Benefits of Pay Disparities?

Many have argued that large pay disparities among employees can harm organizational performance, in large part due to fairness concerns that can harm morale and affect productivity. However, the Boston Globe reports on an intriguing study by Northwestern Professor Adam Galinksy, who found that NBA teams with large salary differentials outperform those clubs with more equal pay among the players. Galinsky offers an explanation for this finding:

“Status is such an important regulating force on people’s behavior, hierarchy solves so many problems of conflict and coordination in groups,” says Adam Galinsky, a psychologist at Northwestern University’s Kellogg School of Management who did the research on social hierarchies on basketball teams. “In order to perform effectively, you often need to have some pattern of deference.”

I'm not suggesting that this study endorses the notion that CEOs should make 100 times what front-line employees take home in pay. However, the study does perhaps have implications for smaller teams within an organization, perhaps including the senior management team itself. It makes sense that an NBA team excels if people understand their role, rather than having multiple players competing to be the go-to guy. Putting aside the pay issues for a moment, management teams surely benefit in most cases from the same type of crystal-clear role definition.

Risks of Combining Banking and Private Equity

INSEAD's Lily Fang and Harvard's Josh Lerner and Victoria Ivashina have a new working paper that examines the impact of combining banking and private equity. According to their paper:

"Between 1983 and 2009, bank-affiliated private equity groups accounted for over a quarter of all private equity investments. Banks' involvement increases during peaks of the private equity cycles. In particular, deals done by bank-affiliated groups are financed at significantly better terms than other deals when the parent bank is part of the lending syndicate, especially during market peaks. Investments made by bank-affiliated groups have slightly worse outcomes than non-affiliated investments, despite the targets having superior performance prior to investments. Investments during market peaks by commercial banks have significantly higher rates of bankruptcy."

New CEO To-Do List

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Haier and the Appreciation of the Yuan

Several weeks ago, Fortune ran an article about several Chinese manufacturers setting up shop here in the US. Writer Sheridan Prasso explained that reliable power, affordable land, skilled labor, transportation cost savings, and generous tax incentives had lured Chinese manufacturers to places such as Camden and Spartanburg, South Carolina. For instance, Haier has begun to produce appliances in Camden, SC. Perhaps most interestingly, Haier even ships some of the high-end refrigerators produced at that factory to China,India, Australia, Mexico, and Canada.

What does the appreciation of the yuan mean for Haier and other Chinese manufacturers setting up factories in the US? It certainly confirms the logic of that strategic move and sets up the opportunity for further expansion. Moreover, it may offer the opportunity for further exports of goods produced at these American factories. If the yuan does continue to appreciate relative to the dollar, one might expect other Chinese multinationals to follow Haier's lead into the US, most probably in states with competitive tax rates and affordable land and labor costs.

Complacency Regarding the U.S. Debt

Former Federal Reserve Chairman Alan Greenspan argues in today's Wall Street Journal that low interest rates and low inflation are fostering complacency with regard to the massive U.S. debt. We should not take comfort in the fact that global investors have flocked to the U.S. dollar as a safe haven in the wake of the debt problems in Europe. After all, U.S. debt levels as a percentage of GDP rival those in many European nations. Moreover, as Greenspan points out, the U.S. may face a sudden rise in interest rates if our debt levels persist, or worse yet, continue to grow unchecked. Greenspan reminds us that, "Long-term rate increases [in interest rates] can emerge with unexpected suddenness. Between early October 1979 and late February 1980, for example, the yield on the 10-year note rose almost four percentage points."

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The Invisible Gorilla: Six Everday Illusions

I recently finished reading a great new book: The Invisible Gorilla and Other Ways Our Intuition Deceives Us, by Christopher Chabris and Daniel Simons. These two scholars conducted the famous "gorilla" video experiment several years ago. Now, they have written a book, drawing on that line of research, to examine six powerful everyday illusions that impair our decision making.

