Trust within the Organizations of the New Economy

Marco Tulio Zanini Trust within Organizations of the New Economy

GABLER EDITION WISSENSCHAFT International Management Studies Herausgegeben von Professorin Dr. Birgitta Wolff

Die Schriftenreihe trägt dazu bei, Erkenntnisse aus der internationalen Unternehmensforschung zu verbreiten. Die meisten Beiträge zeichnen sich durch eine Fundierung auf die theoretische Basis der Neuen Institutionenökonomik sowie eine empirische Analyse aus. Die Reihe ist offen für Arbeiten in deutscher und englischer Sprache. The series aims at circulating insights from research projects on international corporations. Most of its contributions are characterized both by a foundation on a theoretical basis of the New Institutional Economics and an empirical analysis. The series is open to works in German and in English.

Marco Tulio Zanini

Trust within Organizations of the New Economy A Cross-Industrial Study

With a foreword by Prof. Dr. Birgitta Wolff

Deutscher Universitäts-Verlag

Bibliographic information published by Die Deutsche Nationalbibliothek Die Deutsche Nationalbibliothek lists this publication in the Deutsche Nationalbibliografie; detailed bibliographic data is available in the Internet at .

Dissertation Universität Magdeburg, 2007

1st Edition September 2007 All rights reserved © Deutscher Universitäts-Verlag | GWV Fachverlage GmbH, Wiesbaden 2007 Readers: Frauke Schindler / Anita Wilke Deutscher Universitäts-Verlag is a company of Springer Science+Business Media. www.duv.de No part of this publication may be reproduced, stored in a retrieval system or transmitted, mechanical, photocopying or otherwise without prior permission of the copyright holder. Registered and/or industrial names, trade names, trade descriptions etc. cited in this publication are part of the law for trade-mark protection and may not be used free in any form or by any means even if this is not specifically marked. Cover design: Regine Zimmer, Dipl.-Designerin, Frankfurt/Main Printed on acid-free paper Printed in Germany ISBN 978-3-8350-0767-3

To Tulio, Jerusa and Paula

Foreword The role of trust in governing institutions has been disputed for years and is likely to continue to be discussed in the future. Increasing uncertainty and people’s personal concerns about future perspectives seem to have created an increasing need for what we call trust. Simultaneously, the same uncertainty that induces this increased demand for trust seems to be undermining it: in uncertain environments, trust seems to be much harder to generate. This paradox has been the starting point for the empirical study that is presented in Marco Tulio Zanini’s book. In literature, one can find many different views of trust, e.g. trust as a complement to explicit modes of corporate control, trust as a substitute for explicit corporate control, trust as a “third way”, or trust as a somehow comforting notion that people just preach without having any conceptual framework in mind. We wanted to find some data that might provide clues for a better understanding of where and under which conditions trust prevails and thrives, and where it does not. In a sample created from an inquiry into seven major companies from different sectors of the Brazilian economy, Marco Tulio Zanini found impressively clear evidence that trust is more likely to be discovered where we would assume it to be needed least: in relatively stable, hierarchical, and bureaucratic organizations. Comparing data from companies from the “new economy” with those from the “old economy” reveals strong indications that there is comparatively little trust in the new economy firms. This result might inspire further research. I would like to once more express my gratitude to the seven Brazilian corporations that provided valuable advice, information, and active support in the preparation of this study by allowing us to circulate our questionnaire to thousands of employees. Finding a country where access to the major players in important industries can be obtained is quite a challenge. Our appreciation for the cooperation of our Brazilian partners, therefore, cannot be overemphasized. Prof. Dr. Birgitta Wolff

VII

Preface This book is the result of my research as a doctoral student at the Faculty of Economics and Management of Otto-von-Guericke University of Magdeburg during the period 2003-2007. I am very grateful to all the members of the Faculty of Economics and Management, and I especially wish to express my sincere gratitude to my thesis supervisor, Prof. Dr. Birgitta Wolff, for her support, encouragement, and help throughout my research project. Without her support and advice there would not be a thesis at all. I also wish to thank my second advisor, Edward J. Lusk, for his advice as my mentor in statistics throughout the entire research project, and Prof. Dr. Ingo Pies as the third reviewer of the dissertation, and as my professor during the cherished time when I attended his lectures at Martin-Luther-Universität Halle-Wittenberg. I also thank Prof. Dr. Carmen P. Migueles and Prof. Dr. Paulo R. Motta for their contributions. All my colleagues at the Department of International Management, especially Petra Risch, Marjaana Gunkel, Frithjof Pils, Yang Wei, Fan Wu and Christopher Schlägel, deserve to be mentioned for their participation, including my friend Tumenta Kennedy. This empirical research work was only possible with the cooperation of the participant companies. In this sense I would like to express my appreciation and gratitude to the companies who cooperated with us and who have made an invaluable contribution to this research. They were absolutely fundamental to this study. Some of the executives, employees and research team members who made this research project possible have contributed directly with their comments and efforts: Ms. Márcia Magno, Mr. Rodrigo Fonseca, Ms. Silvia Pires Migueles, Mr. Júlio César Fonseca, Mr. Marcelo Arantes, Ms. Sandra Lima, Mr. Helder Luciano de Oliveira, Mr. Luis Guilherme Schymura, Mr. Ralph Chelotti, Ms. Lady Morais, Mr. Jose Armando Campos, Mr. Luiz Carlos Pimenta, and Ms. Graziella Capone de Palma. I am grateful for Nicole Gillespie and Isaiah O. Ugboro for allowing the use of the questionnaire they have developed. I would like to place on record my appreciation of the support received from FIRJAN – Rio de Janeiro’s Industry Federation for its institutional support of the research project, and Sextante do Brasil Institute for allowing me to use their data. I acknowledge with gratitude the financial support of the Brazilian government agency CAPES for sponsoring my studies in Germany, and the help of my employer, Fundação Dom Cabral (FDC), for sponsoring the publication of this study. In conclusion, I have been fortunate in having my family and friends to encourage me during my doctoral studies, mentioning particularly the support of my parents who have, over the years, with the aid of some principles, taught me to sail through troubled waters as well as

IX

calm. I also thank those who have been close to me during my doctoral studies, especially Nelma P. Correa. Dr. Marco Tulio Zanini

X

Abstract Trust is approached in this study as an implicit governance mechanism to coordinate economic exchange. The objective of the thesis is to understand the effects of different industryspecific institutional framework constraints on the levels of trust within business organizations. Different institutional arrangements might change the comparative costs of governance in different industries, restricting the development of some governance mechanisms and favoring others. Specifically, this study aims at understanding the possible differences in the levels of trust between two paradigms: the Old Economy and the New Economy. We argue that singular institutional innovations that better characterize the New Economy, in the form of environmental uncertainty and instability, set considerable constraints on the development of trust. Accordingly, the central hypothesis presented in this study is: “Due to the relatively higher institutional uncertainty and instability, New Economy companies will have a tendency to present lower levels of trust when compared with Old Economy companies.” Moreover, trust lies in the center of relational contracting; by applying the rational choice perspective, the thesis analyzes some additional elements to provide a broad understanding of possible changes; therefore employee commitment and employee turnover are also analyzed. By approaching trust as a dependent variable in a cross-industrial comparison, a questionnaire survey was carried out in the period July-October of 2004 in Brazil assessing the levels of trust and those related elements within seven private companies. The study classified companies into three different groups: ‘Old Economy’ companies, ‘New Economy’ companies, and an alternative category. Confirming the central hypothesis, we found significant lower levels of interpersonal trust in the companies operating in the New Economy. The study confirms the major role of industry-specific institutional frameworks on the development of trust levels within business organizations and concludes that relatively high institutional uncertainty and instability limit the development of trust as a governance mechanism within those companies operating in the New Economy. Moreover, the study also found lower levels of employee commitment and high employee turnover rates in those companies. Our results suggest that relational contracting has, in the New Economy, given way to a considerable extent to a more transactional contract model.

XI

Table of Contents

Table of Contents ................................................................................................................. XIII List of Tables ......................................................................................................................... XIX List of Figures ....................................................................................................................... XXI List of Abbreviations ...........................................................................................................XXIII List of Variables ..................................................................................................................XXIII Glossary ................................................................................................................................ XXV

1

2

Objectives and Structure of the Argument ........................................................................... 1 1.1

Thesis Objectives ........................................................................................................ 4

1.2

Relevance of the Study ................................................................................................ 8

1.3

Division of Chapters.................................................................................................... 9

Trust from the Economic Perspective ................................................................................ 11 2.1

Trust and Monitoring ................................................................................................ 11

2.2

Cooperation and Trust ............................................................................................... 14

2.3

An Economic Definition of Trust.............................................................................. 17

2.4

Properties of Trust ..................................................................................................... 19 2.4.1 Trust as a Three-Part Relation......................................................................... 19 2.4.2 Trust as an Expectation .................................................................................... 21 2.4.3 Behavioral Risk ................................................................................................ 23 2.4.4 The Calculative Placement of Trust ................................................................. 25

2.5

Trust within Organizations ........................................................................................ 26 2.5.1 Trust and Transaction Costs ............................................................................ 26 2.5.2 Trust as a Complement for Price and Authority .............................................. 28 2.5.3 Trust and the Corporate Contract.................................................................... 33 2.5.4 Trust as a Motivational Element ...................................................................... 35 2.5.5 Trust as a Mechanism to Reduce Behavioral Risk ........................................... 38

XIII

2.5.6 Relational Contracting as a Trust-Based Contract.......................................... 42 2.6

Trust and Organizational Performance ..................................................................... 45 2.6.1 Advantages of System-Trust ............................................................................. 45 2.6.2 Empirical Contributions to Performance Analysis .......................................... 49 2.6.3 Trust Investment Analysis................................................................................. 51

2.7

Specific Functions of Trust ....................................................................................... 54 2.7.1 Solving Performance Ambiguity....................................................................... 54 2.7.2 Enforcement of Employee Commitment ........................................................... 55 2.7.3 Information-Sharing and Knowledge Transfer ................................................ 59 2.7.4 Reorganization Processes ................................................................................ 62

2.8

Conditions for Trust Development ............................................................................ 66 2.8.1 Mutual Interests and Incentive Structure ......................................................... 66 2.8.2 Time, Interactions and Stability ....................................................................... 68 2.8.3 Organizational Building-Trust Variables ........................................................ 69 2.8.4 Maintenance of the Reputation System ............................................................ 72 2.8.5 Personal Variables ........................................................................................... 74

2.9

Trust and Institutional Uncertainty ........................................................................... 76 2.9.1 General Concept of Trust and Uncertainty ...................................................... 76 2.9.2 Trust and the Institutional Framework ............................................................ 78 2.9.3 Industry-Specific Institutional Frameworks ..................................................... 80 2.9.4 Effects of Uncertainty and Instability on Trust Development .......................... 83

3

The New Economy (NE) .................................................................................................... 89 3.1

Definition .................................................................................................................. 89 3.1.1 Conceptual Origins .......................................................................................... 90 3.1.2 Adopted Perspective ......................................................................................... 92

3.2

A Knowledge-Based Economy ................................................................................. 94 3.2.1 Knowledge and the Production Function......................................................... 94 3.2.2 The Evolutionary Economics Approach ........................................................... 97 3.2.3 Knowledge in the New Economy ...................................................................... 98

XIV

3.2.4 Characteristics of Knowledge in the New Economy ...................................... 100 3.3

Institutional Inovations............................................................................................ 104 3.3.1 Institutional Changes ..................................................................................... 104 3.3.2 The New Creative Destruction Process ......................................................... 105 3.3.3 Change in the Relative Prices ........................................................................ 108

3.4

New Economy and Old Economy ........................................................................... 111

3.5

Effects of New Economy Characteristics on Organizations ................................... 121 3.5.1 A New Business Environment......................................................................... 123 3.5.2 Network-based Organizational Forms ........................................................... 126 3.5.3 A New Work Dynamics ................................................................................... 128

3.6

The New Telecommunications Industry ................................................................. 131 3.6.1 Privatization: ‘Boom and Bust’...................................................................... 133 3.6.2 The Competitive Model .................................................................................. 134 3.6.3 Network-Based Organizational Forms .......................................................... 137

3.7

Institutional Uncertainties ....................................................................................... 140 3.7.1 Sources of Uncertainties and Instability ........................................................ 140 3.7.2 Demand Uncertainty ...................................................................................... 142 3.7.3 Technological Uncertainty ............................................................................. 144 3.7.4 Regulation Uncertainty .................................................................................. 146 3.7.5 The Stock Market Bubble Effects ................................................................... 149

3.8

The Work Conditions in the New Economy ........................................................... 150

3.9

The Brazilian Telecommunications Case Study ..................................................... 155 3.9.1 Privatization Process ..................................................................................... 155 3.9.2 The “Painful Modernization” ........................................................................ 156 3.9.3 Employment Conditions ................................................................................. 156

4

Empirical Analysis: Hypotheses and Methods................................................................. 161 4.1

Condensing Literature into a Basis for Empirical Research ................................... 161

4.2

Main Hypothesis ..................................................................................................... 163

4.3

Secondary Hypotheses ............................................................................................ 164 XV

4.3.1 Employee Commitment ................................................................................... 165 4.3.2 Employee Turnover Rates .............................................................................. 167 4.4

The Organizations Used for the Study .................................................................... 169 4.4.1 Description of the Organizations Studied ...................................................... 170 4.4.2 Criteria for Classification of the Organizations ............................................ 173

4.5

Validation of the Companies’ Grouping ................................................................. 179 4.5.1 Interviews with Experts .................................................................................. 180 4.5.2 General Profile of Organizations ................................................................... 181 4.5.3 Product Innovation-Diversification Profile ................................................... 184 4.5.4 Planning Process Profile ............................................................................... 185 4.5.5 Human Resource Policy Profile ..................................................................... 187 4.5.6 Market Performance Data Comparison ......................................................... 190 4.5.7 Presentations of Survey Results to Participant Companies ........................... 195

4.6

The Questionnaire Survey ....................................................................................... 196 4.6.1 Construction and Validation of the Questionnaire ........................................ 196 4.6.2 Translation Process........................................................................................ 199 4.6.3 Pre-Tests for Questionnaire Validation ......................................................... 199 4.6.4 Working Material ........................................................................................... 200 4.6.5 The Questionnaire Distribution and Collection Process ............................... 200 4.6.6 General Procedures Adopted ......................................................................... 201 4.6.7 The Study Sample ........................................................................................... 202 4.6.8 Comment Sheet Analysis ................................................................................ 204 4.6.9 Data Entry and Cleaning Procedures ............................................................ 206 4.6.10 Demographic Distribution of Respondents .................................................. 206

5

Hypotheses Test and Analysis: Trust Thrives Where It is Least Needed ........................ 213 5.1

Validity Checking of the Variable Relationships .................................................... 213

5.2

Hypotheses’ Analytical Framework ........................................................................ 216 5.2.1 Analysis of Main Hypothesis .......................................................................... 218 5.2.2 Analyses of Secondary Hypotheses ................................................................ 220

XVI

5.3

Main Hypothesis Test.............................................................................................. 221 5.3.1 Levels of Trust - Mean Comparison ............................................................... 221 5.3.2 Confirming the Effects of Institutional Uncertainties on Trust Levels .......... 224 5.3.3 Supportive Individual Characteristics Analyses ............................................ 229

5.4

Secondary Hypotheses Test .................................................................................... 234 5.4.1 Test of the Relationship between Trust and Employee Commitment ............. 234 5.4.2 Levels of Employee Commitment ................................................................... 236 5.4.3 Employee Turnover Rates .............................................................................. 240

5.5

Main Theoretical Implications ................................................................................ 243 5.5.1 The Major Influence of Industry-Specific Institutional Frameworks ............. 243 5.5.2 New Economy and Old Economy: Singular Organizational Systems ............ 244 5.5.3 New Economy: Moving towards Transactional Contracts ............................ 247 5.5.4 Validation of Game Theory Application ........................................................ 249 5.5.5 The Paradox ................................................................................................... 249 5.5.6 Trust Properties and Dimensions ................................................................... 250 5.5.7 Trust and Performance................................................................................... 250

6 Conclusions and Outlook ................................................................................................. 253 6.1

Contributions to Management Studies .................................................................... 256

6.2

Managerial Usage .................................................................................................... 258

List of References................................................................................................................... 261

Appendix ................................................................................................................................ 287

XVII

List of Tables

Table 2-1:

Difference between Coordination Mechanisms .................................................. 32

Table 3-1:

Keys to the Old Economy and New Economy .................................................. 112

Table 3-2:

Percentual Variation of Work Posts per Industry.............................................. 157

Table 3-3:

Employee Turnover Rates X Investment in Training and Development .......... 159

Table 4-1:

Classification of the Organizations Studied ...................................................... 176

Table 4-2:

General Profile .................................................................................................. 183

Table 4-3:

Innovation-Diversification Profile .................................................................... 184

Table 4-4:

Planning Process Profile.................................................................................... 186

Table 4-5:

Human Resource Policy Data ........................................................................... 189

Table 4-6:

Companies’ Market Performance...................................................................... 194

Table 4-7:

Questionnaire Distribution-Collection per Company ....................................... 203

Table 4-8:

Frequency of Comment Sheet Records ............................................................. 204

Table 4-9:

Demographic Distribution of Respondents ....................................................... 208

Table 4-10: Employment Profile .......................................................................................... 211 Table 5-1:

Validity Checking of the Database - Variables Grouping................................. 214

Table 5-2:

Validity Checking of the Database – Age Categories ....................................... 216

Table 5-3:

Trust Measures – Trust in Superior ................................................................... 222

Table 5-4:

Trust Measures – Trust in a Peer ....................................................................... 223

Table 5-5:

Trust Measures – Trust in Work Team ............................................................. 223

Table 5-6:

Gender/Age Sub Sample Analysis – Male ........................................................ 231

Table 5-7:

Gender/Age Sub Sample Analysis – Female .................................................... 232

Table 5-8:

Consistency Checking between Trust and Employee Commitment Variables ... 235

Table 5-9:

Correlation Tests between Trust and Employee Commitment Variables ......... 236

Table 5-10: Employee Commitment Variables Comparative Analysis................................ 238 Table 5-11: Employee Turnover Rates Comparison ............................................................ 240

XIX

List of Figures

Figure 1-1: Study Analysis..................................................................................................... 05 Figure 1-2: Thesis Frame and Structure ................................................................................. 10 Figure 2-1: Substitute and Complementary Approaches - Trust and/or Monitoring ............. 14 Figure 2-2: Trust Action and Expectation of Trust ................................................................ 18 Figure 2-3: Trust-Expectation as a Subjective Perception of the Trustee’s Motivation ........ 22 Figure 2-4: The Placement of Trust and Risk ........................................................................ 24 Figure 2-5: Cooperation within a Firm as an Infinite Game .................................................. 34 Figure 2-6: Organizational Challenges .................................................................................. 35 Figure 2-7: Trust and Contractual Problems Analyses .......................................................... 40 Figure 2-8: Relationship between Trust and Monitoring in Self-Managing Teams .............. 50 Figure 2-9: Trust Investment Evaluation ............................................................................... 52 Figure 2-10: Managerial Evaluation of Investments on Trust ................................................. 53 Figure 2-11: Trust in the Reorganization Process .................................................................... 63 Figure 2-12: The Role of Trust in the Empowerment Function............................................... 64 Figure 2-13: Information Category in the Formation of the Expectation of Trust .................. 71 Figure 2-14: The General Framework of the Concept of Trust ............................................... 77 Figure 2-15: Framework Effects and Sources of Risk ............................................................. 79 Figure 2-16: Key forces Affecting Organizational Behavior ................................................... 83 Figure 2-17: Cooperative Games under Uncertainty ............................................................... 84 Figure 3-1: Knowledge Production ...................................................................................... 100 Figure 3-2: Service Sector Growth ...................................................................................... 102 Figure 3-3: Technological Innovations Trajectories ............................................................ 108 Figure 3-4: Data Transmission Costs Fallen ........................................................................ 110 Figure 3-5: Microprocessor Price Trends ............................................................................ 110 Figure 3-6: The basic Relationship between Environment and Types of Organizations ..... 122 Figure 3-7: Product Development Cycle.............................................................................. 124 Figure 3-8: Impact Intensity of the New Economy on Different Industries ........................ 132

