Nick Bloom, 149, 2015 The Modern Firm in Theory and Practice Nick Bloom (Stanford Economics and GSB) Lecture 3: Management and incentives 1

Nick Bloom, 149, Incentives/People Management Some drivers of good management Lincoln Electric

Nick Bloom, 149, 2015 Score(1): People are promoted primarily upon the basis of tenure (3): People are promoted upon the basis of performance (5): We actively identify, develop and promote our top performers (16) Promoting high performers

Nick Bloom, 149, 2015 The survey scores to question (16), promoting high performers – all countries, manufacturing 4 All countries, manufacturing firms (100 to 5000 employees), 9820 observations Average 3.02

Nick Bloom, 149, 2015 The survey scores to question (16), promoting high performers: developed countries, hospitals 5 Hospitals, Canada, France, Germany, Italy, Sweden, UK, US, 1183 observations Average 2.44

Nick Bloom, 149, 2015 The survey scores to question (16), promoting high performers: developed countries, schools 6 Schools in Canada, Germany, Sweden, UK, US 777 observations Average 2.41

Nick Bloom, 149, 2015 (14) Rewarding high performance (1): People within our firm are rewarded equally irrespective of performance level (3): Our company has an evaluation system for the awarding of performance related rewards (5): We strive to outperform the competitors by providing ambitious stretch targets with clear performance related accountability and rewards

Nick Bloom, 149, 2015 The survey scores to question (14), rewarding high performance – all countries, manufacturing 8 All countries, manufacturing firms (100 to 5000 employees), 9820 observations Average 2.61

Nick Bloom, 149, 2015 (15) Removing poor performers (“Making room for talent” in McKinsey speak) (1): Poor performers are rarely removed from their positions (3): Suspected poor performers stay in a position for a few years before action is taken (5): We move poor performers out of the company or to less critical roles as soon as a weakness is identified

Nick Bloom, 149, 2015 The survey scores to question (15), removing poor performers – all countries, manufacturing 10 All countries, manufacturing firms (100 to 5000 employees), 9820 observations Average 3.11

Nick Bloom, 149, 2015 The survey scores to question (15), removing poor performers – USA, manufacturing 11 Manufacturing firms (100 to 5000 employees), 1291 observations Average 3.73

Nick Bloom, 149, 2015 The survey scores to question (15), removing poor performers – Japan, manufacturing 12 Manufacturing firms (100 to 5000 employees), 176 observations Average 2.78

Nick Bloom, 149, 2015 The survey scores to question (15), removing poor performers – France, manufacturing 13 Manufacturing firms (100 to 5000 employees), 605 observations Average 2.90

Nick Bloom, 149, 2015 The survey scores to question (15), removing poor performers – US, Canada and UK, retail 14 All countries, retail firms (100 to 5000 employees) 660 observations Average 3.03

Nick Bloom, 149, 2015 The survey scores to question (15), removing poor performers: developed countries, hospitals 15 Hospitals, Canada, France, Germany, Italy, Sweden, UK, US, 1183 observations Average 2.56

Nick Bloom, 149, Incentives/People Management Some drivers of good management -competition -ownership -skills -regulation Lincoln Electric

Nick Bloom, 149, 2015 COMPETITION & MODELS OF MANAGEMENT Various ways that competition may influence management Selection – badly run firms more likely to exit Effort – incentivizes firms to try harder to survive/gain market share We find competition in manufacturing and retail is strongly linked with better management through selection & effort

COMPETITION IMPROVES MANAGEMENT Sample of 9469 manufacturing and 661 retail firms (private sector panel) and 1183 hospitals and 780 schools (public sector panel). Reported competitors defined from the response to the question “How many competitors does your [organization] face?” to to 45+ Manufacturing and Retail (the private sector) Management score Hospitals and Schools (the public sector) Number of Reported Competitors STOP

Dispersed Shareholders Private Equity Family owned, non-family CEO Managers Government Family owned, family CEO Founder owned, founder CEO Management score (by ownership type) FAMILY FIRMS & GOVERNMENT OWNED FIRMS TYPICALLY HAVE THE WORST MANAGEMENT Management scores after controlling for country, industry and number of employees. Data from 9085 manufacturers and 658 retailers. “Founder owned, founder CEO” firms are those still owned and managed by their founders. “Family firms” are those owned by descendants of the founder “Dispersed shareholder” firms are those with no shareholder with more than 25% of equity, such as widely held public firms. ?? THE GREAT OWNERSHIP QUIZ ?? Rank these from 7 ownership types from best to worst by management score: Dispersed shareholders Family owned, family CEO Family owned, non-family CEO Founder owned, founder CEO Government Manager owned and run Private Equity