They describe, for instance, the illusion of attention: "We experience far less in our visual world than we think we do." Put simply, we often see what we expect to see... and, here's the dangerous part: we aren't well aware of the limits to our attention. Here's one great finding that they share. Researcher Peter Jacobsen found that, "Walking and biking were the least dangerous in the cities where they were done the most, and the most dangerous where they were done the least." Now why would that be? According to Chabris and Simons, expectations explain this phenomenon. In a city with lots of pedestrians and bikers, we expect to see them on the streets when we are driving our cars. Thus, we are more likely to see them. When we don't expect to see pedestrians and bikers, we are far less likely to see them.

What's the implication for business leaders? Clearly, we miss many threats to our business because they come from unexpected sources. Our attention is distorted by our pre-existing expectations. That's why we even have to be careful about decisions which we think we are making based on extensive quantitative data analysis. We have to ask ourselves: Did our expectations shape how we gathered the data, and are we seeing a conclusion or pattern in the data simply because that's what we expected or even hoped to see?

Fooling yourself on differentiation

Many executives are fooling themselves about the extent to which their firms are differentiated from the competition. They make three classic mistakes. First, they are defining and judging differentiation for themselves, rather than asking customers. Second, if they are talking to customers, it's often only their best customers, not the less loyal buyers or those folks who are not customers at this time but could be. Finally, these executives are not asking if points of differentiation are truly driving choice among rival firms, as opposed to distinctions that may be real, but largely inconsequential to the consumers' buying decision.

Are you studying your near misses?

The Wall Street Journal had a great article over the weekend titled, "Near Misses are a Hit in Disaster Science." The article discussed how various industries study "near misses" - i.e. incidents which almost result in catastrophe, so as to gain a better understanding of the true probability of so-called low probability events.

While the article is very useful, it does not emphasize enough the most important value that an organization derives from studying near misses. I don't think the most valuable result is a better understanding of probability. I think the real value from near-miss examination and analysis comes from an understanding of the small problems, errors, and breakdowns that could result in a catastrophe. In a near miss, a redundancy in the system or an astute individual caught that small breakdown and prevented a catastrophic failure. However,a catastrophe was only narrowly averted in many instances. Examining the near miss carefully can help solve that problem or prevent that breakdown so that it doesn't occur again.

The key is that near-misses occur much more frequently than large-scale catastrophes. Thus, a true learning organization wants to surface and discuss near-misses, because you can learn and improve more frequently and more quickly, rather than waiting to conduct a lesson learned exercise after a terrible failure.

You can still call it a Chevy!

Several days ago, the New York Times reported about an internal GM memo indicating that the firm no longer wanted employees and dealers referring to its vehicles using the word "Chevy" - instead, they should be referred to by the full and proper brand name: Chevrolet. The memo argued for the importance of brand consistency. Of course, that memo referred to Coke as an example of brand consistency. Um, well, ok... but, isn't Coke a nickname for Coca-Cola? Isn't the reference to Coke actually completely counter to the argument against letting people use the "Chevy" nickname? I mean, you can't make this stuff up. Is the use of the Chevy nickname really the root of the numerous problems at GM? Is this really what they should be focusing on?

Thankfully, the Wall Street Journal reports today that GM has backed off its initial stance, blaming a "poorly worded memo" for the controversy. However, the article goes on to describe the explanation from a GM spokesperson:

It does, however plan to boost its level of formality by focusing on the brand’s full name as it expands into global markets. Spokesman Klaus Peter Martin said the company wants potential customers in new markets to recognize the brand by its full name. He says it is important that people searching information about Chevrolets for the first time are not confused by nicknames they won’t necessarily recognize.

Now that is one interesting explanation. Apparently, you and I might not know that people are talking about Chevrolet vehicles when we see the word "Chevy" on a web search. We might think they are referring to Toyotas or BMWs. We ignorant folks need GM marketing to tell us that indeed it is a Chevrolet.

By the way, how long have the two authors of this internal memo worked at GM? 31 years and 22 years respectively. That's fresh blood infusing fresh thinking into the Chevy brand.

Rethinking the Relationship between Pay and Performance

As I read Dan Ariely's new book, I was particularly intrigued by his research findings regarding the effects of bonus compensation on human performance. Ariely conducted an interesting experiment in India along with several colleagues. They created a a variety of games and tasks for subjects to complete, and they created three conditions (low, medium, high bonus). They chose India so that the bonuses would be small in absolute dollar terms, but very high in terms of their worth to an average Indian citizen. The highest bonus level actually constituted approximately five months’ pay for the subjects in the experiment.