XXI

Figure 3-9: The Layer Model of the New Telecommunications Industry ........................... 135 Figure 3-10: Star or Hub and Spoke ...................................................................................... 139 Figure 3-11: Many to Many ................................................................................................... 139 Figure 3-12: Types of Organizational Arrangements in Telecommunications ...................... 140 Figure 3-13: Sources of Institutional Uncertainties in the New Economy ............................ 141 Figure 3-14: Job Variation per Industry ................................................................................. 158 Figure 4-1: The Analysis of the Hypotheses ........................................................................ 164 Figure 4-2: Stock Market Performance Telecom Brazil, Nasdaq and Ibovespa .................. 191 Figure 4-3: Comparative Proxy Telecom Brazil and Ibovespa ............................................ 192 Figure 4-4: Comparative Proxy Telecom Return and S&P 500 Return............................... 194

XXII

List of Abbreviations NIE

New Institutional Economics

NE

New Economy

OE

Old Economy

ILO

International Labor Organization

OECD

Organization for Economic Cooperation and Development

VAS

Value Added Services

ICT

Information and Communication Technologies

NTC

New Telecommunications Company

FOC

First Order Condition

NPD

New Product Development

PTT

Postal, Telegraph and Telephone

List of Variables L

Potential loss, if the trustee is untrustworthy

G

Potential gain, if the trustee is trustworthy

p

Probability of receiving gain if the trustee is trustworthy

R

Returns of the company as a function of the difference between an optimal (very best) return without opportunism

X

Absence of behavioral risk

O

Inflicted loss due to opportunism

b

Dependent variable of the corporate culture which reflects the level of loss due to opportunism

C

Cost of the implementation of a ‘trust program’

F

Fixed cost for implementing a ‘trust program’

Ei

Environmental variable

XXIII

Glossary: Trust – “Trust is the voluntary risk investment in advance, in a relationship involving the abdication of explicit safeguard control mechanisms against opportunistic behaviour, in the expectation that the other party, despite the absence of such safeguards, will not behave opportunistically.”1 Trust is an expectation or attitude related to a specific behavioural risk situation between two people – A and B (or a group of people), and a specific context X. Corporate Culture – The implicit contractual part of the corporate constitution as informal conventions that all members of the firm have in common, in the form of a shared set of perceptions, rules, values, beliefs and other information. Those elements form an essential part of a corporate set of rules or corporate identity.2 System-Trust – Informal Control Mechanism within hierarchies which might be combined in varying degrees in a complementary relationship with authority and price.3 Self-Enforcing Mechanisms – Implicit institutions that can either not at all or only at prohibitive cost be verified and enforced by third parties.4 Self-enforcing institutions operate in the way that “if one party violates the terms (by defecting) the only recourse of the other is to terminate the agreement.”5 For instance, trust is a self-enforcing mechanism inbuilt in the corporate culture of the firm. Risk – The possibility of suffering harm or loss, or a course involving uncertain danger or hazard.6 Risk is defined as a measurable (often financial) effect of uncertainty when it is possible to calculate probabilities.7 Uncertainty – It refers to situations in which many outcomes are possible but the likelihood of each is unknown.8 It is immeasurable with no possibility of assigning probabilities, and it is caused by many factors with unpredictable outcomes.9 Environmental Uncertainty – Exogenous uncertainties produced by the institutional environment. It can be considered as a lack of predictability in the external changes to the organization emanating from a real and objective external environment. Environmental uncertainty might take many forms, like demand uncertainty, technological uncertainty, competition uncertainty or regulation uncertainty.10

1 2 3 4 5 6 7 8 9 10

Ripperger (1998), p. 45. See Wolff (1996), pp. 97 and 103. See Bradach/Eccles (1989/1998), p. 277. See Wolff (1995), p. 90. See Williamson (1996), p. 122. See Eiteman et al. (2001), p. 56. See Bridgewater (2000), p. 345. See Pindyck/Rubinfeld (2005), p. 154. See Bridgewater (2000), p. 345. See Robertson/Gatignon (1998), pp. 521-525. XXV

New Economy – The New Economy is defined as a set of institutional innovations, as a new macroeconomic configuration that has as its means and driving force the advancement of information and communication technologies (ICT). In this study the term New Economy is used to define an institutional environment characterized by industrial production more based on knowledge-intensive processes, under which ICT companies operate as producers and providers of ICT products and services. Old Economy – The Old Economy is defined as the traditional institutional environment where industrial processes are based on intensive capital/labor and scale economies. In this study the term Old Economy is used to define industries which are consumers of ICT goods and services as production capital. New Telecommunications Industry – A subgroup of the ICT industry which has emerged mostly from worldwide privatization processes occurring in the 80’s and 90’s. They are the main New Economy agents as producers and/or providers of ICT products and services. Industry-Specific Institutional Framework – In this study the term is used to characterize different institutional arrangements of different industries based on a combination of institutional variables, like specific political and legal constraints for a given industry, the state of technology, market dynamics and cultural parameters embedded in the industry. Industryspecific institutional frameworks set different institutional constraints which may change the costs of governance among the different industries. Information – “Information is data which has been organized and communicated.”11 In this sense, we define information as data which is intelligible to the recipient.12 Knowledge – Knowledge is “a set of organized statements of facts or ideas, presenting a reasoned judgment or an experimental result, which is transmitted to others through some communication medium in some systematic form.”13 In this sense, knowledge is defined as the cumulative stock of information and skills derived from the use of information by the recipient.14 Employee Commitment – It is a multidimensional variable related to the level of employees’ identification with an organization and assesses the retention of firm-specific human capital. Employee commitment assesses motives to continue the relationship from an employee’s point of view and provides relevant perspectives for incentive scheme design and evaluation of returns over investments on human capital. Employee Turnover – It is a variable of organizational performance associated with the compensation system and decisions about contracting new workers and maintaining old

11 12 13 14

Porat (1977), p. 5. See Burton-Jones (1999), p. 5. Bell (1973), p. 175, See Burton-Jones (1999), p. 5.

XXVI

workers.15 The associated costs of employee turnover include: recruiting, training and reduced productivity from employing inexperienced personnel. Employee turnover is related to the perspective of employment relationship termination.

15

See Lazear (1998), pp. 169-172. XXVII

1. Objectives and Structure of the Argument Many economic transactions only take place because people trust each other. The cooperation which is generated through trust relationships between individuals creates interdependence. Investments will only pay off, if one or more agents stick to their promises. Trust is a social mechanism that has been approached by many economists, sociologists and organizational theorists.16 Academics and researchers have pointed to the importance of interpersonal trust in promoting consensual relationships and facilitating cooperation between individuals within organizations. The increasing interest of organizational economics and management studies in trust issues is associated with the search for solutions of cooperation problems both within and between contemporary business organizations. Luhmann (2000) notes that unconditional trust which is generated in families and small-scale societies cannot be automatically transferred to complex societies based on the division of labor. According to Luhmann trust relationships are necessary for the reconstruction of special social institutions like friendship networks and patron-client relations.17 These relationships may guarantee an efficient coordination of economic activities with lower costs. Given that business organizations consist basically of bureaucratic and hierarchical organizational structures, trust becomes an implicit mechanism for coordination and control of the routinely organizational tasks among individuals. Earlier on, Max Weber (1906/1946) had already noted the many advantages of the abstract regularities of bureaucracies in the execution of authority as efficient structures to coordinate and sustain production of collective actors, basically through the expansion of rationality.18 Bureaucracies would come to supplant personalized relationships which were highly susceptible to the exclusive dependence on individual influence as a way to govern social systems. The existence of trust within bureaucratic relationships considerably expands the potential to produce cooperative relationships and managerial efficiency by increasing managerial control through an informal mechanism.19 Trust allows a reduction of formal hierarchical control and the expansion of the possibilities of producing results through bureaucracies, and therefore, a possible reduction in transaction costs. Intraorganizational trust may enhance organizational performance in a number of ways. The implicit role of trust in coordination and control of many organizational tasks has been

16

17 18 19

See, for instance, economists: Akerlof (1970), Arrow (1974), Ouchi (1980/1998), Bradach/Eccles (1989/1998), Kreps (1990), Chiles/McMackin (1996), Ripperger (1998), Gibbons (2000) and Wolff (2000); sociologists: Coleman (1990), Gambetta (1988), Fukuyama (1996) and Luhmann (2000); and organizational theorists: Zand (1972), Whitner et al. (1998), Sako/Helper (1998) and Dirks/Ferrin (2001). Luhmann (2000), p. 94. See Weber (1906/1946). See Ripperger (1998), p. 4. 1

observed, facilitating, for example, the knowledge transference process,20 improving organizational efficiency and productivity,21 and thus, decreasing transaction costs.22 In the economic perspective, insights about trust have come mainly from Transaction Costs Economics (TCE) and Game Theory. In the reasoning of such Rational Choice approaches,23 trust is defined as “the voluntary risk investment, in advance, in a relationship under the abdication of explicit safeguard mechanisms of control against opportunistic behavior, in the expectation that the other party, despite the absence of such safeguards, will not behave opportunistically.”24 The economic analytical framework considers trust as a sub-class of risk situations related to human behavior. It is assumed that trust works as a mechanism in economic systems whereby it increases the effectiveness of transactions, whether they take place in markets or within hierarchies. In line with some authors like Ouchi (1980/1998), Bradach and Eccles (1989/1998), and Adler (2001) we adopt the assumption that trust produced by social structures does not simply replace the market or hierarchies but operates as a third complementary governance structure with these two forms.25 Therefore, we assume that these three distinct mechanisms may be present in differing degrees in any real existing organization.26 Within business organizations trust lessens the need to use hierarchy to attenuate opportunism.27 The presence of trust diminishes the needs for explicit safeguard mechanisms against opportunistic behavior between interactive partners, and thus, it reduces the agency costs for monitoring and control. The existence of interpersonal trust in interorganizational relationships involving supervisors, subordinates, peers or teamwork may contribute substantially to the organizational efficiency. Moreover, some economists approaching the relevance of trust have argued that objective measures of performance are seldom perfect and the effectiveness of incentive contracting in organizations depends on a large set of social, psychological and economic factors, not yet fully explored.28 However, for a more appropriate economic evaluation, it is important to observe that management has to consider environmental conditions and the possible benefits in investing in social mechanisms like trust. As Wolff (2000) notes, if there are potential advantages promoting trust in business environments, there are also its associated costs. The economic recommendation is never “the more, the better”, but rather a rational trade-off between its costs and benefits.29 Trust has several properties and this study focuses on some of them. Trust refers to situations of strategic behavioral uncertainty. As Coriat and Guennif (1998) note “the reasons for 20 21 22 23 24 25 26 27 28 29

2

See, for instance, Rolland/Chauvel (2000) and Roberts (2000). See, for instance, Akerlof (1970), Arrow (1974), Ouchi (1980/1998), Ring/van de Ven (1992), Bradach/Eccles (1989/1998), Lane/Buchmann (1998) and Sako (1998b). See, for instance, Kreps (1990), Chiles/McMackin (1996) and Butter/Mosch (2003). See trust in the Rational Choice Theory approach in Ripperger (1998) and Hardin (2002). Ripperger (1998), p. 45. See Ouchi (1980/1998), p. 248, Bradach/Eccles (1989/1998), pp. 277-279 and Adler (2001), p. 218. See Ouchi (1980/1998), p. 248. See Sako/Helper (1998), p. 388. See Baker et al. (1993), Ghoshal/Moran (1996), and Casson (1997b). See Wolff (2000), p. 2.

the emergence of the concepts of trust in economics are easy to formulate. It was developed as a response to the problem of uncertainty in the relationship between economic ‘agents’. From a theoretical point of view, trust is, above all, a consequence of uncertainty”30. Employment contracts, by definition, refer to long-term contractual relationships and are examples of incomplete, imperfect relational contracts designed to deal with behavioral uncertainty.31 When transactions become more complex, long-lasting, specialized and complicated – like an employment contract – it may turn into a relationship between interactive partners (a repeated game) which requires a combination of different control mechanisms as more efficient modes of governance. In this sense, the combination of authority and trust, as alternative control mechanisms (nonexclusive), apply.32 Authority means that one party can get the desired outcome from the other through command and behavioral control, whereas trust performs the same function implicitly allowing lower transaction costs by assuming that parties can get into an exchange without the fear of opportunism. Where there is a lack of reliable evidence, trust is supposed to assure an agent that the desirable course of events will be realized in the unforeseeable future as if being guaranteed from past experiences. It is concerned with personal beliefs or expectations about the other’s motivations and his/her likely actions. These personal beliefs or expectations are constructed within the framework of an on-going interaction between people. Thus, trust is cognitive, in the sense that people evaluate one another’s motivations rationally to decide to trust or distrust. However, it is an imperfect knowledge. The crucial problem is not the incompleteness of trustworthy information about the future, but rather it is our ignorance about the limits of its trustworthiness. Moreover, trust is relational. Wherever there is a chance for individuals to repeatedly exchange with each other over a period of time, time asymmetries in delivery introduce risk into the transaction for the party who must invest resources before receiving return, and therefore trust will be developed to a certain extent.33 It makes trust central to a better understanding of relational contracting. Modern economic contractual theory understands trust as an implicit self-enforcement mechanism.34 Williamson (1985) comments: “idiosyncratic exchange relations that feature personal trust will survive greater stress and will display greater adaptability.”35 Therefore, trust is useful under environmental uncertainty. Business environments under high uncertainty and instability require flexible contracts to deal with many unforeseen contingencies. Once a certain level of trust is present within organizational structures, it allows for high organizational flexibility, decentralization and adaptation.36According to Williamson (1975) unpredictability in business environments makes opportunism difficult to control because a firm would find it

30 31 32 33 34 35 36

Coriat/Guennif (1998), p. 48. See Wolff (1995b), p. 90, and Milgrom/Roberts (1992), p. 132. See Ouchi (1980/1998) and Bradach/Eccles (1989/1998). See Coleman (1990), p. 91. See Bradach/Eccles (1989/1998), Ripperger (1998), Wolff (1996) and Wolff (2000). Williamson (1985), pp. 62-63. See Beckert et al. (1998). 3

difficult to write fully contingent contracts.37 Environmental uncertainty affects organizational behavior considerably by changing conditions and people’s expectations, and it may change people’s willingness to trust each other. Hardin (2002) comments that inherent problems of inconsistency over time and changing conditions that end or threaten to end an interaction, radically change its stakes, and reasonable concealment makes distrust potentially the correct prima facie judgment in many relationships.38 Therefore, the existence of trust, as manifested in the degree of people’s cooperative behavior, becomes important information. As Sako and Helper (1998) note, “the greater the degree of environmental uncertainty, the greater the benefit from being able to trust a trading partner, because trust facilitates decision making in unanticipated circumstances.”39

1.1

Thesis Objectives

This thesis examines the effects of environmental uncertainty created by specific institutional arrangements on the levels of trust within business organizations. The objective is to understand whether trust changes under different industry-specific institutional frameworks. More specifically, the study argues that the combination of some sources of institutional uncertainties (like technological uncertainty, demand uncertainty, and regulatory uncertainty) impose significant constraints to the development of trust within business organizations. The main argument of this study is that different industry-specific institutional frameworks shift a set of specific parameters for corporate governance which might restrict and alter the ways of governing relational contracts. Consequently different industry-specific institutional framework constraints, impose a different capacity for trust development within business organizations resulting in different levels of trust. For a better understanding of the influence of different institutional arrangements on business organizations we chose the New Institutional Economics (NIE) as the theoretical basis of analysis, because it provides potential for the macro-micro linkage, combining elements of law, economics and organization.40 It is more interdisciplinary and has applications to contiguous social sciences. In the last decades, NIE has enlightened and provided a better understanding of human behavior for organizational economics, examining any issue that arises as or can be reformulated as, a contracting problem. High levels of uncertainty and instability can better characterize the business environment, where the companies from the information and communication technologies (ICT) industry operate under the paradigm of the New Economy. In particular, this study will analyze the institutional environment of the new Brazilian telecommunications industry. By using the NIE 37 38 39 40

4

See Williamson (1975). See Hardin (2002), p. 95. Sako/Helper (1998), p. 394. See Williamson (1996), p. 3.

framework analysis, the study focuses on the effects of institutional innovations on the implicit governance structures within the telecommunications companies. This approach introduces some relevant issues related to the effect of the uncertainties and instability of the institutional environment on the choices of governance mechanisms, rather than to follow a technological determinism, commonly presented to describe the issues related to the New Economy. Therefore, technological uncertainty is viewed as one of the institutional elements comprising the general uncertainty that strongly influences the development of trust within hierarchies. The objective of this research will be to establish a relationship between the effects of these institutional changes which characterize the paradigm of the New Economy, as limiting factors, and the development of intra-organizational trust as an alternative control mechanism (see Figure 1-1).

Figure 1-1: Study Analysis Industry-Specific Institutional Constraints Corporate Governance Levels of Trust

Most discussions about the New Economy are focused on the influence of information technology in enhancing productivity or redefining the boundaries of firms and new forms of organization, with little attention given to relational contracting in the new work environment created by these institutional innovations. Recently, some scholars have observed and characterized the new institutional and organizational environment under the heading of the New Economy.41 As they have noted, historically, telecommunications companies have been the economic agents responsible for the ‘revolution’ of the information and communication technologies which occurred in the last decades.42 These companies present singular characteristics due to the influence of a set of institutional innovations. Changes in the nature of the work and relational contracting occurred mainly in the companies of the ICT industry. For example, Burton-Jones (1999) approaching the subject of new work conditions in the New Economy observes the volatility and tempory nature of the employment contracts and the impact on trust relationships of the significant changes in the na-

41 42

See, for instance, Castells (1996/2000), Burton-Jones (1999), Wigand et al. (1999), Audretsch/Thurik (2001), Cooper/Burke (2002), Fransman (2002) and Argandona (2003). See, for instance, Castells (1996/2000), pp. 90-97, and Argandona (2003), p. 4. 5

ture of work due to the increase in self employment, part-time and temporary contracts.43 He comments: “on current trends, employers and employees will be increasingly wary of entering into agreements which contain implicit guarantees or promises. This lack of mutual trust will continue to weaken the value of the employment contract as a form of work arrangement and move the employment relationship away from its relational context towards a more explicit transactional model.”44 According to some scholars, like Argandona (2003), the effects of the New Economy can be better observed in the ICT companies operating closest to the paradigm of the New Economy, specifically the new telecommunications companies, even considering that the institutional innovations affecting the work environment have also influenced other companies from different industries.45 The study argues that these institutional changes significantly influence the levels of trust within the companies operating within the New Economy. In order to analyze the effects of these institutional innovations on the levels of trust, the study will analyze the companies operating within the New Economy in comparison with another group of companies from more traditional industries, here labeled the Old Economy. Therefore, through literature review and collection of empirical quantitative and qualitative information, the study seeks to validate the differences found between these two different institutional environments, New Economy and Old Economy, using comparative case study method. Many scholars have observed a profound change in the nature of the interpersonal relationships among individual members of these organizations, from the organizational perspective of well established communities of the Old Economy, to the configuration of a new work environment under the paradigm of the New Economy. In contrast to the Old Economy, which was organized through socialization in a consistent corporate culture, formed by individuals who interact over a long period of time and who are mutually committed to common objectives, the New Economy has been characterized by high job volatility and instability. The effects of institutional uncertainty and instability constantly impose new demands on human resources management. Institutional uncertainty directly affects organizational behavior and work relationships, for example, increasing internal competition and job volatility, and therefore moving employment relations from a relational contract model to a more transactional contract model.46 This shift is also supported by some structural changes in employment demand, and this becomes even more evident when there is a lack of institutional mechanisms to deal with these changes. The main consequence of these contractual changes is a less interdependent relationship between employer and employee. Following the Rational Choice approach, the thesis observes the institutional environment of the New Economy to structure its hypotheses. Since most of the internal trade among mem43 44 45 46

6

See Burton-Jones (1999), p. 48. Burton-Jones (1999), p. 53. See Castells (1996/2000), pp. 90-97, and Argandona (2003), p. 4. See Burton-Jones (1999), pp. 52-53.

bers of organizations is realized by repeated transactions, the thesis takes the perspective of repeated-games to illustrate the changes affecting relational contracting. People learn that cooperation is in their own best interests. It is evident that the higher the probability of repeated encounters, and hence the higher the expected number of interactions of the game, the lower the probability of cheating in the game and therefore, the higher is the probability of developing trust relationships. When people interact over a period of time, threats and promises concerning future behavior may influence current behavior and repeated games capture this fact of life. By reducing the probability of future encounters between interactive partners, it also reduces the chances for people to trust each other. We argue that in the New Economy, institutional uncertainty and instability influence organizational behavior by changing people’s expectations about their future. Therefore, the central hypothesis presented in this study is: “Due to the relative higher institutional uncertainty and instability, NE companies will have a tendency to present lower levels of trust when compared with OE companies.” In order to determine and validate these differences between New Economy and Old Economy companies, the study will access the levels of trust and other related elements, which provide supportive information through a comparative case study. A questionnaire survey and in-depth interviews are chosen in order to collect qualitative and quantitative data from different groups of companies in a cross-industrial comparison. Additionally, the study will also research supporting data in order to locate the levels of trust into their specific business context and to better understand the scope of the changes to relational contracting. Looking at a broader outlook of the effects on the trust levels within these companies operating in the New Economy, the study will analyze the relationship between trust levels and two other organizational elements as two secondary hypotheses: (1) The relationship between trust levels with employee commitment measures. Employee commitment measures provide a multidimensional perspective of employees’ attachment to the organization (retention) enlarging the understanding of relational contracting. These secondary hypotheses are also considered as validation hypotheses. Therefore, giving rise to the secondary hypothesis (H2): Levels of trust will be positively related to employee commitment levels. Thus, New Economy companies, when compared to the Old Economy companies, will present lower levels of employee commitment. (2) The relationship between trust levels and employee turnover rates, as a threat to the continuity of interactions. Therefore, the secondary hypothesis (H3) is presented: Employee turnover rates influence and will be negatively related to levels of trust. Thus, New Economy companies, when compared to the Old Economy companies, will present higher levels of employee turnover rates. These additional elements provide additional support for a better perception of the changes in the trust levels and the extent of changes to relational contracting between the New and Old Economy. Additionally, some stock market performance information about some companies from the New and Old Economy will be analyzed to better determine the business context in which

7

levels of trust are expected to be found. It will provide a better understanding of the connection between industry characteristics, internal governance modes and market success.

