Alleviating managerial dilemmas in human‐capital‐intensive firms through incentives: Evidence from M&A legal advisors
Published date | 01 February 2017 |
DOI | http://doi.org/10.1002/smj.2473 |
Date | 01 February 2017 |
Author | Olivier Chatain,Philipp Meyer‐Doyle |
Strategic Management Journal
Strat. Mgmt. J.,38: 232–254 (2017)
Published online EarlyView 8 January 2016 in WileyOnline Library (wileyonlinelibrary.com) DOI: 10.1002/smj.2473
Received 16 December 2011;Final revision received22 September 2015
ALLEVIATING MANAGERIAL DILEMMAS IN
HUMAN-CAPITAL-INTENSIVE FIRMS THROUGH
INCENTIVES: EVIDENCE FROM M&A LEGAL
ADVISORS
OLIVIER CHATAIN1*and PHILIPP MEYER-DOYLE2
1Strategy and Business Policy Department, HEC Paris, Jouy-en-Josas, France
2INSEAD, Strategy Area, Singapore
Research summary: We examine how human-capital-intensive rms deploy their human assets
and how rm-specic human capital interacts with incentives to inuence this deployment.
Our empirical context is the UK M&A legal market, where micro-data enable us to observe
the allocation of lawyers to M&A mandates under different incentive regimes. We nd that
law rms actively equalize the workload among their lawyers to seek efciency gains, while
“stretching” lawyers with high rm-specic capital to a greater extent. However, lawyers with
high rm-specic capital also appear to inuence the stafng process in their favor, leading to
unbalanced allocations and less sharing of projects and clients. Paradoxically, law rms may
adopt a seniority-based rent-sharing system that weakens individual incentives to mitigate the
impact of incentive conicts on resource deployment.
Managerial summary: The study highlights the dilemmas when professional service rms
allocate their key individuals to incoming projects, and the role that monetary incentives play
in aggravating or alleviating these dilemmas. In the context of UK M&A law rms, we nd that
partners have a tendency to be attached to too many projects and not to share enough work,
which is exacerbated when individual monetary incentives arestronger.Firms adopting a seniority
based incentive system (lockstep system) are able to alleviate this effect. This implies that thereis
a trade-off between rewarding personal performance versus balancing workloads and fostering
collaboration among professionals. Copyright © 2015 John Wiley & Sons, Ltd.
INTRODUCTION
Human-capital-intensive rms, such as law rms,
consulting rms, accounting rms, investment
banks, advertising rms, and hospitals, play a large
role in modern economies, and as such, are the
subject of an emerging literature that focuses on
Keywords: human-capital-intensive rms; human capi-
tal; managerial dilemmas; incentives; capabilities; micro–
foundations; mergers and acquisitions; law rms
*Correspondence to: Olivier Chatain, HEC Paris, Strategy and
Business Policy Department, 1, rue de la Libération, 78350
Jouy-en-Josas, France. E-mail: chatain@hec.fr
Both authors contributed equally to this article and are listed in
alphabetical order.
Copyright © 2015 John Wiley & Sons, Ltd.
the management of their most crucial resource—
human assets (Blyler and Coff, 2003; Campbell,
Coff, and Kryscynski, 2012; Chadwick and Dabu,
2009; Coff, 1997; Ethiraj and Garg, 2012; Ployhart
and Moliterno, 2011).
While the human assets on which these rms
rely are a critical resource for sustaining their
competitive advantage (Adner and Helfat, 2003;
Coff, 1997), their management also presents a
major challenge (Coff, 1997), particularly as
human-capital-intensive rms rely on organiza-
tional members who have substantial bargaining
power and a preference for autonomy (Ethiraj and
Garg, 2012; Greenwood and Empson, 2003; Teece,
2003; von Nordenycht, 2010). As a result, cat
Alleviating Managerial Dilemmas through Incentives 233
herding— a term used to describe the management
and direction of individuals who value their auton-
omy and the pursuit of their own interests (Anand
et al., 2007; Lowendahl, 2000)— is one of the most
pressing dilemmas. Understanding how dilemmas
rooted in human assets affect rms’ ability to
create rents and how rms resolve such dilemmas
is crucial to strategic management (Castanias and
Helfat, 1991; Coff, 1997), particularly in developed
economies where rms increasingly depend on
human capital for competitive advantage.