Nick Bloom, 149, 2015 FAMILY FIRMS AND MODELS OF MANAGEMENT PRACTICES Impact of family firms depends on involvement Ownership but not management probably positive Concentrated ownership so better monitoring Management typically negative Smaller pool to select CEO from Possible “Carnegie” effect on future CEO’s Less career incentive for non-family managers

Nick Bloom, 149, United States Sweden Germany Japan Italy France UK Canada US Australia Poland Mexico China New Zealand Portugal India Chile Brazil Argentina Republic of Ireland Greece Foreign multinationals Domestic firms OWNERSHIP: MULTINATIONALS APPEAR TO ACHIEVE GOOD MANAGEMENT WHEREVER THEY LOCATE Sample of 7,262 manufacturing and 661 retail firms, of which 5,441 are purely domestic and 2,482 are foreign multinationals. Domestic multinationals are excluded – that is the domestic subsidiaries of multinational firms (like a Toyota subsidiary in Japan). Management score

Nick Bloom, 149, 2015 EDUCATION FOR NON-MANAGERS AND MANAGERS APPEAR LINKED TO BETTER MANAGEMENT Sample of 8,032 manufacturing and 647 retail firms. Non-managers Management score Managers Percentage of employees with a college degree (%) to 1011 to 2526 to to 1011 to 2526 to ?? THE EVEN GREATER SKILLS QUIZ ?? Is management correlated with managers’ skills, non-managers’ skills or both?

Nick Bloom, 149, 2015 LABOR MARKET REGULATION INHIBIT GOOD INCENTIVES MANAGEMENT Note: Averaged across all manufacturing firms within each country (9079 observations). We did not include other sectors as we do not have the same international coverage. Incentives management defined as management practices around hiring, firing, pay and promotions. The index is from the Doing Business database Argentina Australia Brazil Canada Chile China France Germany Great Britain Greece India Italy Japan Mexico New Zealand Poland Portugal Republic of Ireland Sweden UK US World Bank Rigidity of employment index (0-100) Incentives Management (management sample)

Can also ask why do firms not self improve (learn they have bad management practices)?

We asked at the end of the survey: “Excluding yourself, how well managed would you say your firm is on a scale of 1 to 10, where 1 is worst practice, 5 is average and 10 is best practice” So we investigated if firms can self-assess their management practices….

Class question – what do you think we found?

We found firms are too optimistic on management “Average”

…and self-scores show no link to performance

Nick Bloom, 149, Incentives/People Management Some drivers of good management Lincoln Electric

Nick Bloom, 149, 2015 Lincoln is still doing very well “Lincoln Electric is already the largest welding company in the world, with something in the neighborhood of 14% to 15% global share.” (Seeking Alpha)

Nick Bloom, 149, 2015 Lincoln firm and case summary 31

Nick Bloom, 149, 2015 Lincoln firm and case summary 32

Nick Bloom, 149, 2015 Q1 What types of performance incentives does Lincoln Electric provide, and how have these helped to drive performance 33

Nick Bloom, 149, 2015 Q2 What are the downsides of Lincoln Electrics performance incentives – try to relate this to experiences you have had with strong performance incentives 34

Nick Bloom, 149, 2015 Q3 Do you think Lincoln electrics incentive systems would work outside the US? Discuss their possible success/failure in another country you know. 35

Nick Bloom, 149, 2015 MY FAVOURITE QUOTES: [Male manager speaking to an Australian female interviewer] Production Manager: “Your accent is really cute and I love the way you talk. Do you fancy meeting up near the factory?” Interviewer “Sorry, but I’m washing my hair every night for the next month….” The traditional British Chat-Up

Nick Bloom, 149, 2015 Production Manager: “Are you a Brahmin?’ Interviewer “Yes, why do you ask?” Production manager “And are you married?” Interviewer “No?” Production manager “Excellent, excellent, my son is looking for a bride and I think you could be perfect. I must contact your parents to discuss this” The traditional Indian Chat-Up MY FAVOURITE QUOTES:

Nick Bloom, 149, 2015 MY FAVOURITE QUOTES: Interviewer: “How many production sites do you have abroad? Manager in Indiana, US: “Well…we have one in Texas…” Americans on geography Production Manager: “We’re owned by the Mafia” Interviewer: “I think that’s the “Other” category……..although I guess I could put you down as an “Italian multinational” ?” The difficulties of defining ownership in Europe