1.2

Relevance of the Study

Observing the effects of industry-specific institutional arrangement on individuals’ propensity to trust within business organizations, the thesis has the purpose of collecting information that helps us build a more comprehensive understanding about the adoption of trust as a complementary governance mechanism, specifying some questions that at last will contribute to build a more consistent theory of trust in the economic perspective. Observing trust as a starting point to comprehend relational contracting issues, the study is relevant to the understanding of the new ways of governing relational contracts in the New Economy addressing some important issues for future research. This research will provide unique empirical evidences of recent changes to relational contracting in the companies operating in the New Economy, addressing valuable recommendations for management policies, primarily towards the design of incentive schemes and the evaluation of returns on investment in human capital. Although there are some studies that discuss the new employment conditions within the New Economy, there are few empirical studies on the significant changes to relational contracting of the companies operating therein. There are even fewer, if any, assessing the levels of trust in these companies. In other words, the level of discussion about the consequences of the New Economy is macro rather than micro,47 structural rather than relational. Because trust has been strongly related to many organizational tasks and managerial features, it is important for a better understanding of relational contracting issues. The present study brings new issues, not yet investigated, about the influence of specific institutional arrangements on the levels of trust within the companies operating in the New Economy. It provides unique empirical evidence in line with the general tendencies already indicated by some recent studies of the International Labour Organization (ILO) and the Organization for Economic Cooperation and Development (OEDC) that have provided evidence of significant changes in the nature of employment contracts and work conditions worldwide as consequences of the New Economy.48 Based on the literature, this study also proposes some specific situations in which the development of trust would be more appropriate than the application of explicit monitoring and control mechanisms. This study suggests a paradox: even when organizational tasks would require the development of trust as a more efficient mechanism, industry-specific institutional constraints significantly limit the development of trust within those organizations. The New Economy environment suggests that trust could be highly desirable as a control mechanism to coordinate specific tasks linked with the nature of information and knowledge-intensive pro47 48

8

See Argandona (2002), p. 4. See ILO/OEDC (1997), and ILO (2001).

duction systems. However, limiting factors in industry-specific institutional frameworks present problems for the adequate development of trust. In other words, even if trust is highly desirable, the study understands that New Economy companies have considerable hurdles to overcome in developing trust as an efficient mechanism.

1.3

Division of Chapters

This study is structured as follows: Chapter 2 of the thesis develops a conceptual framework of trust, providing a definition and some of its relevant properties in the economic perspective and the approach to trust within economic organizations. It presents some trust specific functions, needs and conditions for trust development and its relationship with organizational performance. Through the analyses of the Economic Contract theory, Transaction Costs Theory and Agency Theory we explore how trust operates within organizations. Moreover, Chapter 2 introduces trust as an organizational variable under different industry-specific institutional framework constraints and the general effect of institutional uncertainty and instability on trust levels. Chapter 3 presents a definition of the New Economy, some paradigmatic differences between New and Old Economy, some specific characteristics of the companies operating in the New Economy, the description of some relevant institutional innovations and a definition and description of the institutional uncertainties and their influence on organizational behavior. Moreover, this Chapter focuses on the new telecommunication industry, presenting some historical data, specific characteristics of its organizational forms and work conditions. Finally, Chapter 3 introduces the case study of the New Brazilian Telecommunications Industry observing the impact of the institutional uncertainties and instability on the work conditions. Chapters 4 and 5 present the empirical study. Chapter 4 presents the central hypothesis of this study, the secondary hypotheses, introduces the methodology applied in the empirical research, research tools, the study organizations, execution of the questionnaire survey, statistical instruments applied and the data analysis methods. Chapter 5 analyzes the research results, the main hypothesis and the secondary hypotheses. Finally, in Chapter 6 the study presents its conclusions and outlook (see Figure 1-2).

9

Figure 1-2: Thesis Frame and Structure

10

2. Trust from the Economic Perspective “There is an element of trust in every transaction”. Arrow (1973), p. 24.

In this chapter in Sections 2.1 to 2.4 we set out our basic approach on trust from the economic perspective, some basic definitions of trust, the idea of trust and cooperation and some relevant properties of the core concept of trust, based mainly on the rational choice approach. Secondly, in Sections 2.5 to 2.8 we analyze trust as an element within economic systems.49 The objective is to understand the role, function and conditions for the development of trust within business companies as a collective phenomenon. We choose the theoretical background from Transaction Costs Economics (TCE) to analyze the effects of trust within business organizations and to understand the possible consequences of “high-trust” and “lowtrust” systems. TCE is more appropriate for our study because the theory emphasizes not the individual but the context where relationships between them occur under certain circumstances.50 Third and finally in Section 2.9, we analyze trust and institutional uncertainty.

2.1 Trust and Monitoring As compared with the other social sciences, the economic approach to business organizations is decidedly more calculative, and “calculativeness can get in the way of trust.”51 As Gibbons (2000) has noted, a calculative conception of trust based on the rational choice approach is useful to clarify the subject from an economic perspective. Not ignoring the other motives of social interaction, here we focus on “pure economic motives” as proposed by Gibbons (2000) as part of the understanding of trust in the economic world.52 The focus on pure economic motives becomes important in order to build a more complete understanding of the trust elements into economic issues. It allows economists and managers to analyze the effects of trust as an implicit governance mechanism for markets and hierarchies. Therefore, general notions of trust presented in this study are related to each other, in the sense that they see trust in a calculative context derived from pecuniary self interest. The New Institutional Economics assumes that individuals have limited rationality. By using their cognitive capabilities individuals make decisions on a calculative basis. Trust is assumed by rational choice theorists as an expectation or attitude regarding specific situations involving behavioral risk when engaging in a relationship with one person or a group of people. It can be acknowledged as a willingness to accept (voluntarily) risky situations based 49 50 51 52

In Luhmann (1980) the term “system-trust” is used to indicate the kind of trust at a more abstract level relating to social systems, which is independent of the trust generated between actual individuals. See Williamson (1985), pp. 15-18. Williamson (1985), p. 405, and Williamson (1996), p. 250. See Gibbons (2000), p. 20. 11

on the subjective perception of other partner’s motivations.53 According to Luhmann (1989), trust is a mechanism to stabilize insecure expectations and to diminish the associated complexity of human behavior.54 Trust is relational. It is a psychological state, which brings together cognitive and affectiveemotional bases as motivational aspects for people’s decisions to engage in cooperative actions.55 However, as Ripperger (1998) notes, even when trust is based on strong emotional bases, such bases consist of reactions developed from a cognitive comprehension. Because emotions are developed as reactions from the cognitive structures, they have for us a comprehensible character.56 Therefore in the economic perspective, trust is rather cognitive. As Hardin (1998) states: “trust is a fundamentally cognitive notion. To trust or distrust others is to have some presumption of knowledge about them.”57 Additionally, another fundamental property of trust largely recognized by theorists is the idea of behavioral risk, which in the perspective of economics is translated as costs.58 The more there is a danger of behavioral risk, the more trust becomes a valuable alternative mechanism to markets and hierarchies within economic systems. It is an attitude which allows for risk-taking decisions related to personal experience.59 As for social systems, trust becomes an implicit contracting or a ‘commodity’, which cannot be bought very easily.60 Organizations can build ‘trust capital’ which works as a self-enforcing mechanism to improve cooperation in economic activities.61 Within hierarchies, it might be an efficient implicit control mechanism, an outcome of the right application of incentives embedded in the social norms and interpersonal relationships among the members of the firm.62 In this sense, the presence of trust can be better acknowledged as an implicit motivation mechanism in order to accomplish organizational tasks. People will be more motivated to cooperate once they have learnt that they do not need safeguards against opportunism. In the economic literature there are basically two approaches on trust as an implicit mechanism in relation to explicit or formal mechanisms. Trust has been approached as a substitute or as a complementary mechanism.63 The substitute approach acknowledges that trust can replace explicit mechanism and vice-versa. In this sense, one should consider the existence of a balance between implicit and explicit forms of control. Trust and formal monitoring are fully 53 54 55 56 57 58 59 60 61 62 63

12

See Ripperger (1998) and Hardin (2002). See Luhmann (1989), p. 1. See Ripperger (1998), pp. 92-95. See loc cit. p. 97. Hardin (1998), p. 11. See Wolff (2000), p. 1. See Luhmann (1988), p. 103. See Arrow (1974), p. 23. See Wolff (1996), pp. 104-105. See Bradach/Eccles (1989/1998), p. 282. See, for instance, trust as substitute in Ring/Van de Ven (1994), Zaheer/Venkatraman (1995), Zaheer et al. (1998) and Ripperger (1998). See, for instance, trust as a complementary mechanism, in Luhmann (1979), Ouchi (1980/1998), Zucker (1986), Bradach/Eccles (1989/1998), Adler (2001) and Woolthuis et al. (2002).

equivalent and might replace each other. This trade-off between the implementation costs of implicit and explicit mechanisms defines the most efficient way of governance. However this approach has been questioned by many economic theorists, social scientist and researchers. According to Woolthuis et al. (2002), there is no consistent empirical evidence that trust and formal control indeed substitute for each other.64 For instance, Van de Ven and Walker (1984) and Aulakh et al. (1996) found in their empirical studies that the use of formal control has negative consequences for the trust between interactive partners.65 Monitoring is interpreted as distrust and therefore it can have a negative impact on the relationship. Accordingly, Luhmann (1979) observes that the use of legal sanctions is generally seen as incompatible with a trust relationship; he noted that legal norms do not fulfill their social function by actually being mobilized, rather they direct expectations of social actors to certain routes of behavior.66 Therefore, in this work we have adopted the complementary assumption understanding that trust produced by social structures does not simply replace explicit monitoring and control mechanisms but operates as a complementary governance structure with them.67 Our approach understands that trust is not fully equivalent to formal control. As will be further illustrated in this chapter, under some specific conditions trust might be the most efficient governance mechanism. We acknowledge the presence of trust as well as formal control in differing degrees in any real organization.68 Figure 2-1 shows Isoquants which illustrate these two approaches.69 Both Line 1 and 2 are Isoquants which represent all input combinations possible to produce efficient control, considering respectively substitute and complementary approaches. All points above or to the right of a point on the lines represent an inefficient application of control. The straight line 1 illustrates the substitute approach. In this case, trust and monitoring can be freely substituted for one another. Alternatively, line 2 presents possible combinations of trust and monitoring under the complementary approach. Under such perspective, the curvature between points x and y represents the limited range of alternatives using trust and monitoring in different proportions, however not as perfect substitutes. The straight segments of line 2 (x-x’ and y-y’) represent the condition of minimum levels of trust and monitoring where no variation of the other complement is possible. Line 2 shows that trust and monitoring are not perfect substitutes, but under certain conditions (points on the curve x-y) they might be employed in different combinations. Under some other conditions - segments x-x’ and y-y’ - there are respectively a minimum level of trust and monitoring. In other words, as observed by Woolthuis et al. (2002): “low trust requires formal control and high trust allows for a limited extent of for-

64 65 66 67 68 69

See Woolthuis et al. (2002), p. 3. See Van de Ven/Walker (1984) and Aulakh et al. (1996). See Luhmann (1979), p. 24. See Ouchi (1980/1998), p. 248, Bradach/Eccles (1989/1998), pp. 277-279, and Adler (2001), p. 218. See Ouchi (1980/1998), p. 248. See Brickley (2001), pp. 111-115. 13

mal control.”70 Therefore, the complementary approach illustrates that a high trust context requires a minimum of monitoring and, on the other hand, high monitoring contexts require a minimum of trust.

Figure 2-1: Substitute and Complementary Approaches – Trust and/or Monitoring Complementary

Substitute

Trust

Trust

x’

x Line 1

Line 2

y Monitoring

y’

Monitoring Source: Based on Brickley et al. (2001), p. 113.

The most efficient input mix of control depends on the costs of these inputs. The total cost (TC) is equal to the sum of the quantities - T and M - of each input used times their respective prices Pt and Pm. Thus, TC = PtT + PmM. Nonetheless, we acknowledge that relative prices depend on environmental characteristics.71 In this sense we understand that trust is a complementary mechanism to explicit control that might contribute to increase corporate efficiency according to specific circumstances. It is necessary to consider the costs of creating and sustaining a trustworthy environment in order to achieve efficiency by reducing transaction costs and increasing probabilities for cooperative actions.

2.2 Cooperation and Trust The Rational Choice approach very often presents a certain similarity between cooperation and trust.72 Game theory has provided important insights to illustrate social interactions between members of a given social group as far as the implications of rationality, self-interest and equilibrium are concerned. Insights provided by game theory provide analytical support to the claim regarding the necessity of integrating social variables into institutional analysis 70 71 72

14

Woolthuis et al. (2002), p. 3. See Woolthuis et al. (2002), p. 14. See Ripperger (1998), pp. 6-7.

and highlight the distinct roles of various institutional elements. For example, they reveal the inherent indeterminacy of the relationship between macro structures - “the rules of the game”73 - and outcomes. Even under the assumption that this structure is common knowledge and individuals are rational, different patterns of behavior can be equilibrium outcomes. Each of these equilibria is supported by different expectations or beliefs that each individual holds regarding others’ behavior (assuming interchangeably beliefs and expectations). Hence, what people believe about how others will behave in various circumstances will have a profound effect on how they will act. Trust is often illustrated in Game Theory as an element responsible for promoting cooperation between interactive partners. Game Theory allows us to better understand the consequences predicted by many scholars in the economic literature about the presence of trust reducing transaction costs and enhancing efficiency in business corporations. In this perspective, in order to establish cooperative actions based on trust, repetitive encounters between interactive partners over a reasonable period of time, reasonable information on the other players and a relative small number of players are necessary. Moreover, a certain probability of continuity with a random, unknown or unforeseeable end date have to be considered.74 The probability has to be that interactive partners will be likely to meet again after the current period. Under these circumstances, interactive partner’s actions from today may affect his or her actions tomorrow. Thus, actions not in the interactive partner’s short-run self-interest (as defined by today’s payoff) may be consistent with his or her overall self-interest (as defined by the total payoff over time) in the long run. Therefore, cooperation based on long-term interaction and mutual trust can overcome the “Prisoners Dilemma” (PD) situation of mutual betrayal.75 Still, trust might emerge when agents interact intensively in other contexts with the presence of third actors, as they try to preserve their reputations.76 In this sense Game Theory allows economists to analyze self-enforcing institutions when price theory does not apply, where it has proven to be helpful in understanding human interactions. By definition, selfenforcing institutions can either not at all or only at prohibitive cost be verified and enforced by third parties.77 Self-enforcing institutions operate in such a way that “if one party violates the terms (by defecting) the only recourse of the other is to terminate the agreement.”78 Therefore it is largely acknowledged by economists that trust has a self-enforcing effect79 in the sense that if individuals believe that everybody will continue to play the trust-game, although the short run payoff from defecting is higher than the long run payoff from rule obedience, it

73 74 75 76 77 78 79

North (1990), p. 4. See, for instance, Axelrod (1984), Kreps (1990), Gibbons (2000), and Ricketts (2002). See Wigand et al. (1999), p. 94. See Kreps (1990), p. 107. See Wolff (1995), p. 90. See Williamson (1996), p. 122. See, for instance, Kreps (1990), p. 103, and Wolff (1996), p. 103. 15

ensures an ongoing cooperation of all parties.80 Therefore trust has been approached mainly through repeated-games models.81 Game theory has provided insights into understanding how trust might emerge within and between firms. Most research on collective action assumes trust increases the likelihood of cooperation. Mainly in the context of common-pool resources situations like the firm, trust refers to an expectation of reciprocity from other interactive actors.82 It is well known that reciprocal strategies that reward cooperation and punish defection are the foundation of cooperation in repeated games. It supports normative assumptions for the emergence of trusty relationships. Reciprocal strategies support cooperation because as long as the other player is using reciprocal strategies, the rewards of sustained cooperation over time outweigh the short term temptation to defect and risk mutual non-cooperation over the course of an exchange relationship.83 According to Ricketts (2002) the firm can also be understood as a method of enabling contractors to adjust to change and of encouraging the discovery of new possibilities for mutually advantageous cooperation.84 Problems arise from the existing lack of information about how far they can trust each other. The possible advantages flowing from cooperative effort through division of labor and exchange, which have been clear enough in the literature since Adam Smith, can only be achieved as gains to the group as a whole if people abide by the terms of an agreement and do not cheat. Exchange requires that each contractor accepts the right of the other regarding the resources at present in their possession. One has to assume also the existence of an agency to enforce property rights. Lack of information might be related not only to technical possibilities, but also to their dealings with one another requiring a trade-sustaining culture.85 For example, Sen (1967) introduced the “Assurance Game.”86 He demonstrates that, when the production of a collective good is technologically limited to a minimum scale, and resources are not enough, like budgetary resources, cooperation can take place as the best strategy. Different from the PD, in the Assurance Game, cooperation is the better equilibrium (Pareto superior) if both are convinced that the other will do so. Within one company, the same situation could be applied for two specialists or departments which have a common task to perform. Although companies work mainly under authority, the Assurance Game provides a rational understanding of individual willingness to cooperate more or less by reciprocity through the alignment of interests. From this perspective, people might accomplish one task trusting and cooperating, more or less, and thus spending more or less effort, and the condition to do so will depend on the individual availability of resources and the perspectives to reach mutual benefits and advantages. 80 81 82 83 84 85 86

16

See also Section 2.6.3. See, for instance, Hardin (1971), Axelrod (1984), Kreps (1990), Casson (1997), Gibbons (2000), Binmore (2000, 2002), and Ricketts (2002). See Ostrom (1990), p. 17. See, for instance, Axelrod (1984), Kreps (1990), and Gibbons (2000). See Ricketts (2002), p. 18. See Ricketts (2002), p. 19. See Sen (1967).

