Client Defections: Companies Are Careful about the Company They Keep
Using the Arthur Andersen/Enron example, Prof. Michael Jensen finds that firms surrounded by stronger audiences and more defecting firms, and that have stronger commitments to quality are more likely to defect.
ANN ARBOR, Mich.—Many firms that dissolve business relationships, such as when companies dropped accounting firm Arthur Andersen after the Enron audit failure, do so to avoid the perception of impropriety, says a University of Michigan business professor.
In a new study, Michael Jensen of U-M's Stephen M. Ross School of Business says that the dissolution of interfirm relationships does not depend necessarily on the uncertainty surrounding a firm whose business practices are called into question.
Instead, an important factor, he says, is "accountability-induced status anxiety"—concerns about being devalued because others question the quality of a firm's partners, which can motivate companies to disassociate from their partners to protect their own status position.
"Accountability triggers status anxiety when firms are directly accountable to important audiences, when firms are surrounded by other firms that already have disassociated themselves from common partners, and when firms have committed themselves to a particular level of partner quality," said Jensen, an assistant professor of strategy.
Jensen's study focused on the defection of Arthur Andersen's approximately 900 publicly traded U.S.-based non-financial firms from Oct. 15, 2001—the day before Enron announced its third-quarter loss—until the last firms had dismissed Arthur Andersen by the end of August 2002.
According to the study, when firms are accountable to strong institutional investors and more security analysts, they are more likely to defect early. In addition, media coverage of prior defections, defections by large firms and defections by firms located near the headquarters of the company under fire result in greater defections overall.
"Firms are not only directly accountable to specific audiences but also indirectly accountable for how other firms react to events because other firms are used to make sense of ambiguous events and represent standards to which firms are compared," Jensen said.
Jensen also found that companies that are highly committed to quality as measured by their willingness to pay higher audit fees, for example, are more likely to defect.
In all, Jensen says his "accountability" perspective differs from the "uncertainty" perspective because it suggests that status not only is important in uncertain situations, but also is important when firms are accountable to external or internal audiences for their behavior.
Though he uses the collapse of Arthur Andersen to test specific accountability arguments, Jensen says his accountability perspective on status is applicable to a variety of contexts, including social relationships, in which people are concerned about the company they keep because they are accountable to others and what they may think.
Finally, Jensen says his study points out the importance of preventing early defections to avoid 'social contagion' that pushes defections to a point beyond which it is too late to stop cascading defections and prevent ultimate collapse.
"It is tempting for managers to use the media to fight these battles, but they run the risk of the media exposure itself pushing defections closer to the tipping point," he said. "Another, and potentially better, strategy would be to privately convince the most important clients not to defect and then have them announce their non-defection decision. This way, managers might, in the future, turn social contagion in their favor."
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