What were the results? You might expect performance to rise with bonus level. After all, that fundamental belief underlies compensation schemes in most companies. However, Ariely and his co-authors found that performance was lowest in the highest bonus condition. The same results held in the United States. What happened? Some combination of stress, fear of losing the money, and other psychological pressures, such as over-attention to the bonus as opposed to the task itself, seemed to cause participants in the highest bonus condition to actually perform poorly on the games and other tasks in the experiment. One can certainly relate to this finding. Consider how many business executives may find themselves obsessing over their compensation toward the end of the year, and perhaps becoming distracted from the actual work that they must accomplish.

By the way, these results hold when the tasks involve some level of cognitive skill. If the tasks are purely mechanical in nature, then higher bonuses yield higher performance. That finding indeed suggests that stress may play a factor in diminishing performance on tasks that require thinking and reasoning (such as many business tasks).

Lingering Effects of Emotions

I just finished Dan Ariely's new book, The Upside of Irrationality. Ariely, of course, is a very accomplished behavioral economist and previously wrote the best-selling and insightful book, Predictably Irrational. Ariely's experimental research provides thought-provoking insights into how the human mind works. Take, for instance, a study he conducted regarding how emotions affect decisions.

Ariely and a colleague, Eduardo Andrade, first began by using two different movie clips to either put individuals in a positive or negative emotional state. Then, they had the subjects play the ultimatum game. In this simple game, participants are given $20. One individual is given the right to decide how much of the $20 they wish to share with another person. If the "receiver" rejects the offer, however, then neither party receives any money. While a "rational" person might accept any offer, given that some money is better than none, most people actually will reject an offer that is perceived to be unfair out of a desire to punish the sender for their selfish behavior. It turns out that a person's emotional state amplifies the effects of this experiment. In other words, being in a negative emotional state raises the odds that you will reject unfair offers. No surprise there, I guess. However, the most interesting part of the research concerns the lingering effects of emotions. Ariely and Andrade find that the amplified effect from a person's emotional state still holds even when you conduct the ultimatum game again later on, after the emotions have apparently subsided. In other words, we aren't just affected by the heat of the moment. If we make decisions in the heat of the moment, we may be setting the stage for a pattern of similar behavior over time.

CVS and the Risks of Vertical Integration

Yesterday, Walgreen's announced that it no longer plans to participate in drug benefit plans offered by CVS Caremark. They apparently are still miffed by what they suspect is inappropriate steering of Caremark drug benefit plan customers to CVS retail stores.

While it is unclear who is right in this dispute, one thing does remain quite clear. The episode highlights the risks of vertical integration. CVS Caremark is both a competitor to Walgreen's, but also a historical partner in that consumers used Caremark drug benefit plans at Walgreen's retail stores in the past. As a firm vertically integrates, it inevitably finds itself competing with its customers and other partners. That often raises apparent conflict of interest concerns, and it can be damaging to the business. Of course, the question remains: Which firm will suffer more from this dispute?

Does the Web Make Us Dumber?

Nicholas Carr and Clay Shirky have a terrific point-counterpoint in today's Wall Street Journal. Carr proves particularly provocative, as he often is. He argues that multi-tasking using a variety of new technological tools, can actually make us "dumber" in many ways. Carr points to some interesting new research conducted by social scientists, which shows that our increasingly divided attention may have harmful effects on our cognitive abilities. For instance, here is what Carr writes about one study performed at Stanford:

"In another experiment, recently conducted at Stanford University's Communication Between Humans and Interactive Media Lab, a team of researchers gave various cognitive tests to 49 people who do a lot of media multitasking and 52 people who multitask much less frequently. The heavy multitaskers performed poorly on all the tests. They were more easily distracted, had less control over their attention, and were much less able to distinguish important information from trivia."

Other research shows that students using web-connected laptops in class may retain less knowledge. Carr provides a good overview of a stream of literature all pointing to such detrimental effects of divided attention driven by technological use.