However, more has to be acknowledged in order to explain how trust might contribute to cooperative forms. What is the role of trust in facilitating cooperation? This is perhaps the central question that spans the interdisciplinary literature on trust and society.87 Although trust is often seen as an efficient lubricant that promotes successful cooperation, trust is not necessary for cooperation.88 Cooperation is not necessarily an indicator of trust and trust alone is not always a condition for cooperation.89 A lack of cooperation can be a result of other factors (such as a lack of sufficient information or chance for future interaction among partners) rather than the absence of trust.90 Cooperation might be reached without consensus or trust. This has been proven since the application of coercive forms of production in Taylor’s model.91 Coercion has been and still is widely used as a means to ensure cooperation. However, it is not a real alternative to trust, because while it gives less cause to worry by enforcing a kind of cooperation in specific acts, it also makes treacherous actions more probable (opportunism). In this sense, Dunn (2000) and Luhmann (2000) share the view that the rational exploitation of other people’s interests can hardly serve as an adequate substitute for trust. On the other hand, according to Gambetta (1998), if there is trust within cooperation, then some amount of coercion is also present, or at least its credible threat.92 He claims that if there is more trust, less coercion is needed, and vice-versa.93

2.3 An Economic Definition of Trust Trust is an element that has been approached in the last decades by many disciplines and through many and varied means. From the economic perspective, it is important to recognize and define the element as part of economic systems in order to help us understand the implications of trust in many contexts and to explain some forms of behavior. Certainly it has been observed by many economic theorists and researchers that the existence of trust significantly changes the interactive system in certain ways. Despite other approaches on trust based on faith, belief or morality, our approach in this work is one based on the rational choice theory. Hence, we take Hardin’s (1998, 2002) and Ripperger’s (1998) arguments that essentially trust is rational expectations about the self-interested behavior of the trusted. It is a Three-Part Relation defined not only by the characteristics of the trustor (A) and the trustee (B), but also by a specific transactional domain or context (X) in which their relation is embedded.94 According to Hardin (2002) trust is an “encapsulated interest”, in which the trustor’s expectations of 87 88 89 90 91

92 93 94

See, for instance, Hardin (1971), Cook (2000), Kramer/Tyler (1996) and Ostrom (1998). See Fukuyama (1995), p. 41, Levi (1998), p. 78, Misztal (1998), p. 17, and Hardin (2002), p. 11. See Ripperger (1998), p. 93. See Misztal (1998), p. 17. Barnard (1938) argued that for authority to be effective, coercion has to be accepted. Similarly, Achian/Demsetz (1972) argue that it is not meaningful to assume that an employee to do what the employer wants in the absence of coercion. See Gambetta (1998), pp. 220-221. See Gambetta (1998), p. 221. See Hardin (1998) and (2002). 17

the trustee’s behavior depend on the assessment of certain motivations of the trustee. Another insight comes from Ripperger’s (1998) work.95 Like Hardin, Ripperger (1998) goes beyond the pure rational choice theory to build a better understanding of trust, including some assumptions of a psychological state. Her work provides an understanding of the placement of trust on cooperative actions. In Ripperger (1998), two independent conditions have to be satisfied in order to have cooperative actions based on trust, the coexistence of an expectation of trust and a trust action. The existence of these two core components support cooperative actions based on trust (see Figure 2-2):96

Figure 2-2: Trust Action and Expectation of Trust

Yes

No

Yes

Cooperation based on Trust

Trust without Cooperation

No

Expectation of Trust

Trust-Action

Cooperation without Trust

Neither Trust nor Cooperation

Source: Ripperger (1998), p. 93 (Translation: Marco Tulio Zanini).

1) Trust Action: One party A provides a voluntary, risk taking act of investing without any contractual safeguards or monitoring to prevent opportunistic behavior of the other party (B). 2) Expectation of Trust: The trusting part A expects from part B that he/she is motivated – without any explicit protection – to react voluntarily without opportunistic behavior (break trust). According to Ripperger’s (1998) definition, expectation of trust and trust action represent the core concepts of a cooperative action based on trust, and they are respectively related to attitude and behavior. As noted before, isolated behavior in the form of a cooperative action is not enough to characterize the placement of trust. It is necessary that the presence of two additional assumptions be embedded in the cooperative behavior: the trust nature of the individuals’ motivations and the presence of behavioral risk. Only with these additional assumptions 95 96

18

See Ripperger (1998). See loc cit. p. 45.

of an initial expectation of trust as a psychological state, and the presence of behavioral risk, can an instance of cooperative behavior be characterized as a trust-action. Therefore, Ripperger (1998) provides the following definition of trust: “trust is the voluntary risk investment in advance, in a relationship under the abdication of explicit safeguard mechanisms of control against opportunistic behavior, in the expectation that the other party, despite the absence of such safeguards, will not behave opportunistically.”97 According to Ripperger’s definition, trust can be better defined as an expectation or attitude related to a specific situation, which is the base for a concrete action. Ripperger’s definition of trust is aligned to other organizational theorists, for instance, Dasgupta (2000) who defines trust as “one’s expectations regarding others’ choice of actions that have a bearing on one’s own choice of action.”98 Zucker (1986) who defines trust as “a set of expectations shared by those in an exchange”99, and Luhmann (2000) who states: “trust is an attitude which allows for risk-taking decisions.”100 Ripperger’s definition also has some similarities with the earlier conceptualizations proposed by influential theorists on organizational psychology such as Deutsch (1962), Zand (1972), and later Mayer et al. (1995). The later defines trust as “the willingness of a party to be vulnerable to the actions of another party based on the expectation that the other will perform a particular action important to the trustor, irrespective of the ability to monitor or control that other party.”101

2.4 Properties of Trust

2.4.1 Trust as a Three-Part Relation According to Hardin’s (2002) “encapsulated interest” accounts, an actor A trusts actor B with respect to some specific behavior. The context (X) helps to determine the extent to which A considers B to be trustworthy in terms of the matter at hand. A can trust in B with respect to some action if B’s reasons for doing it is to take A into account in some relevant way. According to Hardin (1998), typically B’s reason will be that it is in his/her own interest to maintain the relationship with A. Thus, B’s trust in A is typically encapsulated in his/her own interest in fulfilling A’s trust.102 Hardin (2002) notes: “I trust you because your interest encapsulates mine (to some extent), which is to say that you have an interest in fulfilling my trust in particular because you want our relationship to continue.”103 In this sense, we adopt Hardin’s (1998) and Ripperger’s (1988) argument that trust is fundamentally a cognitive no97 98 99 100 101 102 103

Ripperger (1998), p. 45. Translation: Marco Tulio Zanini. Dasgupta (2000), p. 53. Zucker (1986), p. 54. Luhmann (2000), p. 103. Mayer et al. (1995), p. 712. See Hardin (1998), p. 12. See Hardin (2002), p. 3. 19

tion.104 To trust or distrust others is to have some presumption of knowledge about them. For Hardin (2002), there must be a minimal core part of significant range of trust, which is a clear, well defined interest at stake in the continuation of the relationship. In line with the principles of the repetitive-game approach, Hardin (2002) emphasize that typically people will trust in those with whom they have ongoing relationships grounded in some interest and benefits from the interaction. The richer an ongoing relationship and the more valuable for us, the more trusting and trustworthy we are likely to be in that relationship. In this sense some relationships might be grounded in a more valuable range of material benefits, interests or any perceived advantage and, not necessarily based on present perceived advantages. For example, people can enjoy the relationship with others and have an interest in maintaining it because they perceive some future advantages or benefits based on reciprocity. Moreover, people can trust in various ways. Hardin (2002) notes that many of our relationships with others develop from relatively minor interactions to become much richer in the future.105 It means, we might calculate cognitively in the present the possible benefits from these interactions in the future. Furthermore, people do not necessarily have the same interests and goals that would render trust a relevant factor. Hardin (2002) states: “I trust you because I think it is in your interests to attend to my interests in the relevant matter. This is not merely to say that you and I have the same interests. Rather, it is to say that you have an interest in attending to my interests because, typically, you want our relationship to continue.”106 Thus, people might show trust to maintain an ongoing relationship and not be damaged by their failure to fulfill the other’s trust, because it might be economically beneficial for them or because they value this relationship for many reasons, including nonmaterial reasons. Moreover, people trust each other regarding a specific situation X. It means trust might be regarded only for one specific situation X, “to do Y”, or “in matters Y”, and it does not necessarily imply continuity to trust ten times X.107 Merely having the same interests with respect to some matter does not meet the condition of trust as encapsulated interest: although it can often give A reason to expect B to do what A would want B to do or what would serve A’s interests (because it is simultaneously serves both player’s interest). The encapsulated-interest account does entail that the trustor and those trusted have compatible interests over at least some matters, but such incentive compatibility between parties, while necessary, is not sufficient for that account, which further requires that the trustee values the continuation of the relationship with the trustor and has compatible interests at least in part for this reason. Hardin (2002) exemplifies it: “Other drivers on a highway and myself enjoy incentive compatibility, and therefore each of us avoids accidents with one another. Generally, however, there is no sense in which the other drivers want me to be in

104 105 106 107

20

See Hardin (1998), p. 11, and Ripperger (1998), p. 97. See Hardin (2002), p. 4. Hardin (2002), p. 4. See Hardin (2002), pp. 9-10.

the relationship of driving on the same road with them, and therefore I am not in a relationship of trust as encapsulated interests with them.”108 Therefore, people might be trustworthy because they have some common interests with respect to some matter but they might not necessarily be motivated to place trust and maintain an ongoing relationship. For the encapsulated interest account it further requires that the trustee values the continuation of the relationship with the trustor and has compatible interest (incentives) at least in part for this reason. In this sense, commitments to assure the continuation of the relationship matter. Additionally it is important to note a common misconception of trust. Hardin (2002) notes that there is a mistaken impulse to understand that trust is a significant issue only when there is doubt in the trustee’s likely performance. Hardin comments: “Under this view, I have greater trust the less I expect you to fulfill my trust…If it is trust only when I have little reason to expect you to fulfill my expectation and not when I have substantial reason to expect you to do so, then I did not ever trust my mother, do not trust my son, closer friends…”109

2.4.2 Trust as an Expectation According to Ripperger (1998), an expectation of trust, which provides the basis for a trust action, lies in the trustor’s subjective perception of the trustee’s motivation (perceived selfinterests) to correspond to his/her (trustor) investment. Hardin (2002) understands that the trustee encapsulates the trustor’s interests in order to act in a trustworthy manner, as he notes: “this fact that makes my trust more than merely expectations about your behavior. Any expectations I have are grounded in an understanding (perhaps mistaken) of your interests (encapsulated) specifically with respect to me.”110 According to Ripperger (1998) each expectation of trust as a subjective psychological state has two elements in a dualistic coexistent situation: an emotional aspect and a cognitive aspect.111 These two coexistent components prevail over each other according to a specific person and situation. Sometimes an expectation of trust will be based more on emotional aspects, with others it will be based more on cognitive aspects. According to Ripperger (1998), agents might be motivated differently on a more emotional or cognitive basis, according to a specific person, group of people, situation and context or circumstances.112 The cognitive basis brings to the trustor’s expectation the capacity to calculate the risk in a given situation, thus Ripperger defines this part as cognitive trust or calculative trust (kalkulierendes Vertrauen); on the other hand, the emotional basis brings affective and emotional aspects to the expectation of the trustor.113 Ripperger comments that this emotional 108 109 110 111 112 113

Hardin (2002), pp. 4-5. Hardin (2002), p. 73. Hardin (2002), p. 3. See Ripperger (1998), pp. 92-98. See Ripperger (1998), pp. 96-97. See Ripperger (1998), p. 97. 21

aspect of an expectation of trust cannot be removed from the analysis of trust because it brings a fundamental element of belief. She notes that this element of belief is necessary to overcome cognitive gaps caused by uncertainties of limited intellectual penetration.114 However, Ripperger observes that emotional elements are reactions developed to cognitive comprehension. Personal feelings built on emotional reactions are developed to cognitive comprehension regarding specific situations. Because emotions develop as a reaction to the cognitive structures in specific situations, they have for us a comprehensible character.115 Hence, although each expectation of trust brings together cognitive and affective-emotional aspects in a dualistic and coexistent way, the cognitive aspect is first and foremost in the analysis of the trustee’s motivation and reactions. Consequently, once trust is basically attributed to the trustee’s motivation (by trustor’s subjective perception), each trust event has to first acknowledge the cognitive aspects of the trustee’s motivation, even under strong emotional circumstances.116 The construction of the expectation of trust is built up by the trustor’s subjective perception of trustee’s motivation to honor or dishonor the placement of his or her investment (see Figure 2-3). The personal cognitive and emotional structures of the trustor are influenced by his or her subjective forms of perception and the objective characteristics of a given situation, the present information of a specific situation and the information acquired from the past.117 Figure 2-3: Trust-Expectation as a Subjective Perception of the Trustee’s Motivation Information acuired from the past

Expectation of the Trustor: Subjective Perception of Trustee’s Motivation

Cognitive and Emotional element of the Trustor

Filter

Subjective uncertainty about trustee’s motivation

True trustee’s motivation remains hidden

Motivation of the Trustee

Information of the specific situation from the present

Source: Ripperger (1998), p. 95 (Translation: Marco Tulio Zanini). 114 115 116 117

22

See Ripperger (1998), p. 97. See Ripperger (1998), p. 97. See Ripperger (1998), p. 98. See Ripperger (1998), p. 95.

In this way, Ripperger (1998) introduces the concept of information asymmetry to the expectation of trust. According to the author, the trustor’s decisions will be formulated from some information acquired from the past (as reputation) and information of the specific situation in the present time about the trustee’s motivations to honor his/her investment. In this sense, Ripperger (1998) observes a filter dividing the true motivation of the trustee and the subjective uncertainty of the trustor.118 Thus, we perform our subjective evaluation of the other person’s (or group) characteristics, based on limited information about his/her self-interest motivations (encapsulated interests) towards our investment. The expectation of trust exists potentially (in the trustor’s mind) before assuming real form in a voluntary action, as the source of the trustor’s motivation formed by his/her subjective perception. This expectation continues to exist during the course of a specific trust-action, during realization of the outcome with the ending of the behavioral risk, and even after that, as a disposition towards the interactive partner. In other words, trust is an expectation related to a specific person and situation, and it exists independently of a concrete action.119 For that reason, we can say that A (trustor) may trust B (trustee) independently of whether a concrete action takes place or not. Thus, we say that A has a willingness to engage voluntarily in a (specific) risk situation with B. Whether A has a chance or not to exercise his expectation of trust with B by placing his/her trust in a concrete action with B will depend on the chances of interaction between these two agents. Hence, trust is viewed as an (implicit) motivational element for a possible (explicit) concrete action. Trust is better understood as an attitude or expectation, which is the origin of a calculative action – the placement of trust. Therefore, according to their personal motivations toward an interactive partner (or partners), individuals will choose to engage or not with others.

2.4.3 Behavioral Risk Most scholars agree that the intentional and voluntary acceptance of vulnerability and behavioral risk is central to the concept of trust. As Coleman (1990) notes, “situations involving trust constitute a subclass of those involving risk. They are situations in which the risk one takes depends on the performance of another actor.”120 In this way, Luhmann (1989) understands trust as a mechanism to stabilize insecure expectations and to decrease the associated complexity of human behavior.121 According to Luhmann (1989) the trust motivation of the trustor does not lie in the increasing of safety under relative reduction of uncertainty, but on the contrary, in the increasing of the capacity to tolerate uncertainty at the expense of safety.122 Along the same line of reasoning we have Bradach and Eccles’s (1989/1998) argument: 118 119 120 121 122

See Ripperger (1998), p. 65. See Hardin (2002), p. 11. Coleman (1990), p. 91. See Luhmann (1989), p. 1. See Luhmann (1989), p. 88. 23

“trust is a type of expectation that alleviates the fear that one’s exchange partner will act opportunistically. Of course, the risk of opportunism must be present for trust to operate”. Behavioral risk arises in any trust relationship between parties because of the time gaps. Coleman (1990) introduces the role of time in the placement of behavioral risk: “one way in which the transactions that make up social action differ from those of the classical model of a perfect market lies in the role of time.”123 Coleman (1990) notes that transactions are consummated only over a period of time, and there are time gaps between the deliveries of parts. He states, there are cases in which “an actor makes a unilateral transfer of control over certain resources to another actor, based on a hope or expectation that the other’s actions will satisfy his interests better than would his own actions; yet he can only be certain at some time after he has made the transfer.”124 Time asymmetries in delivery introduce risk into a unilateral action or transaction for the party who must invest resources before receiving a return. Thus, trust works as a social mechanism necessary to enforce economic transactions under risk.

Figure 2-4: The Placement of Trust and Risk Gaps of Time T0

A decides to make or not a trust-investment based on perceived B’s motivations

Critical

T1 Risky Zone A invests in B though a concrete trust-action

T2

T3

B decides to accept or reject A’s investment

Outcomes rise for A and B

Placement of Trust Expectation of Trust Source: Inspired by Coleman (1990). Figure 2-4 shows the possible gap in time which introduces risk between interactive partners A (trustor) and B (trustee), and the critical risk zone between the placement of trust by A (trustor) based on perceptions of B’s motivations. First (T0), A has an initial subjective expectation of trust about to engage or not in a risky situation with B based on his/her perception of B’s motivations to fulfill this expectation. Second (T1), A decides to invest in a risky situation through a concrete action accepting voluntarily B’s behavioral risk of betrayal. At the moment 123 124

24

Coleman (1990), p. 91. Loc cit. p. 91.

(T1) A becomes vulnerable to B’s reaction and risk is introduced, B has the option of rejecting or corresponding to A’s expectation (T2). Considering that B accepts A’s trust investment, an outcome will be possible at that moment (T3). Moreover, there is widespread agreement amongst researchers on two conditions required for trust to exist: risk and interdependence.125 In the event of B corresponding to A’s trust, the interdependence between the agents establishes a reciprocal relationship because both are not self-sufficient to produce the best outcome in (T3).126 The interdependence situation is brought about because the interests of one agent cannot be satisfied without the trust investment (risk investment) of the other. This interdependence situation supports a common task of both agents, and only through this cooperative situation can a better outcome be achieved.

2.4.4 The Calculative Placement of Trust The central problem of placing trust refers to a problem of dependency through putting some resource in other people’s hands. This problem exists because the trustor lacks some information or because he/she makes a specific investment.127 Coleman (1990) formulates some hypothetical examples to illustrate different situations with the placement of trust by agents where trust is placed differently according to specific situations. He observes four points in the placement of trust between a trustor and trustee:128 first (1) “the placement of trust allows an action on the part of the trustee that would not have been possible otherwise… the placement of trust involves putting resources in the hands of parties who will use them to their own benefit, to the trustor’s benefit, or both”; secondly (2), “if the trustee is trustworthy, the person who places trust is better off than if trust were not placed, whereas if the trustee is not trustworthy, the trustor is worse off than if trust were not placed”; thirdly (3), “the action of placing trust involves the trustor’s voluntarily placing resources at the disposal of another party (the trustee), without any real commitment from that other party”129; and fourthly (4), “(trust situations) involves time lag. Each has to do with future actions on the part of the trustee.” The first two points are related to decisions under risk situations, the second, Coleman notes, “unlike those social exchanges which require the voluntary action of two parties, placement of trust may be a voluntary action of one party alone, the trustor.”130 By assuming that, Coleman introduces a calculative placement of trust on the postulate of maximization of utility under risk considering three variables: potential loss, if the trustee is untrustworthy (L), potential gain, if the trustee is trustworthy (G) and the chance of receiving gain as the proba125 126

127 128 129 130

See, for instance, Ostrom/Walker (2003) and Gillespie (2003), p. 4. We assume that in the short run perspective B tries to maximize his/her personal payoff even against A. Otherwise there would be no risk because the contract is perfectly self-enforced ‘by nature’. However, both players A and B accept to play the ‘trust-game’ once it is possible for both to achieve a better outcome in the long run. See Wolff (2000), p. 5. Coleman (1990), pp. 97-99. Coleman (1990), p. 99. Loc cit. p. 99. 25

bility that the trustee is trustworthy (p). Thus rational actors will place trust observing these variables: Trustor decides: Yes, if p / 1 – p is greater than L / G Indifferent, if p / 1 – p equals L / G. No, if p / 1 – p is less than L / G A rational analysis of trust can lead to intentional or motivational movement by the trustee as well as by the trustor. Taking into account the rationality of both intentional parties, in a trusting relationship A must think strategically, because A’s purposes are served by the interaction between what A does and what another does (or others do). In this sense, trust becomes a strategy for dealing with behavioral risk situations in decision-taking processes.

