, “Internal Audit Outsourcing and the Risk of Misleading or Fraudulent Financial Reporting: Did Sarbanes-Oxley Get It Wrong?” coauthored with Doug Prawitt and David Wood, is currently under review at Contemporary Accounting Review.

Categories: Research Notes