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The Currency of Favors

5/12/2008 --

Ross researchers explore the age-old question: Does flattery get you anywhere?

James Westphal's research frequently focuses on management practices and social relations among corporate leaders. Since joining the Ross School as professor of strategy in 2006, he has looked closely at the culture of flattery and favors that influences corporate boards and Wall Street securities analysts. Some of his findings are examined in the Q&A that follows.

Do American business practices encourage a culture of flattery and favors?

In the case of top management and corporate boards, our business practices do allow a role for flattery. Board selection and promotion occurs mainly through informal social ties and recommendations by people who already hold corporate board seats. Because of the informality of the process, social influence can play a greater role than if the process were very formal and truly led by some independent party.

How widespread is this?

It's quite widespread in the sense that it's common for managers to engage in ingratiation toward CEOs. Based on our survey data, we also see relatively high levels of ingratiation and other social influence processes between outside directors on boards. Moreover, when CEOs or directors receive ingratiation they seem to feel an obligation to reciprocate by doing something for the "ingratiator." This reciprocation is the real norm and makes the social influence processes powerful.

Is this behavior accepted as "just the way things are done" on corporate boards and in upper-management circles?

Yes, I don't think that ingratiatory behavior in this context is typically frowned upon. Clearly, some people are more adept at social influence than others, but by and large, this is a population of people who know how to influence their peers. That's partly why they have gotten where they are.

Can ingratiating behavior toward fellow directors help ethnic minorities and women obtain board appointments? Is this "leveling the playing field" or simply appointing individuals who may or may not be qualified?

I would view it more as leveling the playing field. We find that ethnic minorities and women get more benefits from their experience and qualifications when they engage in this behavior. If they don't, they are disadvantaged in getting board appointments. On the other hand, for white males, it could be more a case of compensating for lack of experience. We have evidence that white males who lack high levels of management experience engage in higher levels of ingratiation.

In a companion study, you uncover continuing discrimination against ethnic minorities and women on corporate boards.

We find that once ethnic minorities or women achieve their first board appointment, they are systematically disadvantaged in getting further board appointments. They also realize fewer benefits from following prescribed behaviors such as giving strategic advice to CEOs and are punished more for engaging in socially unapproved behaviors such as monitoring and control of CEO decision making. They also are rewarded less for ingratiatory behavior. So they are caught between a rock and a hard place.

Does ingratiation that leads to board appointments negatively impact shareholders?

Ingratiation can have adverse consequences, depending upon the company's situation. There are two basic forms of board involvement: One takes the form of cooperative advice and counsel, and the other involves more independent "monitoring and control" behavior. Cooperation can be effective, provided the firm is performing well and the management strategy is sound. However, if the firm is not performing well and significant strategic change is required, then monitoring and control behavior by the board may be necessary. Our research suggests that if directors are appointed on the basis of their ingratiatory behavior, they are less likely to engage in that monitoring and control behavior.

What should be changed in the selection process to promote better governance?

The biggest change would be to cast a wider net when looking for board candidates. We find that if board candidates are recruited through informal networks, then social influence affects the recommendations. However, social influence is less likely to play a role in the selection process if boards look more broadly for individuals who don't have any kind of network ties to current members of the nominating committee. This means going outside the regular social circle of corporate leaders who hold multiple board appointments to find a new population of individuals who can serve in that capacity. Engaging headhunting firms and giving them more influence in the selection process is one way to achieve this.

Turning to Wall Street, your research reveals that favors from corporate executives influence securities analysts' behavior. What kind of favor rendering have you identified?

We've identified both professional and personal favors. Professional favors include things such as putting an analyst in touch with a manager at a buyer or supplier firm, or offering to meet with the analyst's clients. Personal favors include providing career advice or recommending the analyst for a job position.

How does favoritism affect analysts' stocks rankings and evaluations of investment opportunities?

We found that the greater the extent to which an executive provided favors to an analyst, the lower the likelihood that the analyst would downgrade the firm following the release of negative earnings surprises or other unfavorable firm information.

Where does this behavior fall on a continuum of socializing and networking at one end and bribery and securities fraud at the other?

Well, there's nothing illegal about this behavior. Favor rendering goes on every day among colleagues at U.S. corporations. However, many people don't realize it is occurring in relations between executives and analysts. Clearly, it's not bribery. Rather, it is the kind of behavior top managers use to build social networks or to forge relations with key constituencies of their firm. Some would say that's good leadership.

Are securities analysts crossing an invisible line by downplaying bad news about firms' performance in their reports?

To some people, this is clearly unethical, and they believe there should be a serious reappraisal of how analysts relate to executives. Others disagree, contending that these favors enable analysts to do their job by giving them access to information on buyer and supplier firms. The problem with the latter argument is that in our research we find accepting favors biases analysts' decision making. So even if analysts are nave in intent, accepting these favors does have negative consequences.

How does favor rendering serve management interests at the expense of shareholders over the long term?

Right now, we're looking at who is hurt by these practices. Professional investors who take a short-term interest in firms may actually benefit. Some anecdotal evidence suggests they are sometimes aware of favor rendering and know which analysts engage in it and when. The people who are potentially hurt by these practices are investors who take a longer-term position or smaller investors who aren't privy to the kinds of social relations that occur between executives and analysts.

Could, or should, anything be done to mitigate this culture of favors on Wall Street?

First, people need to be aware of what is going on. If these practices are deemed to be unethical, the solution for changing them lies in socializing analysts not to accept favors, or a least to consider the possible consequences of accepting favors. Analysts may not realize this behavior is affecting their decision making to the extent it is, so they need to be educated by firms, professional societies and business schools.

James Westphal is the Robert G. Rodkey Collegiate Professor of Business Administration at Ross.

Written by Claudia Capos

For more information, contact:
Bernie DeGroat, (734) 936-1015 or 647-1847, bernied@umich.edu