2.5 Trust within Organizations

2.5.1 Trust and Transaction Costs As pointed out by Arrow (1974), from the economic point of view, trust is remarkable as an efficient lubricant to economic exchange and the most efficient form of mechanism governing transactions.131 Generally, there are two possible perspectives from which to observe the efficiency of trust reducing transaction costs; first one can understand trust as a mechanism which inhibits opportunism by motivating people to cooperate with each other without explicit safeguard mechanisms, so the same output can be realized at lower costs. Secondly, as an element which promotes competitive advantage in reaching a superior performance, when trust develops and becomes an effective instrument for reaching corporate objectives more efficiently. In this case the output can be increased. For an effective analysis of the presence of trust within business organizations, it is important to understand how trust may influence transaction costs. Transaction Costs Economics has recognized that efficiency in economizing is fundamentally a function of both production costs and transaction costs.132 Transaction costs are the “costs of running the economic system.”133 Because exchange itself is costly, the most fundamental unit of analysis in economic organization theory is the transaction – or the transfer of goods or services from one individual to another. According to Williamson (1985) the key dimensions for describing transaction are (1) asset specificity, (2) uncertainty, and (3) frequency.134 Milgrom and Roberts (1992) consider additionally other relevant attributes: (4) complexity, (5) difficulty to measure performance and (6) connectedness of the transaction to 131 132 133 134

26

See Arrow (1974), p. 23. See Williamson (1985), p. 22. Arrow (1969), p. 48. See Williamson (1975) and (1996).

other transactions involving other people.135 The transactions costs rise as a result of the coordination of exchange among interactive actors, thus the theory is fundamentally concerned with the governance of contractual relations.136 Opportunism and bounded rationality are the key behavioral assumptions on which transaction costs economics relies.137 Transaction costs involve all of the costs associated with conducing exchanges within and between firms and can be decomposed into ex ante (search and contracting) and ex post transaction costs (monitoring and enforcement costs).138 Search and contracting costs include the costs of identifying a desirable trading partner and then negotiating and writing a mutual acceptable agreement. Monitoring and enforcement costs refer to the costs associated with monitoring the agreement and then taking the actions necessary to ensure that each party fulfils the predetermined set of obligations. The organizational imperative is “organize transactions so as to economize on bounded rationality while simultaneously safeguarding them against the hazards of opportunism.”139 Trust may reduce transaction costs in a number of ways. Although minimizing transaction costs is certainly an important goal for an organization, generating an environment of cooperation alongside it, to achieve one’s targets is also essential for the company, and trust is a critical element in such an environment. The consequences of these cooperative relationships go beyond the cost-reducing effects. For example, under conditions of high trust, transaction partners will spend less time on ex ante contracting because parties are confident that payoffs will be fairly divided. As a result, exchange partners do not have to plan for all future contingencies based on their trust on each other that equitable adjustments will be made as conditions change. In this way, trust promotes negotiating efficiency by enabling each party to be more flexible in granting concessions because of the expectation that the exchange partner will reciprocate in the future. This allows contractors to achieve “serial equity” (equity over a long period of time) rather than requiring immediate or “spot equity”.140 It reduces considerably the investments on ex ante bargaining. Additionally, negotiations will probably be more efficient because parties will have greater confidence that information provided by the other is not misrepresented.141 Trust has also an inverse relationship with ex post monitoring and enforcement costs for two main reasons: first, under conditions of high trust, trading parties will spend less time and resources on monitoring. If each exchange partner is confident that the other will not behave opportunistically, he/she can devote fewer resources to monitoring. On the other hand, in the absence of trust exchange partners will need to invest resources on monitoring and in enforcing the contract. Second, trust may reduce transaction costs by reducing the amount of time and resources on ex post bar135 136 137 138 139 140 141

See Milgrom/Roberts (1992), p. 30. See Williamson (1985), p. 20. See Williamson (1996), p. 253. See Williamson (1985), p. 20. Williamson (1985), p. 32. See Ouchi (1984), p. 14, and Dyer (1997), pp. 549-550. For example, Zaheer et al. (1998) found a negative relationship between inter-organizational trust and negotiation costs. 27

gaining and haggling over problems that arise in the course of transacting. In a high trust context, each party will assume that the other party is acting in ‘good faith’ and will interpret behaviors more positively.142 Consequently, trading partners spend less time haggling over problems that have emerged during the course of transacting due to mutual trust that inequities will be fairly addressed and remedied. Moving our analysis to modern business enterprises, monitoring and explicit control are time-consuming. At the most basic level, it seems clear that high-trust relationships enjoy less monitoring and require less time and energy. Managers can spend greater time in decision-making and implementation since things take less time, energy and control. Manager’s time can be dedicated to other activities rather than to managing low-trust relationships.

2.5.2 Trust as a Complement for Price and Authority From the economic perspective, social systems demand coordination in order to archive efficiency. The coordination activity requires the consumption of resources and thus, the production of related costs of contracting such as preparation, exchange, execution, control and adaptation. As we observed, the high proportion of these costs will be associated essentially with the dimensions of transactions, such as uncertainty, specificity and complexity of the work, the period of time over which transactions are repeated, difficulty of measuring performance in the transaction and how connected the transactions are to other transactions involving other people.143 Transaction Cost Economics explicitly regard efficiency as the fundamental element in determining the nature of organizations to coordinate the system, and thus, an organization such as a corporation exists because it can mediate economic transactions between its members, at lower costs than a market mechanism can.144 Markets and Hierarchies are traditional mechanisms of coordination, which have respectively, price and authority as traditional specialized control mechanisms created for and attached to each transaction. The price system is one means of organizing society to mediate competition for society’s scarce resources; it allows goods to be transferred through commerce. Individuals derive their income by selling their services, their personal services and the services of things they own, at given prices.145 However, it presents successes and failures.146 There are alternative means of achieving, in a more efficient manner, the allocation of resources. As well pointed out by Ronald Coase and Oliver Williamson,147 organizations are means of achieving the benefits of collective action in situations in which the price system

142

See Uzzi (1997), p. 39. See Williamson (1975) and (1985), and Milgrom/Roberts (1992), p. 30. See Coase (1937), pp. 390-391. 145 See Arrow (1974), p. 20. 146 See, for instance, Ouchi (1979), pp. 837-839, and Ouchi (1980/1998), pp. 249-252. 147 See Coase (1937) and Williamson (1975). 143 144

28

fails.148 An alternative to market is to establish a relational contract, for example, a hierarchy or authority relation in which a manager evaluates the facts and alternative courses of action and then instructs the other parties on what to do.149 Relational contracts are incomplete by nature. Uncertainty and bounded rationality make it impossible to foresee and agree on all future eventualities of contracts, and thus, they cannot be enforced by courts, they remain incomplete running on a more relational basis. Thus, relational contracts are embedded in a social system of relationships.150 Gibbons (2000) notes an important advantage of relational contracts. While formal contracts are almost complete and do not specify important future events which require adaptations, relational contracts allow the parties to utilize their detailed knowledge of their situations to adapt to new contingencies as they rise.151 In order to assure efficiency in relational contracting some enforcement mechanisms should be designed. Firms, as hierarchies, work mainly through authority. Therefore, a firm, especially a large corporation, provides another major area within which price relations are held in partial abeyance. In Coase (1937), a firm is a hierarchy, a structured system of authority relations. Individuals create firms by voluntary contracting in order to achieve with others more than they could alone in the marketplace. By becoming an employee in a hierarchical firm, for example, an individual submits to the authority of a superior, but in return he/she is able to earn more than is possible as an independent contractor in the market. Ouchi (1980/1998) attributes two main advantages to hierarchies: first, they use the employment relation, which is an incomplete contract. It overcomes the problem of dealing with future uncertainties, and it closely monitors the employee’s performance minimizing the problem of opportunistic behavior. Secondly, hierarchies can create an atmosphere of trust between employees much more readily than a market can between exchange partners. Because members of an organization learn that longterm relationships will reward good performance and punish the poor, they assume some common purposes and develop some congruence of goal.152 Thus, markets and hierarchies constitute two fundamentally different means for economic coordination. The former coordinates by exchange (price), the latter by direct command (authority). However, as markets, hierarchies also present failures. According to Ouchi (1980/1998), hierarchies can fail basically when the ambiguity of performance evaluation becomes significantly greater than that which brings about market failure.”153 When tasks become highly complex, unique, completely integrated (when there is a high interdependence in the process of execution of parts of the task), or ambiguous for other reasons, it becomes impossible to evaluate externally the value added by any individual and

148 149 150 151 152 153

See Arrow (1974), p. 33. See Milgrom/Roberts (1992), p. 259. See Furubotn/Richter (1991), p. 18. See Gibbons (2000), p. 13. See Ouchi (1980/1998), p. 250. Ouchi (1980/1998), p. 250. 29

bureaucratic mechanisms fail.154 Regarding the ambiguity problem, Ouchi (1980/1998) notes, “any standard which is applied will be by definition arbitrary and therefore inadequate.”155 In these cases standard mechanisms of performance measurement can no longer be efficiently applied. Performance measurement becomes subject to idiosyncratic interpretation and people might perceive them equitable only in so far as they believe that they contain a reasonable amount of accurate information. According to Ouchi (1980/1998) employment relations are relatively efficient when the measurement of performance is ambiguous but the employer’s goals are not.156 In an employment relation; each employee depends on the employer to distribute rewards equitably; if employees do not trust the employer to do so, they will demand contractual protections such as union representation and transaction costs will rise.”157 Thus, Ouchi (1980/1998) observes basically two critical elements in the efficiency of market versus employment: (1) the ambiguity of the measurements of individual performance, and (2) the congruence of the employer’s and employee’s goals.158 Beyond these traditional forms of coordination, a group of scholars have provided an alternative to market and hierarchies: networks.159 Cook et al. (2002) note that, when uncertainty and risk are associated with economic and social transactions, relatively closed trust networks often emerge to facilitate various types of informal cooperation. Under conditions of uncertainty, trust networks are created to provide a more secure transaction environment, especially when there is no reliable contract law or enforcement or when the issues in exchange cannot be well handled with explicit contracts.160 Uncertainty can arise from a number of sources and lead to different types of network solutions. Under high uncertainty and risk, transactions are likely to occur primarily among parties who know each other well and form relatively closed associations or groups (e.g. families or informal membership associations), in which the group boundaries are clear and membership is easily determined (e.g. it is easy to detect who is in and who is out of the group). According to Nohria and Eccles (1992) “the term network refers to a new ideal type of organization that is virtually different from the Weberian bureaucracy…and is characterized by relations that are based on neither hierarchical authority nor market transactions.”161 In contrast with markets or hierarchies, networks coordinate through 154 155 156 157 158 159

160 161

30

See Ouchi (1980/1998), pp. 250-251. Ouchi (1980/1998), p. 251. See Ouchi (1980/1998), p. 251. Ouchi (1980/1998), p. 251. Ouchi (1980/1998), p. 251. See, for instance, Bradach/Eccles (1989/1998), Ouchi (1980/1998), Powell (1990), Ring/Van de Ven (1992), Zaheer/Venkatraman (1995), Sydow/Windeler (1998), Calton/Lad (1995), Nooteboom (1996), Baker et al. (1999), Wigand et al. (1999) and Cook et al. (2002). See Cook et al. (2002), p. 2. See Nohria/Eccles (1992), p. 288. It is important to note that in Williamson (1975), Chapter 3, relational contracts are “hybrid” forms lying on a continuum between two extremes, market and hierarchies. In contrast, Powell (1990), Nohria/Eccles (1992), Baker et al. (1999), Wigand et al. (1999), Gibbons (2000), and Adler (2001) understand that a set of governance structures is at least two-dimensional (integrated vs. not, relational governance vs. spot) in which case it is not possible to array all governance structures on a line between markets and hierarchies. This two dimensional view of governance understands that networks are neither market nor hierarchy, but alternative forms.

less formal, more egalitarian and cooperative means.162 Where interpersonal relationships take place, a certain degree of trust must exist between interactive partners. According to Bradach and Eccles (1989/1998), relationship networks are complementary forms of coordination for markets and hierarchies and have trust as their main control mechanism. They observe that trust produced by social structures does not simply replace market and hierarchy but complements the two forms.163 According to the authors, “price, authority and trust are combined with each other in assorted ways in the empirical world.”164 Accordingly, Ouchi (1980/1989) observes that markets, hierarchies and networks are distinct mechanisms which may be present in different degrees, in any real organization.165 Bradach and Eccles (1989/1998) argue that many recent researches on the delineation of the form of coordination structures have combined the features of markets and hierarchies, as non-exclusive forms of coordination. Elements of ideal types are often found mixed together empirically and embedded in, or lead to, the formation of collateral social structures. In particular, they claim, that a great deal of research has pointed out the existence of stable long-term relationships between interdependent exchange partners.166 This line of work highlights the fact that work relationships between independent exchange partners can be stabilized through formal (e.g. written contracts, ‘hostage exchanges’) and informal mechanisms (e.g. trust).167 Bradach and Eccles (1989/1998) note that “transactions are rarely governed solely by market, hierarchies or trust, but these mechanisms serve as the building blocks for the complex social structures so common in organizational life.”168 It means there is a coexistence and combination of the three kinds of control mechanisms (see Table 2-1). On the other hand, it is also observed that the presence of trust also reduces the need for hierarchical structures of monitoring and control. Within hierarchies trust works as an efficient form of coordination by minimizing goal incongruence and tolerating high levels of ambiguity in performance evaluation.169

162 163 164 165 166 167 168 169

Thompson (1998), p. 171. See Bradach/Eccles (1989/1998), pp. 277-278. Loc cit. p. 289. See Ouchi (1980/1998), p. 248. See Bradach/Eccles (1989/1998), p. 277. See Bradach/Eccles (1989/1998), p. 279. Loc cit. p. 277. See Ouchi (1980/1998), p. 251. 31

Table 2-1: Difference between Coordination Mechanisms Criteria of differentiation

Forms of Coordination Market

Hierarchies

Control in the sense of Behavioral Control

Price

Authority

Control in the sense of Behavioral Monitoring

Output Control

Networks

Trust (Norms and Values)

Behavioral Control

Self Control

Source: Vogt (1997), p. 57 (Translation: Marco Tulio Zanini). Relationship networks work through interpersonal relationships based on reciprocity, values and beliefs, which might coexist with formal authority. Many empirical studies have found the existence of network forms of coordination though groups of companies and informal groups of people, which goes beyond the traditional limits of the firms (inter or intraorganizational forms).170 Relationship networks are based on trust between interactive partners, which works as an informal control mechanism. Bradach and Eccles (1989/1998) observe that these arrangements enable firms to: gain access to know-how unavailable in-house; spread the risk associated with uncertain ventures; benefit from economy of scale; enter new product and geographical markets rapidly; manage inter-organizational dependencies; and respond quickly and flexibly to changing circumstances.171 In Chiles and McMackin (1996), trust is a moderator mechanism. As asset specificity increases, firms would move from market governance into hybrid arrangements, and at sufficiently high levels of asset specificity, into a formal hierarchy, although such a movement would be moderated by the risk propensity of the managers involved in the decisions and the levels of trust they have in their partners.172 Rational Choice Theory, mainly through game theory, has provided important arguments to support the study of relationship networks. Examples are Hayek’s studies (1989/1998) about the coexistence of intentional and spontaneous forms of governance, and Axelrod (1984) and Kreps (1990) about cooperative games. Hayek (1989/1998) argues the coexistence of two different functions of government: intentional and spontaneous. Regarding the spontaneous form, Hayek understands that it cannot be exercised by command as is the case of intentional form of governance, but through the improvement of the rules of interaction and behavior among interactive partners. By using experiments on 170 171 172

32

See, for instance, Putnam (1996), Castells (1999) and Lorenz (2000). See Bradach/Eccles (1989/1998), p. 279. See Chiles/McMackin (1996).

reciprocal strategies of cooperative games, Axelrod (1984) demonstrated two important points in the study of relationship networks: first, mutual expectations of repetitive encounters with an unknown end date based solely on reciprocity are sufficient to induce them to cooperate, and in this way, trust can emerge spontaneously through repetitive interactions; secondly, cooperation among agents can emerge without a central authority. As we introduce in this Chapter, Kreps (1990) understands that organizations are reputation effect mechanisms held by a network of relational contracts.173

2.5.3 Trust and the Corporate Contract According to Williamson (1985), transaction costs economics poses the problem of economic organization as a problem of contracting.174 Modern Economic Contract Theory explains the transformation of the individual action into collective action through the raising of the corporate constitution.175 One of the main topics of the theory is to ensure efficiency in economic transactions by modeling efficient mechanisms which incorporate incentives and participation constraints. It proposes that every type of exchange system or human interaction can be described as an explicit and/or implicit contractual relationship, thus the theory has its basic idea in that every process of production or service provision can be modeled as an explicit or implicit contract that organizes the exchange of resources or services against other benefits.176 Differently from bilateral contracts, the corporate constitution consists of multilateral contracts.177 The firm is a nexus of contracts based on a constitution, where each individual, as a corporate constituency, accepts initial conditions and supplies some asset in return for some gain.178 The firm is a common signatory of these contracts and the entity that connects them to form a nexus assuming the coexistence of formal and informal parts of a corporate constitution.179 Wolff (1996) notes the stipulations of the corporate constitution are contained explicitly through formal agreements that can be enforced by third parties (courts), as in labor contracts or written corporate conventions, or implicitly, in the corporate culture of the firm.180 As Wolff (1996) notes “although they are not written down, form an essential part of the corporate set of rules or corporate identity.”181 The function of the corporate culture is, therefore, to assure information for interactive partners in order to reduce uncertainty about other partner’s behavior. The informal conventions inbuilt in the corporate culture provide valuable information to the members of the firm in order to support the coordination of the production processes. It is important to observe that, contrary to explicit contracts; implicit 173 174 175 176 177 178 179 180 181

See Hayek (1989/1998), Axelrod (1984) and Kreps (1990). See Williamson (1985), p. 20. See Wolff (1996), p. 96. See Wolff (2002), pp. 139 and 142. See Wolff (1996), p. 96-97. See Coase (1937), Williamson (1996, 1998), and Wolff (1996). See Wolff (1996), pp. 96-97. See Wolff (1996), p. 103. Wolff (1996), p. 103. 33

contracts cannot be contracted upon and not be monitored and enforced by courts or verified by third parties.182 Therefore, the enforcement of the corporate culture must rely on selfenforcing mechanisms. The implicit contract incorporates the strategic function of trust embedded in the corporate culture of the firm. Trust inbuilt in the corporate culture has a selfenforcing effect, in the sense that if individuals believe that everybody will continue to play the trust-game, although the short run payoff from defecting is higher than the long run payoff from rule obedience, it ensures an ongoing cooperation of all parties (see Figure 2-5).

Figure 2-5: Cooperation within a Firm as an Infinite Game -5/15

-5/15

No Trust

Trust

B

Trust

A

No Trust

No Trust

0/0

B

10/10

Trust

A

Trust

10/10 A

No Trust

-5/15

No Trust

Source: Modified by Wolff (1995a), p.125, from Kreps (1990), p.100.

Wolff (1995a) takes the examples from Kreps (1990) and Axelrod’s (1984) tit-for-tat strategy on game theory to describe the function of corporate culture as the implicit part of the corporate constitution. The conditions stipulated by the corporate constitution have to assure all players that everybody will continue to choose the trust-option as an infinite game.183 An example of the trust effects is the reputations built over interactions to deal with unforeseen contingencies.184 Therefore, trust has a hostage effect in enforcing ongoing cooperative relations among members of the firm. According to Wolff (1996), “the trust, which has been generated, can be regarded as a result of continued investments, the returns of which reduce transaction costs. Therefore, the output can be increased or the same output can be realized at lower costs.”185 In this perspective, trust becomes an implicit mechanism to enforce contractual relations, and it gives rise to the understanding of the corporate culture as a strategic instrument for productivity and performance.

182 183 184 185

34

See Wolff (1996), pp. 103-105. See Kreps (1990), p. 100, in Wolff (1995a), p. 125, Wolff (1996), p. 103, and Wolff (2000), p. 8. See Kreps (1990), pp. 124-125. Wolff (1996), p. 104.

2.5.4 Trust as a Motivational Element From the organizational perspective, it can be argued that the transaction costs result from the costs of coordinating and motivating.186 The coordination task concerns the creation of rules, as inputs, that coordinate individual or collective action, assigning the allocation of property rights (and duties) within the firm. The motivation task concerns the creation of incentives that motivate individuals to behave according to the created rules (see Figure 2-6).

Figure 2-6: Organizational Challenges

Empowerment Coordination: ability to accomplish the assigned task

Reliance

Allocation of Input

Responsibility

Task Individual

Motivation: the willingness to accomplish the assigned task

Distribution of Output

Trust

Source: Based on Wolff/Lazear (2001), p. 51.

