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Substitution Effects of Formal and Informal Corporate Governance Mechanisms in the Nonprofit Sector. Public and Nonprofit Division AOM 2006. A dead end for governance?. Corporate governance has received a great deal of attention over the past two decades (Aoki, 2001)
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Substitution Effects of Formal and Informal Corporate Governance Mechanisms in the Nonprofit Sector Public and Nonprofit Division AOM 2006
A dead end for governance? • Corporate governance has received a great deal of attention over the past two decades (Aoki, 2001) • However, virtually all popular mechanisms have produced inconclusive empirical findings, such as; • the board of directors (Daily, Dalton, & Cannella, 2003) • incentive alignment (Barkema and Gomez-Mejia, 1998) • all agency controls (Jensen & Murphy, 1990) AOM 2006 – Public and Nonprofit Division
Why such inconclusiveness? • Numerous mediators probably exist between mechanisms and performance (Wiseman and Gomez-Mejia, 1998) • Ongoing tension between cooperation and control of various governance mechanisms (Sundamurthy & Lewis, 2003) • Focus solely on agency theory mechanisms (Emirbayer & Goodwin, 1994). • View that “more is always better” (Hoskisson, Johnson, & Moesel, 1994) AOM 2006 – Public and Nonprofit Division
What to attack first? • The “low hanging fruit”… • Identifying the paradoxes that exist between multiple governance mechanisms is important for gaining a deeper understanding of the culmination of contradictory findings (Demb & Neubauer, 1992). • Firm performance and curbing managerial opportunism is a function of the entire set of governance mechanisms employed by the firm at any given point in time (Walsh et al., 1990). • Informal mechanisms are typically overlooked by proponents of agency theory, and in fact, often modeled as “noise” (Oliver, 1996; Ring & Van de Ven, 1992) AOM 2006 – Public and Nonprofit Division
How can the nonprofit sector help? • “Agency theory focus” – Incorporates multiple theoretical lenses (institutional, social networks) which have formed the basis of governance research within the nonprofit sector (Miller-Millesen, 2003) • “More is always better” - Permits the examination of substitution and complementary effects between governance mechanisms by introducing sector variance in an otherwise homogeneous for-profit sector • Previous research has focused only on the substitution of “internal” and “external” mechanisms within large publicly traded U.S. organizations (Peasnell et al., 2003) • More reliance on “informal” rather than “formal” mechanisms in the nonprofit sector (Olson, 2000) AOM 2006 – Public and Nonprofit Division
The importance of substitution • First identified by Williamson (1985) which argues that the incremental impact of a governance mechanism on curbing managerial opportunism is dependent upon the existing set of mechanisms employed by the firm • Again highlighted by Eisenhardt (1989) in highlighting the tradeoff between “behavior-based” and “outcome-based” contracts • Despite ongoing warnings, researchers continue to view governance mechanisms as linearly additive and complementary to one another (Peasnell et al, 2003; Das et al, 1998; Zajac et al, 1994) AOM 2006 – Public and Nonprofit Division
Formal vs. Informal Mechanisms • “Formal mechanisms” are defined as any instrument which is codified by contract or explicitly embodied within a legally enforceable or regulatory framework • Such as incentive contracts (Barkema & Gomez-Mejia, 1998), disclosure regulations (Hillman & Dalziel, 2003), and the market for corporate control (Fama, 1980) • “Informal mechanisms” are defined as any influence upon opportunistic behavior that is implicit or non-binding legally • Such as institutional norms (North, 1990), reputation (Baysinger & Hoskisson, 1990), and trust (Das et al, 1998) AOM 2006 – Public and Nonprofit Division
Hypotheses Development H1: Informal mechanisms of governance are more effective at curbing managerial opportunism than formal mechanism of governance Why? • “Ratting out” has been shown to be more effective than formal sanctions for board members (Westphal & Khanna, 2003) • Informal norms often exist at routine or subconscious levels thereby precluding rational opportunism (Brass et al, 2004) • Formal mechanisms often create a “gaming atmosphere” (Ghoshal et al, 1996; Walsh et al, 1990) AOM 2006 – Public and Nonprofit Division
Hypotheses Development H2: Informal mechanisms of governance are more efficient at curbing managerial opportunism than formal mechanism of governance Why? • Direct costs of formal mechanisms such as regulations, incentives, and takeovers are very costly (Jensen, 1993) and indirect costs of information leakage to competitors and risk averse behavior (Bettis, 1983; Hoskisson & Hitt, 1988) • While the costs of informal mechanisms can be high, they are often more dispersed amongst society or groups (Uzzi, 1997) • Cumulative cost of formal mechanisms is logarithmic (Zajac et al, 1994) while informal mechanisms are exponential (Scott, 1987) AOM 2006 – Public and Nonprofit Division
Hypotheses Development H3a: Informal mechanisms are adequate substitutes and positive complements to existing formal mechanisms of governance H3b: Formal mechanisms are inadequate substitutes and negative complements to existing formal mechanisms of governance Why? • Informal mechanisms, such as trust, reduce the need for formal governance mechanisms such as monitoring (Abrahamson et al, 1992) • However, the reduction of informal mechanisms, such as trust, tend to be more dichotomous as opposed to incremental which is more common during the building process (Uzzi, 1997; Mizruchi, 1992) • The reduction of informal mechanisms diminishes the impact of other informal mechanisms in a negative spiral manner (Granovetter, 1985) AOM 2006 – Public and Nonprofit Division
Next Steps • Empirical evidence! • Broader, multi-dimensional measures of key constructs using SEM, especially; • Performance • Opportunism • Part of a larger cross-sectional comparative study of nonprofit and for-profit sector organizations using mediating “opportunism” and “resource providing” variables with multiple controls AOM 2006 – Public and Nonprofit Division