Several days ago, I blogged about new research suggesting that email may make it easier for individuals to lie. Now, we have Carr's column that warns us about the dangers of multi-tasking. Hopefully, this new work will cause us to exercise a bit more caution as we proceed with the implementation of technology in our workplaces and classrooms. I'm a big believer in using technology to enable and enhance learning, but I'm certainly sensitive to the divided attention problem.

BP Oil Disaster: Lesson from Other Catastrophes

As a scholar who has examined a number of catastrophic failures, I have been tracking the BP oil spill with great interest. I hope to be able to write an in-depth case study about the failure. With details still coming out about the events leading up to the catastrophe, I'm not yet ready to draw any conclusions. However, I can offer a review of a few of the major conclusions from my research, as well as others' work, on prior catastrophic failures in a broad range of fields stretching from space travel to health care.

1. Catastrophic failures generally do not have a single root cause. They are typically the result of a chain of errors, mistakes, and small failures.

2. People and organizations often downplay ambiguous threats, i.e. warning signs, that crop out in the days, weeks, and months prior to the catastrophe.

3. Organizations often have cultures that don't promote sufficient candor and open dialogue. Thus, people with knowledge about critical risks may not speak up about their concerns regarding a potential failure.

4. People with intuitive concerns about certain risks sometimes are dismissed because they lack extensive data to support their concerns.

5. Organizations often overestimate how human and system redundancy they have in place to protect them from catastrophe.

6. People often underestimate the probability of what they perceive to be extremely low probability events.

7. Cognitive biases often distort managerial judgments, contributing to catastrophe.

Email Makes Lying Easier

The Uncommon Knowledge column from the Boston Sunday Globe reports on a new study by Naquin and colleagues published in the Journal of Applied Psychology. Here is what the Globe reports:

In one experiment, anonymous business students were asked to divvy up an imaginary pot of money between themselves and another person. Students who were required to submit their decision by e-mail were more likely to misrepresent the size of the pot than students who were required to submit their decision using pen and paper. Likewise, in an experiment involving real money and without anonymity, business managers misrepresented the size of a pot of money in an e-mail communication more than they did in a paper communication.

I find the results very intriguing. They suggest that technology doesn't always help us be "more connected" to others. In some ways, it makes our relationships more distant or less personal perhaps. As a result, we may not apply the same ethical and moral code when using technology to communicate with others. This research certainly makes you think.

Myths about Speaking Up

My classmate from the HBS doctoral program, Jim Detert, and several coauthors have published some fascinating findings about why people are afraid to speak up. They examined the impact of income, education, and gender on the likelihood that someone would be unwilling to speak up due to fear or a sense of futility. They found that people with higher incomes were just as likely to withhold their input from senior managers as those with lower incomes. Similarly, education levels did not make a significant difference on the likelihood of speaking up. Finally, contrary conventional wisdom, they found that women were no more likely to withhold their input than men. Of course, this research is not saying that large status differences within a small team don't matter. People may fear speaking up if they perceive themselves as low in expertise, power, or status relative to other team members.

Google Builds a Trading Floor

Business Week reports that Google has created its own in-house trading floor to manage its $26.5 billion in cash and short-term investments. The company has hired a number of top traders and analysts from Wall Street firms to run its in-house operation. Does this make sense? One could justify this move only if you believe that Google can be more effective and efficient at managing its own investments than it could under any other organizational arrangement. In other words, is this better than Google outsourcing the function? Is it better than Google creating an alliance or joint venture with an outside entity to do this together? Why should we believe that Google can manage its investments more effectively than outside experts?

The article suggests one reason why Google may be able to do this well. Business Week reports that Google has developed a proprietary technology that enables them to track their portfolio more effectively than many outside investment firms. Of course, we don't know how true this claim is. Perhaps some investment firms would challenge this assertion. However, even if we grant that Google has developed a technological edge, we have to ask: Would Google be better served selling this technology to investment firms? Would Google realize more value by making a business out of the software that it has developed as opposed to simply using it to manage its own cash holdings? Perhaps that is what they intend to do. Maybe they are simply testing the technology first in-house. We shall see.