The information function refers to the task of coordination, while the capital and enforcement functions cover motivational aspects of the organization.187 It is assumed that different organizational forms and institutional and contractual arrangements will represent different solutions to the problems of coordination and motivation. These problems give rise to transaction costs, which manifest themselves differently in different contexts.188 It becomes crucial to minimize these costs, when the aim of a formal organization is to “achieve efficiency in coordination and motivation”189 through the allocation of input and output rights. The allocation of input rights (such as capital, command and information resources) is understood as the coordination task in the firm while the allocation of output rights (such as sharing of profits according to individual’s efforts) is seen as a motivation mechanism. Moreover, coordination and motivation are closely connected and it becomes necessary to ensure that the input and output rights are in balance, that is to say, the employees of an organization have to bear the consequences of their decisions.190

186 187 188 189 190

See Milgrom/Roberts (1992), pp. 25-35, Wolff (1995a), pp. 20-22, and Wolff (1999), p. 43. See Wolff (1996), p. 105. See Milgrom/Roberts (1992), p. 29. Milgrom/Roberts (1992), p. 25. See Wolff/Lazear (2001), pp. 47-52. 35

According to Ripperger (1998), reliance and trust are distinct mechanisms to cope respectively with coordination and motivational tasks.191 They are related to the difference between the risk based on competence, when reliance is required between interactions partners, and behavioral risk, when trust is required between them. This analysis becomes relevant, for example, in the empowerment function of individuals within the firm.192 The empowerment function requires confidence in the allocation of resources based on individuals’ ability to accomplish the task. Correspondingly, it requires the attribution of responsibility based on trust over the efficient use of resources. The more relevant the tasks allowing individuals to have access to company’s capital resources, confidential information and command, inevitably the more responsibility based on trust should be attributed to them. People are ‘trusted’ with functions which involve higher behavioral risk because the performance of these tasks has more significant consequences to the overall performance of the firm. Milgrom and Roberts (1992) note, “motivation problems arise only because some plans cannot be described in a complete, enforceable contract.”193 In general terms, incomplete contracts lead to problems of information asymmetries and imperfect commitment – “the inability of parties to bind themselves to follow through on threats and promises that they would like to make but which, having made, they would later like to renounce.”194 Capital and enforcement mechanism might be efficiently applied to cope with the problem of imperfect commitment.195 The relevance of trust as enforcing mechanism becomes evident because of opportunism. Relevant tasks requiring the participation of individuals may never be efficiently accomplished without the voluntary investment of their best efforts, if they do not trust each other. As Milgrom and Roberts (1992) note, “fear of opportunism may deter parties from relying on one another as much as they should for efficiency.”196 It means that better outcomes may not be consummated because people are just reluctant to rely on each other. Certainly monetary incentives are solutions for the motivation problems and have been widely used by management. For example, an increase in wages certainly can motivate employees to work harder. By increasing wages and distributing additional bonuses for good performance management can motivate employees to be more efficient and to cooperate reasonably with each other as their rewards for superior performance might motivate them to adopt the desired course of action. However, in many circumstances a focus solely on monetary rewards may not be the most efficient way of gaining the individual’s best efforts because it may not minimize completely the problem of opportunism. Moreover, people are not motivated only by money. They have different preferences reflected in their individual utility functions, and any

191 192 193 194 195 196

36

See Ripperger (1998), p. 40. See also Section 2.9.1. See Section 2.7.4. Milgrom/Roberts (1992), p. 127. Milgrom/Roberts (1992), p. 30. See Wolff (1996), p. 105. Milgrom/Roberts (1992), p. 128.

compensation offered as an incentive has to be evaluated in these terms (incentive compatibility constraints).197 In many contemporary enterprises the importance of voluntary participation of individuals has increased significantly because organizational tasks have been increasingly driven by innovation, creativity, and teamwork cooperation, and in many cases it has determined in the end the company’s competitive advantage.198 It means that, in many cases a firms’ competitive advantage has been based on tasks which require a high degree of informal informationsharing and knowledge-transfer through cooperation among specialists in order to generate a better outcome. The more critical it becomes, the more trust is relevant.199 It gives rise to the understanding of trust as part of the ‘social capital’ of the firm.200 Trust motivates individuals, for the reason that, over time, transactions become more socially embedded in the form of informal socio-psychological contracts. In this sense, trust covers the function of binding credible commitments between parties avoiding the risk of harm and damage when engaging in interpersonal relationships.201 As Williamson (1985) comments: “idiosyncratic exchange relations that feature personal trust will survive greater stress and will display greater adaptability.”202 In this sense, we adopt the assumption that trust can be acknowledged as an implicit motivational element within social systems. For instance, Jeffries and Reed (2000) observe that interpersonal trust affects overall motivation to find optimal solutions to problems of adaptation.203 According to some authors the presence of trust fulfills some sociopsychological needs for immediate satisfaction related to the task, emanating from an individual and it is rather personal.204 In other words, such motivation implies that individuals derive some utility from performing the task itself, not only from the monetary rewards.205 Osterloh and Frey (2000) claim that, under some circumstances such implicit motivation is preferable to explicit motivation, such as monetary incentives, in the case of (1) tasks that require creativity, speed of learning and conceptual understanding, (2) in multiple-task problems when contracts cannot completely specify all relevant aspects of employee behavior and its desired outcome, and in (3) transfer of tacit knowledge.206 On the other hand, the authors comment that, implicit motivation is more difficult to change and the outcome more uncertain than relying on explicit motivation. Moreover, as motivation is not a goal in itself but it should serve to support a firm’s goals, it might be that immediate satisfaction does not necessarily contribute to achieving externally set goals.

197 198 199 200 201 202 203 204 205 206

See Milgrom/Roberts (1992), p. 599, and Rehu (2005), pp. 25-27. See Dosi (1988), p. 222. See Adler (2001), p. 215. See Coleman (1990), p. 304, and Fukuyama (1995), p. 10. See Adler (2001), p. 220. Williamson (1985), pp. 62-63. See Jeffries/Reed (2000), pp. 874-876. See, for instance, Tyler (1998), p. 163, Ostrom (2000), p. 138 and Frey/Jegen (2001), p. 600. See Wolff (1999), pp. 164-165. See Osterloh/Frey (2000), p. 10. 37

2.5.5 Trust as a Mechanism to Reduce Behavioral Risk Earlier, Knight (1921/1965) viewed the firm advantages of reduction of risk cost through risk allocation between owner-manager and employees.207 The idea of reducing behavioral risk is the fundamental property of trust largely recognized by theorists, which in the economics perspective is translated as economizing in transaction cost. In the face of complexity, Luhmann (1989) understands trust as a mechanism to stabilize insecure expectations and to decrease the associated complexity of human behavior.208 Where there is a dearth of reliable evidence, trust is supposed to assure an agent that the desirable course of events will be realized in the unknown future as if being guaranteed from past experience. This fundamental property of trust facilitates a great number of organizational tasks and managerial devices.209 In this sense, trust might operate efficiently as a complementary control mechanism with the authority system. Employment contracts and long-term cooperation contracts are typical examples of contractual incompleteness necessarily involving a certain level of mutual trust. Rather than anticipate all contingencies, relational contracts anticipate a series of uncertain, open-ended, incomplete exchanges over a reasonably long term relationship. Agency Theory provides a clear way to analyze the situations where lack of trust is relatively high. The theory applies to one type of dyadic vertical relationship from the perspective of one of the parties: the principal. Contractual problems can be significantly reduced by the placement of trust. For instance, let us consider A as the Principal and B as the Agent. A is willing to trust B, and the latter is willing to accept A’s trust-investment. We assume that they differ in their utility function, calculation, incentives and sanctions, potential surroundings and in the linked alternatives of activities and risks. By accepting the trust-investment from A, B creates an implicit contract between him and A, in order to fulfill the expectations of A. The fulfillment of this expectation is the subject of this implicit contract. 210 The objective of economic contract theory is to design a contract that minimizes the costs to the principal of this agency relationship, namely, agency costs.211 This solution should optimize the principal’s utility function, given two constraints: the agent needs to agree to work for the principal (participation constraint) and the agent needs to work hard despite the cost of effort to the agent (incentive constraint).212 The principal bears the risk of his/her delegation to the agent of certain tasks. On one hand the principal will carry the benefit and costs of the delegated tasks which entails risk inherent to the tasks resulting from environmental uncertainty. On the other hand, the agent carries the costs of his/her effort. In addition, the principal also suffers the risk of the agent not behaving in the best interests of the principal. Both of 207 208 209 210 211 212

38

See Knight (1921/1965). See Luhmann (1989), p. 1. See Dirk/Ferrin (2001), pp. 453-454. See Ripperger (1998), p. 78. See Milgrom/Roberts (1992), pp. 237-239. See Milgrom/Roberts (1992), p. 129.

these types of risk arise from the attitudinal and informational context in which the agency relationship takes place. The members differ with respect to their own goal as well as their attitude toward risk.213 The principal has two non-exclusive options to reduce agency costs: incentives and monitoring. Contracts may provide incentives to reduce the attitudinal differences by aligning the interests of the agent with those of the principal. It might be also possible to monitor the behavior of the agent in order to reduce information asymmetry. Both of these alternatives are part of the agency costs that the principal intends to reduce. In general, there are two ways of limiting the principal’s disadvantages, either by a reduction of the information asymmetry, or by a coalignment of interests between principal and agent.214 Based on previous Figure 2-4, Figure 2-7 is useful to analyze the relationship between trust and basic contractual problems.215 Adverse Selection, Moral Hazards and Hold-Up are contractual problems due to the incomplete nature of the agency relationship that can be significantly minimized by trust. The first two refers to information asymmetry problems; the last refers to one-sided specific investment problem.216 A reduction of ex ante asymmetry (Adverse Selection Problem) can be furthered by Signaling or Screening through self selection of potential contract partners. Signaling implies certain actions on the agent’s part to prove his quality. The agent bears the costs of these actions. Screening implies certain activities on the side of the principal, selecting better agents. In this case the principal carries the costs. One of the mechanisms that can also reduce the problem of Adverse Selection, for example, is reputation. Kreps (1990) shows how reputations based on trust avoid transaction costs of specifying and enforcing terms of the transaction. When contingencies are observable but not verifiable, reputation based on trust can be the only effective mechanism.217 On the other hand, a coalignment of interests is the main idea behind all mechanisms which lead to a reduction of expost contractual problems (Moral Hazard and Hold Up), and it can be reached by all contractual terms that establish a mechanism to reduce a sharing of residual incomes. Because the agent does not want to loose the relationship with the principal, he will behave according to the contract. However, the more the work force is specialized, the higher the probability of monitoring problems due to information asymmetries. In this case, and to some extent in all cases in practical life, the relationship between principal and agent relies on routinely interpersonal relationships based on some level of trust.218 The possibility of the creation of a trusting environment would reduce the possibility of selfish opportunistic behavior of the agents. Ripperger (1998) understands that trust reduces the agency costs efficiently and can 213 214 215 216 217 218

According to Bairman (1982), if these differences did not exist, agency costs could be fully avoided with an appropriate contract. See Huppert/Wolff (2002), p. 108. For an in-depth discussion about contractual problems, see for instance, Milgrom/Roberts (1992), Wolff (1995a, 1995b, 1996) Wolff/Huppert (2002) and Huppert/Wolff (2002). See Wolff (1995a), p. 73, and Wolff (2000), p. 6. See Kreps (1990), p. 108. See Ouchi (1980/1998), p. 247. 39

contribute to overcome all these problems in a way that explicit mechanisms would not, because they would be too expensive or impossible to implement.219 In this sense, trust becomes an explanation for cooperative actions when explicit control mechanisms do not efficiently apply. Through the ‘absorption’ of risk, trust might contribute to provide agency solutions to reduce the problems.

Figure 2-7: Trust and Contractual Problems Analyses Contractual Problems Adverse Selection

Moral Hazard

Hold-Up

Gaps of Time T0

A decides to make or not a trust-investment based on perceived B’s motivations

T1 Critial Risk Zone

A invest on B though a concrete trust-action

T2

T3

B decides to accept or reject A’s investment

Outcomes rise for A and B

Placement of Trust Expectation of Trust Source: Inspired by Coleman (1990).

The Adverse Selection problem occurs when the principal cannot monitor and verify all characteristics of the agent and he lacks information on the actual quality of the goods or services offered by the agent (skills, reliability, etc.).220 When trust is involved in the Adverse Selection problem, the costs of Screening can be reduced once the principal gets sufficient confidence in the agent’s credentials and no more information is necessary for his/her decision. The principal will try to choose the agent based both on his/her competence and trustworthiness.221 Candidates may try to influence the principal’s decision on their own behalf. Also the principal has to get accurate and selective information about prospective agents. The principal’s expenses in obtaining information are reduced when he/she can select a potential candidate based on trust. The perception of quality and trustworthiness of agent’s credentials, in the form of certificates, diplomas, etc. is essential to the selection process to prove agent’s 219 220 221

40

See Ripperger (1998), pp. 78-80. See Wolff (1996), pp. 86-87. See Wolff (1996), p. 75.

quality. This information can be acquired, but not exclusively, though formal or informal channels. Formal channels can be references from recognized trustworthy people or institutions (for example, the principal can access the agent’s through report documents like certificates and diplomas), or informal channels, for example, an informal relationship network based on trustworthiness (for example, the principal gets to know about a potential candidate by the recommendation of a colleague from another company). Concerning Moral Hazard and Hold-Up problems, trust can act as a social-psychological mechanism providing incentives and sanctions as a cost-efficient complement for explicit incentives systems and monitoring activities in order to create coalignment of interests.222 According to Ripperger (1998), the placement of trust by the principal can intrinsically motivate the agent, and therefore his willingness to perform.223 Behind this idea, trust brings some autonomy to the agent, who is able to decide whether to honor or dishonor the principal’s trust investment, investing efforts proportionally to his/her perception of utility in the present and/or in the future. A Hold-Up problem refers to one-sided dependency relationship. In this case, the principal might depend on agent’s performance and specific skills to increase his utility. The higher the degree of human asset specificity in this relationship, the more worthy is the existence of trust in order to attenuate opportunism. Moral Hazard problems bring doubt about the agent’s efforts and performance. It becomes critical when the principal cannot monitor the agent’s efforts and when the state of uncertainty introduces considerable risk into the transactions. In cases of high uncertainty about the agent’s performance, the principal should consider the use of implicit control mechanisms. In these cases trust is highly desirable as a source of motivation because it makes it easier to create a coalignment of interests.224 It means that the principal chooses to depend less on explicit monitoring and control, and more on trust. The principal will choose to guarantee the contract with the agent based on social and psychological mechanisms that already exist within the agency relationship.225 On the other hand, it leaves a chance for the agent (trustee) to honor or dishonor the principal’s trust investment through his/her degree of effort to accomplish the task. In this case, the agent influences directly the principal’s utility function. The agent will choose to honor the placement of trust if the costs of his/her behavior are lower than his utility.226 The agent might be intrinsically and/or extrinsically motivated to provide some level of effort (honor) according to his/her utility function.227 Ripperger (1998) comments that it is important to note that trust and explicit mechanisms can be implemented in a complementary way, however, they are not substitutes.228 She observes that if the principal increases the monitoring activities in the relationship with the agent, the agent will no longer maintain trust in the principal. In this case, 222 223 224 225 226 227 228

See Ripperger (1998), p. 80. See Ripperger (1998), p. 80. See Ripperger (1998), p. 76. See Ripperger (1998), p. 76. See Ripperger (1998), p. 76. See Rehu (2005), pp. 24-27. See Ripperger (1998), p. 80. 41

the agent will think that the principal has broken the implicit contract, thus decreasing his motivation and his level of efforts.229 A spiral of distrust is thus formed that can lead to a complete breakdown of the trust relationship. From the economic perspective, the intensification of the monitoring activity increases the possibilities for the agent’s opportunistic behavior. According to Ripperger it occurs due to the psychological and social costs of bad conscience caused by the breakdown of the trust relationship as a relational contract.

2.5.6 Relational Contracting as a Trust-Based Contract Trust is central for a better evaluation of relational contracting.230 Relational contracts, like employment contracts, are incomplete contracts used to explain cooperation in a world with unforeseeable events.231 By definition, relational contracts refer to long-term contractual relationships in a way that any new information that is available, exogenously or endogenously, might generate new behavioral options for the contracting partners.232 Therefore, it might be advantageous to all contracting parties to incorporate such new information into the relationship seeking a sequential equilibrium.233 Relational contracts cannot be monitored or enforced by third parties; therefore, contractual rearrangements are required over time in order to assure the on-going cooperation among all interactive partners within the system.234 According to a given context, trust might be highly desirable and more efficient in order to deal with those behavioral uncertainties caused by the appearance of new information. The more the frequency of new information arising within the system, the more the chances of increasing behavioral uncertainty, the more it is necessary to rely on relational contracts and efficient self-enforcing mechanisms. Thus, the relevance of trust as an efficient governance mechanism is primarily related to the degree of exogenous or endogenous uncertainty in the form of the absence or inaccuracy of information, or in the frequency of the new information within the system that might change people’s behavior. Moreover, self-enforcing mechanisms, like trust, are particularly important when the termination of

229

230

231 232 233

234

42

Excessive safeguards, for example, in the form of constant monitoring to observe partner’s behavior can undermine the relational contract. Van de Ven/Walker (1984) found that excessive monitoring and the use of formal safeguards led to distrust among the parties and increased the likelihood that the relationship would be severed. See trust as central element in relational contracting in Kreps (1990), Wolff (1996), pp. 102-105, Casson (1997), pp. 7-9, Gibbons (2000) and Gibbons (2001). Gibbons (2001) observes that relational contracts are sometimes called “self-enforcing” or “implicit”, or both. Our use of “relational” follows the legal literature, particularly Macneil (1978). For early definitions on relational contract from the economic perspective see Simon (1951) and Bull (1987). See Furubotn/Richter (2001), pp. 175 and 265. See Wolff (1995), p. 91. See Bull (1987), p. 149. He used a game theory definition for implicit contracts that is: “An implicit contract is a noncontractual agreement that corresponds to a Nash equilibrium to the repeated, post-hiring, bilateral trading game other than the degenerate agreement consisting of a sequence of Nash equilibria to the oneshot trading game.” See Wolff (1995), p. 91.

a trading relationship is too costly (particularly those in which quasi-rent is generated by investing in assets specific to a particular relationship). Relational contracts rely on relationship-specific investment and they combine features of formal contracting with reputational self-enforcement. Enforcement mechanisms might vary in cost and effectiveness, and what ultimately defines the effectiveness of these different mechanisms is the institutional arrangement.235 Particularly, employment contracts rely on selfenforcing mechanisms because they are difficult to monitor and measure;236 therefore they can be better explained through the reputation model of rational behavior in the face of unforeseen contingencies.237 The logic is that parties agree to cooperate in advance in the long term because both want to maintain their reputation for future transactions. For instance, according to Macauley (1963) businessmen keep commitments based on their reputation and personal friendship.238 The central premise of relational contracting is that it is trust-based (risk allocation or risk absorption in sharing resources), while still allowing for a legal core, in order to maintain the reputation mechanism enforcing commitments to mutual benefits.239 Each party motivated to maintain credibility and reputation with the other will behave in a cooperative way.240 Keefer and Knack (2005) observe: “Where the parties inherently trust each other, transactions that require credible promises are easier to consummate.”241 The condition for that are the longterm expectations of mutual advantageous relationships. Trust becomes essential in relational contracting because “in the absence of trust it would become very costly to arrange for alternative sanctions and guarantees, and many opportunities for mutually beneficial cooperation would have to be foregone.”242 Thus, the absence of trust might imply the absence of transactions and mutual beneficial situations. The essence of trust-based approach to contracting is that it rests on an understanding that each party should benefit from the relationship. Relational contracting involves sharing of open communication and sensitive information to promote complementary expertise rather than each party investing in its own. Macneil (1978) outlines two norms regarding to relational contracting: harmonizing internal conflict and preserving relationships.243 In employment contracts the absence of trust might imply the absence of optimum levels of efforts to achieve cooperation, and therefore, an inefficient use of the human resources. Where judicial solutions are substituted by private ordering, making promises trustworthy requires credible commitments (credibility) which are the “cement” of relational contracts 235 236 237 238 239 240 241 242 243

See Hadfield (2005), p. 200. See Keefer/Knack (2005), p. 706. See Kreps (1990) and Wolff (1996). See Macauley (1963), p. 62. See Kreps (1990), Wolff (1996), pp. 102-105, Casson (1997), pp. 7-9, and Gibbons (2000). See Kreps (1990). See Keefer/Knack (2005), p. 706. See Arrow (1969), p. 62. See Macneil (1978), p. 895. 43

between individuals.244 Credible commitments involve reciprocal acts designed to safeguard a bilateral relationship in conjunction with irreversible and specialized investments.245 As observed before, mutual trust can be used as a hostage device to build credible commitments, as reputations, through specific investments over time when people start to use reciprocal strategies.246 In Kreps (1990) reputation effects are built over a system of social norms and principles of fairness and mutual benefits which should give hierarchical inferiors an idea ex ante how the organization will react to circumstances as they arise.247 Ultimately, these principles should drive behaviors and expectations within the firm providing considerable social conditioning as job security and protection against exploitation.248 Trust rests on repeated interactions of irreversible investments. If those experiences support the trust invested, it becomes a self-enforcing mechanism attenuating the risk of opportunism between parties. A Reputation system is built over trust relationships over time, and at the same time, it is a condition for trust development as pattern of behavior.249 It is what Hardin (2002) calls the maintenance of trust through a ‘feedback loop’ effect.250 Therefore, trust can be seen as a rational form of cooperation under behavioral risk weighing up likely benefits and costs. Firms can also be acknowledged as networks of relational contracts between its members.251 According to Furubotn and Richter (2001), they are social constructs that involve, besides their rules, investments in the cultivation of the relationship between individuals.252 They claim “strengthening the organizational culture (mutual trust) represents an important goal of such investments.”253 The levels of trust within the firm, therefore, can be understood as indicators of the efficiency of relational contracting. One of the main functions of the networks of relational contracts based on mutual trust relationships is to overcome future spot market uncertainties. As Furubotn and Richter (2001) wrote: “they can be used to overcome the difficulties posed by the absence, or the limitations, of the market for future goods. They extend into the future and help reduce uncertainty regarding future spot markets. They facilitate adaptation to unforeseen events in a world driven by changes such as those arising from the appearance of new products, new markets, new production technologies, new forms of organization, and the results of political and natural events. They contribute to the rational formation of expectations (Simon 1991), and they help decision makers overcome problems arising from informational asymmetries (like the lemons problems).”254

244 245 246 247 248 249 250 251 252 253 254

44

See Furubotn/Richter (2001), p. 276. See Williamson (1985), pp. 190-191, and Williamson (1996), p. 120. See Kreps (1990), Wolff (1996), p. 103, and Furubotn/Richter (2001), pp. 276-277. See Kreps (1990), p. 125. See Williamson (1985), pp. 247 and 249. See section 3.5.4. for reputation system as a condition for trust development. See Hardin (2002), pp. 145-150. See Furubotn/Richter (2001), p. 266. See Furubotn/Richter (2001), p. 266. Furubotn/Richter (2001), p. 266. Furubotn/Richter (2001), p. 277.