Yet, we know relatively little about how
human-capital-intensive rms deal with the
dilemmas arising from their human assets. Orga-
nizational design is an important lever used by
human-capital-intensive rms to mitigate such
dilemmas. As one of the most important dimen-
sions of organizational design, incentives may offer
an appropriate organizational response to such
dilemmas, particularly in response to the bargain-
ing power of human assets (Coff, 1997; Gilson
and Mnookin, 1985; von Nordenycht, 2010).
However, incentives can also create additional
problems, particularly for individuals with greater
rm-specic human capital, who may use their
unique position to game incentive systems (Frank
and Obloj, 2013; Obloj and Sengul, 2012). The
differentiated use of incentives to mitigate such
problems therefore needs to be better understood.
In this article, we address this gap by exam-
ining how the managerial dilemma of cat herd-
ing arises in human-capital-intensive rms and how
rms can mitigate such problems through their
rent-sharing system. We focus on one important
domain in which cat herding manifests itself, and
where human-capital-intensive rms actively man-
age the phenomenon through incentive systems:
human asset allocation, that is, deciding which orga-
nization member should work on which project.
While human-capital-intensive rms seek
efciency in the allocation of human assets to
incoming projects, human assets have their own
interests with respect to which projects to work
on, and may try to inuence project allocation to
their advantage, even to the detriment of the rm
(Milgrom and Roberts, 1988)— a classic manifes-
tation of the cat-herding problem. Ironically, this
adverse effect may be precipitated by greater levels
of rm-specic human capital— a resource seen as
highly desirable and crucial in shaping competitive
advantage in human asset-intensive rms (Camp-
bell et al., 2012)— as an intricate knowledge of the
rm’s inner working associated with rm-specic
capital may also enable individuals to manipulate
internal processes to their advantage. In this regard,
deviation from the optimal allocation for the rm
will more severely affect rms where scarce human
assets are a pivotal resource and where their optimal
use is critical to competitive advantage. Knowledge
of how the opposing effects of efciency and
inuence shape the allocation of human assets
to projects in rms, and what role human capital
and incentives play in shaping these forces, would
not only improve our understanding of how rms
can mitigate some of the management dilemmas
prevalent in human-capital-intensive rms through
certain incentive structures (Coff, 1997; von
Nordenycht, 2010), but also shed light on the
intricacies of resource allocation in rms in general,
and ultimately, how different incentive regimes
enable rms to generate rents from human assets
(Castanias and Helfat, 1991).
Our empirical setting is the assignment of senior
lawyers (partners) in UK law rms to new M&A
advisory mandates. Law rms provide a particu-
larly good setting for our study as they are the clas-
sic human-capital-intensive rm in which problems
such as cat herding are particularly magnied and
exposed. Moreover, the deployment of human cap-
ital in such rms (Kor and Leblebici, 2005) and
how it is assembled in teams (Haas, 2006) has been
shown to matter to their strategy and performance.
Our dataset comprises the population of partners
of the top UK law rms and all M&As where at
least one party— acquirer, seller, or target—was
based in the United Kingdom between 2003 and
2005, including detailed data on which partner was
working on which deal for which party as well as
the characteristics of partners, rms, and mandates.
These ne-grained data allow us to observe the pat-
tern of allocation of lawyers to new M&A advi-
sory mandates,1specically whether it is consistent
with the notion that lawyers with greater levels of
rm-specic human capital try to inuence the allo-
cation process to their own advantage, and how dif-
ferent incentive systems moderate the effect of such
inuence.
We nd, rst, that rms divert new projects
away from heavily utilized human assets and toward
1M&A advisory services provide a good setting to study these
issues. M&As are economically important, carrying high stakes
for the actors involved. Legal work is also representative of the
high value service work that takes a prominent role in modern
economies.
Copyright © 2015 John Wiley & Sons, Ltd. Strat. Mgmt. J.,38: 232–254 (2017)
DOI: 10.1002/smj
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