Post-Acquisition Restructuring and HRM Policies in a Multi-unit Firm

1. Post-Acquisition Restructuring, HRM Policies and Performance: Insider Econometrics in a Multi-unit Firm Hein Bogaard & Jan Svejnar The 16th Dubrovnik Economic Conference June 23-25, 2010

2. Goals • Advance “insider econometrics” literature • Usually analyzing effects of intra-firm (HRM) reforms on productivity • Usual problem – potential endogeneity of reforms (more likely to be implemented in units where they have high marginal impact ) • Provide new/different analysis of reforms in Central-East European (CEE) firms after foreign acquisition • Most analyses use limited data on many firms • We use detailed data on one firm/bank (with about 180 branches)

3. Literature: Insider Econometrics -- Banks • Insider Econometrics -- measuring impact of HRM policies on performance within a well-understood production process (Ichniowski and Shaw, 2003) – usually in advanced economies • Research on banks -- branch-level determination and implementation of work practices (Bartel, 2004), employee attitudes/satisfaction (Bartel et al., 2003) and training (Jones et al., 2008) -- all affect productivity

4. Literature:Ownership-governance-performance • Foreign ownership is associated with better performance of firms and banks in CEE region (e.g. Bonin et al, 2005a,b; Fries and Taci, 2005; Havrylchyk, 2008; Estrin et al., 2009) • Differences are attributed to: • Corporate governance (e.g. Majnoni et al, 2003) • Financial relationships with foreign parents (e.g. De Haas and Naaborg, 2005b) • We consider role of work practices and HRM policies transferred by a foreign parent

5. Background and Approach • Studies of individual (Lazear, 2000) and team (Hansen, 1997; Hamilton et al., 2003) incentives have considered homogenous tasks • We analyze reforms involving task differentiation -- reforms in our bank => greater individual responsibility and higher-powered incentives for a subset of employees • Approach • Examine sales productivity in 180 branches of a foreign-owned bank • Have five years (20 quarters) of data on sales performance and organizational structure of each branch • Exploit structure of data and fact that the reforms were determined centrally and gradually implemented bank-wide => can deal better with endogeneity of HRM reforms at branch level (IV estimation and propensity score matching)

6. Our results • Reforms improved sales productivity, but • Differentiation of incentives among co-workers has limited success of reforms -- in particular with regard to quality / profitability improvements

7. Data • Bank in the CEE region, acquired by a Western-European owner around 2000 • Bank’s branches serve retail and SME clients and are incentivized to maximize “sales” of loans and deposits • Quarterly balance sheets and profit/loss accounts for up to 200 branches between 2003 and 2007 (≈ 3,250 obs.) • Quarterly data on the number of employees and the functional structure of the branches

8. Institutional setting • Conservative incumbent executives • Team-based incentives in branches • Foreign acquirers sought to improve sales and client retention/acquisition • Stratification of functions within branches giving subset of employees (“Bankers” and “Advisors”) individual incentives • Bankers and advisors expected to improve sales quantity and quality (profitability, product mix)

9. OLD Branch Operational Model Branch Manager Branch Manager Middle Management Retail Middle Management Middle Management SMEs Middle Management Payment Comfort SME Bankers + Assistants Retail Bankers + Assistants Client Services SMEs Client Services Retail Client Services Private Banking Retail Client Advisors SME Client Advisors Cashiers / Admin Staff Arrow Indicates hierarchical relationship Functions in box with dashed outline only in select (mostly large) branches NEW Branch Operational Model Individual Incentives Branch Incentives Branch Incentives 9

10. Incentive Structure 75% Bankers Bonus (% of base salary) 40% Advisors & Other Staff 25% 16% 10% 70% 100% 150% 200% Realized Sales / Planned Sales (%) Note: Bankers’ and advisors' final bonuses are based on a 70/30 weighted average of personal and branch performance. All other non-managerial staff receives a bonus based on branch performance

12. Empirical Approach • Baseline model used to assess the impact of HRM reforms on productivity • Footing is the sum of loans outstanding plus savings and deposits held by the branch (Bartel et al, 2003) • Index i is for branches, j for region and t for period (quarter/year)