2.6 Trust and Organizational Performance Coase (1937) initially emphasized that the comparative advantage of firms does not result from market failures and externalities, but rather from their capacity to organize transactions internally.255 At about the same time, Barnard (1938) emphatically defined formal organizations as “a system of consciously coordinated personal activities of forces” 256, the efficiency of which depends on communication, willingness to serve and shared purposes. Later, Coase (2002) added some other features to the costs of coordination within the firm, like the transaction costs of the ability to purchase and supply, the influence of laws, the social system, culture and the effects of technological changes, namely the ‘digital revolution’.257 According to these statements, the comparative advantage of firms lies mostly in relational features, and trust plays a significant role in enhancing all the abovementioned descriptions. Particularly in economics, many works have given emphasis to this feature.258 Management is increasingly focused on identifying the drivers of performance metrics in these critical relationships. Cannon et al. (2000) show the transactions that comprise organizational interactions are also comprised of critical intangibles which are rarely specified. It is also observed by Baker et al. (1993) that objective measures of performance are seldom perfect and the effectiveness of incentive contracting in organizations depends on a large set of social, psychological and economic factors.259 Thus, when examining drivers of successful organizational arrangements, it is necessary to capture these often subtle, hidden factors that influence relationship economics. Each case related to organizational tasks and the possibilities of assuring environmental conditions for its development have to be analyzed. Because a lot of the elements of the corporate culture are relational and they are not written down anywhere, a minimum level of trust is necessary in order to run the system; otherwise it would be impossible to take part in any transaction when the exchange requires any gap of time between the delivering of some goods or benefit of specialization in exchange. The more the levels of trust increase within the social system, the more efficient might be the use of the existent resources and the more cooperative actions are likely to take place, decreasing transaction costs.

2.6.1 Advantages of System-Trust For a more adequate economic analyzes, it is important to consider levels of trust within organizations, as independent variables that might contribute potentially to the organizational performance; however they are not determinant variables for performance. Empirical studies have often suggested a more moderating effect of trust rather than a direct effect on perfor255 256 257 258 259

See Coase (1937), p. 387. Barnard (1938), p. 72. See Coase (2002), p. 47. See, for instance, Casson (1997a/1997b). See Baker et al. (1993). 45

mance outcomes.260 It means that trust alone does not determine superior performance, or even that “low trust” companies will not present necessarily an inferior market performance. As observed before, the institutional context where transactions occur defines the efficiency of alternative governance mechanisms. Because the notion of trust brings unconditionally the idea of behavioral risk, from the economic perspective it suggests also its associated costs.261 Trust development is time-consuming and it requires specific investments for it to emerge in the system. Thus, if “high trust” environments bring potential advantages, on the other side of the coin there are necessary investments to build a trust atmosphere. The precise economic recommendation could never be “the more, the better”, but the consideration of a rational trade-off between different kinds of governance structures according to desired goals.262 Therefore, it is important to observe the associated costs in choosing between traditional explicit mechanism of monitoring and control or the creation and maintenance of a work environment based on trust. The potential managerial use of trust might require consecutive investments to maintain internally a stable environment (considering all endogenous and exogenous factors), behavioral norms and policies. The maintenance of such “high trust” business environment, allows parties to exchange without safeguards against opportunism, accepting high levels of risk. In a “low trust” business environment, people are afraid to deposit trust in each other, because they perceive a low level of motivations to act reciprocally with their potential interactive partners which leaves more chances for potential losses. However, according to specific environmental contexts, it might be possible that internal competition among individuals (which inhibits the placement of trust relationships) is more likely to produce better results. Insights from Tournament theory provide valuable analytical information on this matter.263 When the efficiency of a business unit is linked with this kind of strategy which fosters internal competition, it allows a selection of individuals and it might privilege individual effort instead of the collective one.264 In some circumstances, in order to produce a better outcome it can be more efficient to rely on low levels of interactions among workers and high individual performance rather than in team work performance. In this case, promotions including bonus and rewards as motivators are usually determined by relative workers’ performance. The larger the raise associated with a given promotion or reward, the higher the effort that workers exert to get the job. As a result workers strive hard to obtain

260 261 262 263

264

46

See a review of empirical studies on trust in Dirks/Ferrin (2001). See Wolff (2002), p. 1. See Wolff (2000), p. 2. For an in-depth discussion of Tournament theory, see for instance, Lazear/Rosen (1981) and Lazear (1998), pp. 225-227. Tournament theory provides an explanation of wage differences in terms of relative performance. The theory states that in many cases relative differences in performance, not absolute differences, determine earnings. See Lazear (1998), p. 226.

promotions that carry large salaries.265 For example, it often happens when new companies enter in highly competitive markets. At the very first moment, it might be desirable to privilege individual performance strategies to gain market-share in the short term by sacrificing any possible gains from internal cooperative behavior based on the long term rewards. In this case, internal competition might take place instead of cooperation among employees in order to create immediate incentives as a more efficient mechanism. In other words, creating a trust atmosphere which fosters cooperation among employees within the company may not be the best strategy as a control mechanism to reach the desirable outcomes, and thus, it may not be privileged. On the other hand, under such circumstances when reward systems foster competition among workers the building trust process can be difficult and lengthy. Moreover, other situations suggest the use of explicit control in preference to trust: when output is relatively easy to be measured,266 when tasks have low complexity and do not require creativity, speed of learning, conceptual understanding, or do not require transfer of tacit knowledge.267 On the other hand, it does not seem to be the case when production requires knowledgesharing in the form of sensitive information in order to deal with highly complex and specialized tasks and in the case of teamwork gains through interaction.268 It often occurs when organizational tasks are based on innovation, creation and product development.269 In these cases the best outcome is usually achieved as a product of people’s interactions and intensive exchanges. In this sense, Lazear (1998) observes that high level of competition among workers might be a problem which affects the organizational atmosphere, workers behavior, and that might be unproductive.270 He notes that those situations might encourage significantly opportunistic behavior among employees. Therefore, reward structures should be aligned with worker cooperation strategies. In the circumstances where cooperation among workers is important, firms can opt for an alternative way to affect worker behavior by changing the reward structure for lower wage spread, segregating workers by personality and inhibiting competition among team work. These situations suggest the use of trust as more efficient control mechanism. It is also observed that trust becomes critical when performance measures become more ambiguous. As Ouchi (1980/1998) comments, trust becomes fundamental to the alignment of individual and organizational objectives.271 In these cases, traditional bureaucratic mechanisms based on explicit control can fail because it becomes impossible to evaluate externally the value added per individual.

265 266 267 268 269 270 271

See Lazear (1998), p. 226. See Ouchi (1980/1998), pp. 250-251, and Osterloh/Frey (2000), p. 10. See Osterloh/Frey (2000), p. 10. See, for instance, Ouchi (1980/1998), Sako/Helper (1998) and Adler (2001). See Osterloh/Frey (2000), p. 10, and Adler (2001), p. 215. See Lazear (1998), pp. 261-262. See Ouchi (1980/1998), p. 251. 47

Some scholars observe that the intensive use of explicit control mechanisms, like formal monitoring, has a greater probability of increasing the chances for opportunism.272 As we observed before, the emphasis on explicit safeguards might damage the development of trust relationships. Damaging trust relationships might be costly because inherently, trust doesn’t call for additional expenses in legal safeguards. Where trust exists at a certain level, the need for explicit monitoring and control and associated costs will decrease. Moreover, the intensive use of explicit control mechanisms involves not only investments in monitoring and formal control, but probably a considerable loss of implicit motivation of individuals to generate commitments towards organizational goals.273 Therefore, because legal contracts can be inefficient (too costly, inherently incomplete, possibly unverifiable and subject to the particularities of the addressed legal system) they can be used only in extreme situations or to fulfill standard requirements of the legal framework. One has to observe that formal agreements such as explicit contracts might work extrinsically as motivation to encourage prospective interactive partners to place trust in each other.274 An employment contract is an example which provides a reasonable illustration of these situations. Although an explicit contract is usually signed between parties, it cannot take away all risk involved in the interactions, because bounded rationality and incomplete information make it impossible to calculate all possible contingencies. However, exactly because a formal contract previously exists between these parties, a relational contract might develop between them. In other words, trust is complemented by formal mechanisms that contain the risk of misplaced trust. In this case the formal contract works only as a broad safeguard mechanism to frame some general principles and expectations within the relationship without prevention against all future contingencies. Ouchi (1980/1998) and Dasgupta (2000) emphasize that the inability to monitor other’s actions is crucial in deciding for explicit mechanisms or trust.275 Dasgupta (2000) speaks of trust as involving correct expectations about the actions of other people who influence one’s own choice of actions when that action must be chosen even before it is possible to monitor the actions of these others.276 In the same vein, Lorenz (2000) and Gambetta (2000) argue that if there are associated costs related to the promotion of trust, those are even higher in the absence of trust.277 Similarly, he argues that the necessity of trust is directly related to our incapacity to monitor other’s actions. According to Gambetta (2000), because trust is invested even before trustees’ reactions are known; it supposes the superiority of the efficiency of this implicit mechanism over explicit monitoring and control mechanisms.278 Gambetta (1993) uses the example of Sicilian Mafia to illustrate how introducing behavioral uncertainty into the system (under the absence of trust) requires a third party in order to assure economic ex272 273 274 275 276 277 278

48

See, for instance, Van de Ven/Walker (1984) and Aulakh et al. (1996). See Ripperger (1998), p. 80. See Gambetta (2000), pp. 221-222. See Ouchi (1980/1998), pp. 250-251, and Dasgupta (2000), p. 51. See Dasgupta (2000), p. 51. See Lorenz (2000), p. 209, and Gambetta (2000), p. 235. See Gambetta (2000), p. 221.

change. The Sicilian Mafia works as the third party in order to assure economic exchange between partners – increasing significantly transaction costs. On the other hand, the Mafia itself is an example of a network which relies on trust among its members based on informality, clan and loyalty.279 Therefore, empirically we will always find a combination and coexistence of the explicit and implicit control mechanisms within different business environments in a complementary way.280 For instance, Bradach and Eccles (1989/1998) argue that many recent researches on the delineation of the form of coordination structures have combined the features of markets and hierarchies, as non-exclusive forms of coordination. Elements of ideal types are often found mixed together empirically and embedded in, or lead to, the formation of collateral social structures. In particular, they claim that a great deal of research has pointed out the existence of stable long-term relationships between interdependent exchange partners.281 As observed, this line of work highlights the fact that work relationships between independent exchange partners can be stabilized through formal and informal mechanism. Ouchi (1980/1998) notes that, a complementary condition between explicit and implicit control mechanisms is frequently found in different degrees, in any real organization.282

2.6.2 Empirical Contributions to Performance Analysis Many empirical studies relate the benefits and advantages of trust to individual, group and organizational performance. Empirical research has demonstrated the strong relationship of the positive effects of trust with the knowledge-transfer process,283 organizational commitment,284 organizational efficiency and productivity,285 communication, acceptance of decision/goal, organizational citizenship behaviors, employee satisfaction, negotiation process, conflict mediation, individual performance, and team performance.286 Trust has also been observed as mediator for distributive and procedural justice, job satisfaction, and turnover intentions.287 Dirks and Ferrin (2001) present a large study on the empirical evidence of trust and its effects on individual’s attitudes and behavior within organizations in order to understand the general benefits of trust to these individuals and their organizations. According to the authors, it can be generally expected that superior levels of trust result in more positive attitudes, high levels of cooperative behavior and consequently, superior performance. Their study focused on quantitative measured trust (i.e., with a survey), and the element trust was 279 280 281 282 283 284 285 286 287

See Gambetta (1993). See Ouchi (1980/1998), p. 248, and Bradach/Eccles (1989/1998), p. 277. See Bradach/Eccles (1989/1998), pp. 277 and 279. See Ouchi (1980/1998), p. 248. See, for instance, Rolland/Chauvel (2000) and Roberts (2000). See, for instance, Pillai et al. (1999), Brockner et al. (1997), Ugboro (2003), Farrell (2003), Crossman/LeeKelley (2004), Lazzarini et al. (2004), and When/Kwon (2004). See, for instance, Ring/van de Ven (1992), Lane/Buchmann (1998), and Sako (1998b). See Dirks/Ferrin (2001). See, for instance, Aryee et al. (2002). 49

defined as a cognitive psychological state (as we do in this study). Trust was approached as an independent variable related to a dependent variable that was a behavior, an indicator of performance, or a work-related attitude or cognition. Among many others, trust was positively related to employee commitment, communication, accuracy of information, and acceptance of decision/goal. In conclusion, Dirks and Ferrin’s meta-analysis of trust studies provides a list of empirical works on the positive relationship between trust and individual performance, group performance and unit performance.288 Empirical research about virtual work teams have shown that due to the lack of physical interaction, and the absence of its verbal and non verbal properties, and communication with face-to-face interaction, virtual teams demonstrated a lack of trust reverting to the traditional authority- based control systems for self-control and autonomy. Not surprisingly, low-trust teams were found to be less productive than trustworthy ones.289 However, although they are rare, other studies like Langfred (2004) explored how trust and monitoring interacted with individual autonomy to affect performance in self-managing teams (see Figure 2-8).290

Figure 2-8: Relationship between Trust and Monitoring in Self-Managing Teams

MONITORING

M2 M1

C1

C2 TRUST Source: Modified from Langfred (2004), p. 392.

He explored boundary conditions and contingencies under which high trust in teams can be harmful and concluded that the excessive levels of trust might be prejudicial in specific circumstances. Langfred (2004) used 300 participants of different nationalities and gender groups distributed within 76 teams with response rate of 83 percent.291 He concluded that, under some conditions, namely high individual autonomy and high levels of trust, trust in self-managing teams can be harmful because the members of such teams become reluctant to 288 289 290 291

50

See Dirks/Ferrin (2001), p. 453-454. See Coutu (1998), and Jarvenpaa et al. (1998). See Langfred (2004), p. 385. See Langfred (2004), p. 388.

monitor each other. He notes: “This pattern suggests that the more team members trust one another, the less they choose to monitor one another, and when this condition is combined with high levels of individual autonomy, performance suffers”.292 Therefore, Langfred (2004) provides arguments that, the interaction between the amount of autonomy and the amount of monitoring in a team reveals some negative effects of high trust on team performance. To the best of our knowledge Langfred’s (2004) is one of the few studies that attempts to investigate possible negative effects of high levels of trust on performance, and it becomes valuable to analyze some questions about the value of trust through the lens of the economic efficiency principle. However, Langfred’s work is an exception rather than regular empirical evidence.

2.6.3 Trust Investment Analysis Trust can contribute substantially to organizational performance according to a given context; however, any corporate program to improve trust should follow the economic principles of efficiency in which the benefit of such a program should surpass its costs. We exemplify it by taking a simple model to illustrate the gain condition of investments on a specific ‘trust program’ within a given company.293 We take (R) as the returns of the company as a function difference between an optimal (very best) return without opportunism i.e. in the absence of behavioral risk (X) and an inflicted loss due to (O) opportunism. Thus, we have the first function: (1) R = X – O The parameter O (loss due to opportunism) can be defined as follows: (2) O = b/ C+1 The function (2) assumes that the loss due to opportunism (O) is a function of b over C+1, given that b > 0, where b is assumed as a dependent variable of the corporate culture which reflects the level of loss due to opportunism within the company;294 also, given that C • 0, where C is assumed to be the variable cost of the implementation of a ‘trust program’. If we continue this analysis, there will be a fixed cost F for implementing this program. This gives rise to the following profit function: (03) P = X – O – (C + F) By inserting function (2) into (3) P = X – b/ (C+1) – C – F

292 293 294

Langfred (2004), p. 391. See Wieland (1996), pp. 178-180. Note that we want to understand just one aspect of the corporate culture regarding the possible creation of trust – increasing investments in the ‘trust program’ which will decrease the variable b related to the level of opportunism. 51

The profit function allows us to understand the additional benefits of the ‘trust program’ by minimizing the costs of opportunism O. We can take now the First Order Condition (FOC) of the profit function to understand the relationship between the marginal benefit (MB) and marginal costs (MC) of the ‘trust program’. So, we have: (4) (FOC) C = ¥b – 1 From this result, we have the relationship in Figure 2-9. Figure 2-9 allows us to understand that by investing in a ‘trust program’, C1 leads to a return R1, and the optimal cost relation Copt. leads to the optimal return Ropt. Note that any additional investment before the optimal point, leads to a “more than” increase in the return. On the other hand, after the optimal point, any additional investment will lead to an increase in return at a diminishing rate (see point C2, R2). Also, the area between the revenue curve (R) and cost curve (Ctotal) depicts the possible profits (P) of the ‘trust program’. Therefore it can be seen that the benefit of introducing such ‘trust program’ falls between the points H1 and H2.

Figure 2-9: Trust Investment Evaluation

C, R Ctotal

R2 Ropt.

P

Cvariable

R1

F

R

Ffixed H1

C1

Copt.

C2

H2

C

Source: Based on Wieland (1996), p. 179, (Translation: Marco Tulio Zanini).

52

In order to follow the objective of this study, it is additionally important to consider an environmental variable, which changes according to different industry-specific institutional frameworks.295 Costs will probably change under different industrial environmental variables such as the industrial nature of the activities, level of internal competition, bargaining power of employer and employees (buyers and sellers), levels of transfer prices, characteristics of technology employed, the availability of substitutes, etc. Therefore, an environmental variable (Ei) will influence differently the development of trust within companies from different industries (Ei1, Ei2, Ei3 … Ein). It becomes important for management to observe two questions in order to invest in trust development: First, how desirable it might be for a company to develop and sustain trust among its members. Secondly, observing the influence of exogenous and endogenous variables, how possible it is for a company to develop trust efficiently. The first question refers to the definition of the optimum level of trust - the possible benefits that might arise from consecutive investments in the creation and maintenance of trust within the system for specific purposes; the second question points to the limiting environmental factors which might restrict trust development – implementing that level of trust given specific circumstances. Management should evaluate the costs of implementing the features for trust development under its specific environment observing managerial need and capacity (see Figure 2-10). In other words, even when trust is highly desirable, limiting factors, like the level of environmental uncertainty and instability, might be a problem for the efficient development of trust as an element of the corporate culture. As we show later on, institutional frameworks might represent a considerable constraint to this task.