Nick Bloom, 149, 2015 MY FAVOURITE QUOTES: The bizarre Interviewer: “[long silence]……hello, hello….are you still there….hello” Production Manager: “…….I’m sorry, I just got distracted by a submarine surfacing in front of my window” The unbelievable [Male manager speaking to a female interviewer] Production Manager: “I would like you to call me “Daddy” when we talk” [End of interview…]

Nick Bloom, 149, 2015 Incentives Wrap-Up Large variation in incentives: hiring, firing, pay and promotions On average more “aggressive” use of these practices associated with better performance: e.g. Lincoln But: a)Part of a more general system of practices b)Depends on country, culture and process c)Needs to be applied correctly Next Wednesday monitoring and Danaher case Works for donuts

Nick Bloom, 149, 2015 BACK UP 41

Nick Bloom, 149, 2015 Score(1): Senior management do not communicate that attracting, retaining and developing talent throughout the organization is a top priority (3): Senior management believe and communicate that having top talent throughout the organization is a key way to win (5): Senior managers are evaluated and held accountable on the strength of the talent pool they actively build (13) Managing human capital

Nick Bloom, 149, 2015 (13) Managing human capital (1): Senior management do not communicate that attracting, retaining and developing talent throughout the organization is a top priority (3): Senior management believe and communicate that having top talent throughout the organization is a key way to win (5): Senior managers are evaluated and held accountable on the strength of the talent pool they actively build

Nick Bloom, 149, 2015 The survey scores to question (13), managing human capital – all countries, manufacturing 44 All countries, manufacturing firms (100 to 5000 employees), 9806 observations Average 2.43

Nick Bloom, 149, 2015 Score(1): Failure to achieve agreed objectives does not carry any consequences (3): Failure to achieve agreed results is tolerated for a period before action is taken. (5): A failure to achieve agreed targets drives retraining in identified areas of weakness or moving individuals to where their skills are appropriate (7) Consequence management

Nick Bloom, 149, 2015 (7) Consequence management (1): Failure to achieve agreed objectives does not carry any consequences (3): Failure to achieve agreed results is tolerated for a period before action is taken. (5): A failure to achieve agreed targets drives retraining in identified areas of weakness or moving individuals to where their skills are appropriate

Nick Bloom, 149, 2015 The survey scores to question (7), consequence management – all countries, manufacturing 47 All countries, manufacturing firms (100 to 5000 employees), 9820 observations Average 3.56

Nick Bloom, 149, 2015 (6) Performance dialogue (1): The right data or information for a constructive discussion is often not present or conversations overly focus on data that is not meaningful. Clear agenda is not known and purpose is not stated explicitly (3): Review conversations are held with the appropriate data and information present. Objectives of meetings are clear to all participating and a clear agenda is present. Conversations do not, as a matter of course, drive to the root causes of the problems. (5): Regular review/performance conversations focus on problem solving and addressing root causes. Purpose, agenda and follow-up steps are clear to all. Meetings are an opportunity for constructive feedback and coaching.

Nick Bloom, 149, 2015 Performance dialogue (6): all countries, manufacturing 49 All countries, manufacturing firms (100 to 5000 employees), 9794 observations Average 3.19

Nick Bloom, 149, Score(1): Other than JIT delivery from suppliers few modern manufacturing techniques have been introduced, (or have been introduced in an ad-hoc manner) (3): Some aspects of modern manufacturing techniques have been introduced, through informal/isolated change programs (5): All major aspects of modern manufacturing have been introduced (Just-in-time, autonomation, flexible manpower, support systems, attitudes and behaviour) in a formal way (1) Modern manufacturing, introduction

Nick Bloom, 149, 2015 Modern manufacturing (1): all countries, manufacturing 51 All countries, manufacturing firms (100 to 5000 employees), 9830 observations Average 2.77

Nick Bloom, 149, Marking out a factory floor

Nick Bloom, 149, Score(1): Performance is reviewed infrequently or in an un- meaningful way e.g. only success or failure is noted. (3): Performance is reviewed periodically with successes and failures identified. Results are communicated to senior management. No clear follow-up plan is adopted. (5): Performance is continually reviewed, based on indicators tracked. All aspects are followed up ensure continuous improvement. Results are communicated to all staff (5) Performance review