13. Empirical Approach (2) • Estimation of equation (3) is subject to two sources of endogeneity bias: • Bankers and advisors are assigned to well-performing branches – bias can be eliminated by using fixed effects • Bankers and advisors are assigned to branches where they have the largest incremental effect on productivity – fixed effects will not eliminate bias

14. Empirical Approach • Exploit structure of data to develop an IV strategy • Reforms mandated by headquarters for all branches • For each branch i in period t, the state of reforms in branches k, (k, i) Є K, i ≠ k, is informative about the reforms in branch i, but not correlated with εijt • As instruments for (bankers + advisors)ijt/FTEijt and interactions, we use averages of (bankers + advisors)kjt/FTEkjt for branches in the same region or size group as branch i

15. Note In the GMM estimates, (Bankers + Advisors )/ FTE, its square and its interaction with FTE are instrumented using the strategy discussed on the previous slide. All regressions include Region x Year x Quarter Fixed Effects. Robust standard errors, clustered by branch, in brackets

16. Robustness • Results are robust to: • inclusion of Operational Expenses (includes wages, a proxy for “worker quality”) • one-by-one exclusion of regions • Exclusion of branch “i” in first stage (JIVE estimator; Angrist, Imbens and Krueger, 1999) • Consistent results in loglinear specification • Also in Retail / SME segments (except SME loans) 19

17. Robustness (2) • We also implement an estimator based on the generalized propensity score (Hirano and Imbens, 2004; Imai and Van Dyk, 2004) • Difference-in-difference estimates of the impact of bankers and advisors on sales productivity respectively about a year after these functions were introduced to the branches

19. Advisors / Employee

20. The Quality of Sales • We do not find that the introduction of bankers and advisors had a positive impact on the quality of sales in terms of product mix (mortgages, mutual funds), or productivity • Exception: the arrival of advisors had a positive effect on profits and mortgage sales (but negative on mutual fund sales)

21. Summary of Results • Productivity is lower in branches with more employees • The contribution to productivity of bankers and advisors to sales is higher in branches with more employees • There is a concave relationship between (Bankers + Advisors)/FTE and sales productivity • The arrival of advisors had a bigger impact on productivity than that of bankers • The impact of bankers and advisors on sales quality is mixed at best

22. Discussion • The finding of low productivity + high marginal contribution of bankers and advisors in large branches is consistent with free riding (Alchian and Demsetz, 1972) • In our setting (transition economy, heterogeneous tasks), there are limitations to the efficacy of group incentives (contrast with Wageman, 1995; Hansen, 1997; Hamilton et al, 2003)

23. Discussion (2) • We develop a model of employee behavior within the incentive structure to further analyze the results • Focus on • Concavity in marginal contribution of bankers and advisors to sales → local demand factors • Lack of quality improvements / large contribution of advisors to productivity → collusion / imperfectly observable quality (Baker, 2000; Agarwal and Wang, 2009)

24. Discussion • Under standard assumptions about cost and productivity • Employee productivity depends on (local) demand for bank services (+, more demand raises productivity), incentives (+), the marginal cost of effort (-) and individual and branch level lending targets (-) • Banker/advisor effort also depends on the weight given to individual performance (+) relative to branch level performance • Lending by other employees may reduce productivity

25. Discussion • Based on the model: • The concavity in the relationship between the number of bankers and advisors per employee and productivity could be due to: • An over-allocation of bankers and advisors to branches relative to local demand • Lack of cashiers to provide the “services” that make bankers and advisors productive

26. Discussion (3) • What if HQ (the principal) cannot observe quality? • Due to differentiation in incentives, branch employees have an incentive to misrepresent cashier’s loans as banker or advisor loans • Bankers could bribe cashiers to allow them to book a sale about to be made by the cashier • Bribery becomes more difficult when differences in incentives are smaller • Hence, the large positive impact of advisors on performance despite the fact that they have less powerful incentives than bankers

27. Conclusions • In collecting data for insider econometrics studies, collecting a sample of units / firms that were subject to a common impulse for organizational reforms provides ready instruments to control for endogeneity • The reforms introduced were ambitious and relied on internal controls for quality assurance. Considering the outcome, it is important to calibrate organizational structures to local manager’s ability • This work contributes to the ownership-governance-performance literature in banking and can provide an impetus for further research into organizational choices and performance