Figure 2-10: Managerial Evaluation of Investments on Trust Specific Institutional Environment

Corporate Governance

Managerial Need for Trust Development

295

Managerial Capacity for Trust Development

This assumption is in line with the reasoning behind our previous definition of trust as a three-part relation (see Sections 2.4. and 2.9). For instance, Woolthuis et al. (2002), p.14, observe that for a better understanding of the relationship between trust and formal control, trust should be analyzed under environmental conditions. 53

2.7 Specific Functions of Trust

2.7.1 Solving Performance Ambiguity As observed in Section 2.5.2, hierarchies fail basically when the ambiguity of performance evaluation becomes significantly greater than that which brings about market failure.296 According to Ouchi (1980/1998) when tasks become highly complex, unique, completely integrated (when there is a high interdependence in the process of execution of parts of the task), or ambiguous for other reasons, it becomes impossible to evaluate externally the value added by any individual, and bureaucratic mechanisms fail.297 He notes that employment relations are relatively efficient when the measurement of performance is ambiguous but the employer’s goals are not. In an employment relation; each employee depends on the employer to distribute rewards equitably; if employees do not trust the employer to do so, they will demand contractual protections such as union representation and transaction costs will rise.”298 Regarding the ambiguity problem, Ouchi (1980/1998) notes, “any standard which is applied will be by definition arbitrary and therefore inadequate”.299 In these cases standard mechanisms of performance measurement can no longer be efficiently applied. Performance measurements become subject to idiosyncratic interpretation and people might perceive them equitable only in so far as they believe that they contain a reasonable amount of accurate information. Mainly when tasks involve creativity and innovation based on intensive knowledge application and multi-group tasks, it becomes difficult for management to rely only on objective measures. Moreover, objective measures of performance are seldom perfect and the effectiveness of incentive contracting in organizations depends on a large set of social, psychological and economic factors.300 In this sense, many contemporary firms have been developing more complex metrics that go beyond market-based performance criteria for organizational assessment, like “balanced scorecard”,301 in order to develop more efficient control mechanisms and identify and nurture their “core competences” over the longer term.302 However, in many cases, subjective measures based on idiosyncratic evaluations of the relationships between managers and employees are the usual ways to evaluate and distribute rewards.303 As commented before, trust becomes important when management has difficulty in accessing employee’s individual performance. The coalignment of interests between individual’s and corporate goals might be achieved only if employees perceive a fair system of reward based on assessment of their contributions. In other words, under some circumstances the coalignment of interests 296 297 298 299 300 301 302 303

54

See Ouchi (1980/1998), p. 250. See Ouchi (1980/1998), pp. 250-251. Ouchi (1980/1998), p. 251. Ouchi (1980/1998), p. 251. See, for instance, Baker et al. (1993), Ghoshal/Moran (1996), and Casson (1997b). See Kaplan/Norton (1996). See Adler (2001), p. 220. See Tosi et al. (1994), p. 42.

might be better achieved if employees trust management to measure and to share equitably the outcomes of their individual efforts, otherwise, a sense of unfairness might have a negative motivational effect. Facing difficulties to access individual performance, a system that privileges the use of perceived fairness norms and mutually beneficial rules by aligning interests can more easily win over people’s best efforts. If people’s efforts are proportionally aligned with the incentives schemes, according to Ouchi (1980/1998), in the cases of difficulty in accessing individual performance, it seems to be much more appropriate to promote trust to control exchange.304

2.7.2 Enforcement of Employee Commitment Trust and the formation of employee commitment are solutions to the problem of social uncertainty305 and there is a close relationship between them in the way that the former might significantly (implicitly) foster the latter. In order to understand this relationship, initially we have to differentiate between those commitments necessary for people to trust each other as preconditions for trust investments, and the concept of employee commitment. Regarding the former, the literature on the calculative approach on trust creates a strong relationship with commitment.306 The creation of committed relationships as repeated, long-term interactions among the same interactive partners allows for a hosting effect of trust as an informal mechanism that supports cooperation under social uncertainty. The continuity of a trusting relationship over time depends on mutual interests and incentive compatibility in order to create commitments.307 Therefore, the most common way is to structure incentives to match the desired commitment. Presumably from this perspective it can be assumed that perceived commitments constitute preconditions for sustaining the ongoing trust relationships. If not, people would not have reasons to enter risky situations. Regarding the concept of employee commitment, very often organizational economics and management literature provide a multidimensional perspective of this element. In this study we borrow the general definition of Robbins and Coulter (1999) of employee commitment, that is “an employee’s orientation toward the organization in terms of his or her loyalty to, identification with, and involvement in the organization.”308 According to the author job involvement is the degree to which an employee identifies with his/her job, actively participates 304 305 306 307 308

See Ouchi (1980/1998). See Yamagishi/Yamagishi (1994), p. 130. See, for instance, Ripperger (1998), and Hardin (2002). See Hardin (2002), p. 5. See Robbins/Coulter (1999), p. 420. We assume the terms ‘orientation’, ‘identification’ and ‘involvement’ in the sense of corporate culture efficiency, calculated by its capacity to generate cooperative relations as trust-options (see Section 2.5.3). Another similar definition widely accepted comes from Porter et al. (1974) who define employee commitment as the relative strength of the individual’s involvement with, and in a particular organization. This is operationalized in terms of three factors: a strong desire to remain a member of the organization; a strong belief in, and acceptance of, the values and goals of the organization; and a readiness to exert considerable effort on behalf of the organization. 55

in it, and considers his/her job performance to be important to his/her self-worth. However it is widely acknowledged by organizational theorists that employee commitment is a multidimensional variable. For instance, Steers (1977) and Meyer and Allen (1997) provide a multidimensional definition of employee commitment. According to Steers (1977) it is: “the relative strength of an individual’s identification with and involvement in a particular organization; (1) a strong belief in and acceptance of the organization’s goals and values; (2) a willingness to exert considerable effort on behalf of the organization; and (3) a strong desire to maintain membership in the organization.”309 Meyer and Allen (1997) present another multidimensional view of employee commitment for empirical research. They propose that employee commitment consist of three components: affective – based on emotional attachments to the organization having experienced membership positively; continuance – based on calculative reasoning as a decision to remain with the organization because of the costs of leaving; and normative – based on normative bases as the sense of obligation to continue with the organization for loyalty. These definitions allow us to understand that employee commitment is the positive effect of incentive schemas applied to organizations. The multidimensional levels of employee commitment assess the degree of attachment of the employees with respect to a specific organization and its members. Moreover, by observing empirical studies on employee commitment, Legge (1995) comments that employee commitment measures are the best predictor of actual labor turnover and it has a strong relationship with employee satisfaction and motivation, and a moderate relationship with performance.310 These issues will be addressed in our empirical study (See Chapter 4). Organizational theorists and researches have developed a supportive understanding of employee commitment. Legge (1995) observes that the development of the subject has been intimately connected to the management of cultural change.311 In this sense, Legge notes, organizational commitment is related to organizational structures, policies and culture. This line of approach has its roots in cognitive theories and assumes instrumental and calculative motivations.312 This view considers that individuals become committed as a result of incentives, like pension schemes and investments in human capital development, which would be lost, at a cost to the individual, if he/she were to leave. In this line, Meyer and Allen (1997) note that individuals might be committed differently to the organization, the unit, the supervisor, and/or the workgroup for different reasons.313 The authors point out that the primary benefit of commitment is employee retention. Therefore, for performance evaluation purposes, employee commitment evaluates the retention of firm-specific human capital. From the economic perspective, Barnard (1938) argued earlier that there is a gap between the organizational objectives pursued by the executive and the personal objectives held by the 309 310 311 312 313

56

See Steers (1977), p. 48. See Lagge (1995), p. 183. See Legge (1995), p. 174. See also Tosi et al. (1994), p. 259. See discussions in Legge (1995), pp. 174-207, Coopey/Hartley (1991), p. 19, and Guest (1992), p. 115. See Meyer/Allen (1997), p. 14.

individual members, so that successful organizational performance would require both effectiveness of activities and satisfaction of individual motives.314 Barnard observed that an organization consists of people having diverse and conflicting interests, yet each person gains from interacting with others, in particular through their coordinated activities. In the perspective of the contractual incompleteness with unforeseen contingencies it is essentially a motivational problem. As Milgrom and Roberts (1992) note, imperfect commitment is one of the main motivation problems which affect transaction costs.315 How management can design efficient mechanisms to generate employee’s willingness to provide their best through the alignment of their personal interests towards organizational goals. It is important to note that employees might be strongly committed to each other, but not necessarily commitment to an organization’s objectives. Therefore, in order to archive employee commitment, a condition has to be satisfied, that is, the coalignment of employee’s interests and organizational objectives. In this sense, it is necessary to structure incentives’ schemes to match the desired employee commitments. It can be acknowledged that employee commitment is a result of a set of well-designed motivational incentives to achieve the congruence of interests between individual and organizational goals. However, individuals might be committed to organizational objectives through different supportive incentives and reasons. It can be assumed that individuals have different preferences (different individual utility functions) which are contingent on their needs.316 Their commitments might be built on a variety of material and nonmaterial incentives to satisfy these needs. The efficiency of an incentive scheme is associated with the correct understanding of people’s preferences, considering in its design, material (i.e., wages, bonus, etc.) and nonmaterial incentives (i.e., recognition, work task, etc.).317 The authors observe that some nonpecuniary benefits and costs whose values are subjective can only be evaluated by the employee. The authors claim: “people may form personal attachments to their co-workers or communities; they may have pride or pleasure in their work and want to see projects through to completion; they may value the firm’s style, prestige, or corporate culture…they may have private estimates of the firm’s prospects and how these will influence their own futures; or they may simply find one job more or less pleasing to do than another.”318 They claim ultimately that, all of this increases worker’s productivity to the firm. Therefore not only material incentives should be considered, but also to a large extent nonmaterial incentives which become increasingly important as contracts move toward long-term relationships. Referring to self-enforcement mechanisms, Furubotn and Richter (2001) argue that “the exchange of hostages in the form of investments in feelings may be understood as a device to make commitments credible.”319 The authors comment on Frank’s (1990) work. Frank (1990) distinguishes between commitment models and self-interest models. He explains 314 315 316 317 318 319

See Barnard (1938), pp. 34-36. See Milgrom/Roberts (1992), p. 30. See Rehu (2005), p. 24. See Milgrom/Roberts (1992), p. 345. Milgrom/Roberts (1992), p. 345. Furubotn/Richter (2001), p. 161. 57

the former as concerned with situations in which seemingly irrational behavior can be explained by the existence of emotional predispositions that serve to solve commitment problems, while the latter type considers cases in which people always act narrowly and straightforwardly in the pursuit of self-interest.320 As many scholars do, Furubotn and Richter (2001) argue that the concept of “loyalty” may be assessed from a more general perspective of commitment. For the authors, “loyalty can be understood as the identification of an individual with corporate goals; and feelings and emotions are involved in such association.”321 Along the same line of reasoning, Simon (1991) emphasized, “Pride and work and organizational loyalty are widespread phenomena in organizations…Willingness of employees at all levels to assume responsibility for producing results – not simply “following rules” – is generally believed to be a major determinant of organizational success.”322 Thus, employee commitment consists in a multidimensional variable built on a combination of intrinsic and extrinsic incentives. It considers not only calculative self-interest, but also those incentives and benefits which come from the socialization and interaction within the organization, like standards of reciprocity and affective-emotional attachments. In this sense, the link of employee commitment with trust becomes clear. As observed in Section 2.4.2, both employee commitment and trust complement each other as sources of information to encourage the placement of trust. In this case, trust might work as an efficient motivational (self-enforcing) mechanism to promote employee commitment. Some observations suggest a strong relationship between the building process of trust and employee commitment. Antecedents of both trust and employee commitment include perceptions of fairness, and mutual expectations.323 It can be observed that both trust and employee commitment rely on long-term expectations and require long-term strategies to develop.324 Therefore, both trust and employee commitment are built on the congruence of interests created by incentive design and long term perspectives. Employee commitment will represent the employees’ general degree of attachment to the organization considering material and nonmaterial incentives. If the incentive scheme is well designed to reach the organization’s objectives, presumably it builds credible commitments, like reputations, that motivate agents to trust and cooperate with each other to reach common benefits. Finally it might work as a motivational element to enforce employee commitment. As Milgrom and Roberts (1992) note, “achieving commitment can be very valuable because it can affect other’s expectations about your behavior and thereby the behavior they adopt.”325 Bachmann (2003) claims that when people engage in trust actions they are making pre320 321 322 323 324 325

58

See Frank (1990), in Furubotn/Richter (2001), p. 161. Furubotn/Richter (2001), p. 161. See also loyalty as a general concept of employee commitment in Legge (1995), Robbins/Coulter (1999), and Simon (1991). See Simon (1991), pp. 34-37. See, for instance, fairness as antecedent of trust in Ouchi (1980/1998), p. 250, Kreps (1990), p. 124, and Keefer/Knack (2005), p. 716, as antecedent of employee commitment in Guest (1997), pp. 21-22. See Guest (1997), p. 21, and Morgan/Hunt (1994), p. 21. Milgrom/Roberts (1992), p. 133.

commitments, in the sense that they assume the other party will not behave opportunistically.326 In this sense Morgan and Hunt (1994) note that trust is a determinant of relationship commitment that is, trust is valued in a way that partners will commit to relationships which possess trust.327 Hence, trust can be acknowledged as one element to foster employee commitment, as a motivational mechanism which creates implicit commitments among agents. What one can observe is a ‘virtuous cycle’ between trust and employee commitment,328 mainly through empirical evidence.329 For example, When and Kwon (2004) propose a conceptual model where trust is a basic factor in building commitments in a network form.330 Although trust is not necessarily a determinant factor in the creation of employee commitment, it can be assumed that, whatever may be the organizational context and its respective incentive scheme design for enforcing employee commitment, a certain level of trust is present to maintain a reasonable level of interaction among people mainly in long-term relationships. The higher the levels of trust, the stronger are the commitments among people to fulfill others’ expectations. If these commitments among exchange partners are aligned to achieve organizational goals, it is expected that an increase in the levels of trust will be directly related to an increase in the levels of employee commitment. Therefore, understanding employee commitment measures as predictors of labor turnover with a strong relationship with employee satisfaction and motivation, and a moderate relationship with performance,331 will be analyzed in our empirical study in relation to trust measures (see Chapter 4). It will provide a broader understanding of the effects of incentive schemes on employee’s behavior toward employees’ future expectations, and therefore, of the possible changes in relational contracts.

2.7.3 Information-Sharing and Knowledge Transfer There are some circumstances in which trust is more desirable than the application of other explicit mechanisms.332 According to Adler (2001), as knowledge-transfer becomes increasingly important in our economy, trust has turned out to be increasingly important to deal with knowledge-based assets.333 One of the problems of organizing coordination is the availability of information within the companies. This information can be explicit or implicit knowledge written in manuals or only available in people’s minds because it would be impossible or inefficient to write it down. A considerable amount of information in the form of tacit knowledge is not written or explicitly available, but it exists in the form of intellectual capital and unwrit326 327 328 329

330 331 332 333

See Bachmann (2003), p. 59. See Morgan/Hunt (1994), p. 35. Instead of “a virtuous cycle”, Hardin (2002), pp. 146-148 calls it a “causal feedback loop.” See the relationship between trust and employee commitment in Pillai et al. (1999), Brockner et al. (1997), Ugboro (2003), Farrell (2003), Crossman/Lee-Kelley (2004), Lazzarini et al. (2004), and When/Kwon (2004). See When/Kwon (2004), pp. 5-6. See Lagge (1995), p. 183. See Osterloh/Frey (2000), p.10. See Adler (2001), p. 215. 59

ten implicit rules (embedded in the corporate culture) in order to coordinate corporate activities, driving routines and behaviors within the system.334 And it becomes vital, for example, to sustain the innovation process. Moreover, empirical evidence shows that information and communication activities represent two thirds of management working hours.335 Some works indicate that trust facilitates enormously the information-sharing process within organizations.336 Once the presence of trust reduces behavioral uncertainty among interactive partners, it increases the probability of trading partner’s willingness to expand the amount of information sharing and explore new mutually beneficial arrangements. As trust declines, people are increasingly unwilling to take risks and demand greater protection against the probability of betrayal and damages. If partners can trust that others will not behave opportunistically, it will be more willing to share confidential and relevant information regarding production costs, product design and development, and process innovations.337 For example, in teamwork focused on product development, people will voluntarily share their expertise and provide their best contributions only if they can be sure that the others will not steal their ideas and contributions, or will not share them with ‘outsiders’. In the absence of trust, information sharing on costs of new ideas and technologies is unlikely because information could be stolen or used opportunistically. The lack of trust may cause suppressing of potentially relevant information that would be useful for problem solving or innovation processes. In economic terms, this kind of risk related to “Hidden intention” is acknowledged as the Hold Up problem.338 It might happen when there is a dependency of the principal on the resources which the agent contributes to the production process. Even if it is possible to monitor and evaluate the agent’s effort and all external factors, the principal does not have the means to change the situation. For example, people working on systems or product development may be unwilling to share information if they do not believe that others will work cooperatively in a reciprocal manner. In particular, they may suppress this information because they might feel that their information exposes their weaknesses for their peers or supervisors, even if the sharing of this information could lead to effective contributions. It means, under the fear of harm and possible damage by using their contributions, people might be fearful of providing their full knowledge for the use of the team.339 In this way trust reinforces the prospect of continuity in a relationship and commitment among members, working basically as a motivational element to strengthen the informal channels of information supplying within the system. The presence of trust becomes more critical as soon as the knowledge transferring process as intellectual property becomes one of the main sources of profit to companies. As was commented before, the more the work force is specialized, the more difficult it is to monitor 334 335 336 337 338 339

60

See Wolff (1996), p. 105, and Williamson (1985), p. 62. See, for instance, Picot/Reichwald (1987). See, for instance, Rolland/Chauvel (2000), Roberts (2000) and Dekker et al. (2002). See Aoki (1988), p. 123, and Nishiguchi (1994), p. 45. See Wolff (1995b), p. 88. See Detecom (2004), pp. 77-78. The empirical study presents a variety of management styles, among them a trust-based management style is illustrated to foster creativity and customer relationship.

agents. In this case the relationship between people relies on routinely interpersonal relationships based on some level of trust. Lane and Buchmann (1998) argue that productive systems based on information and intensive knowledge application require much information sharing in the form of tacit information built through consensual relationships. In this way, they argue that relationships based on trust become highly desirable property, not only as an implicit control mechanism for the productive activities, but also as a precondition for companies reaching superior performance and competitive advantage in a new business environment.340 As the costs of information transfer increase, it becomes specific knowledge.341 For instance, technology companies working with innovation as a continuous and intensive product development within high competitive markets, specific knowledge in the form of high human asset specificity becomes the most important capital of the firm. Mainly in the case of large hierarchical companies, internal routines, processes and resources allocation are subject to constant change for adaptation to new demands. An example of this is the Information and Communication Technologies (ICT) industry environment where companies survive under continuous reorganization processes due to intensive technological innovation and competition. According to Rothwell (1992), innovation is very much a people-centered process where ‘intangibles’ are more significant than ‘tangibles’. According to the author, hardware changes seem to be amongst the least difficult aspects of industrial innovation while behavioral and cultural features are less easily amenable to managerial control.342 The development of specific products is often related to specific knowledge regarding a specific technology, and this knowledge, as capital, is held by individuals who establish routines and processes to deploy products. In this case, rather than formal processes internalized through hierarchies, the ownership of specific knowledge is commonly retained by a small group of experts or even a single person, as idiosyncratic or assembled knowledge.343 In this sense, Kunda (1992) notes the effects of implicit control creating high employee commitment in high-technological corporations. Kunda observes that implicit motivation is extremely important to maintain an innovation process and it is highly dependent on the efficacy of the corporate culture as a guideline for action.344 In many circumstances under high competitive markets and intensive product development, when time becomes a critical factor it is not possible to retain this knowledge-capital because it is also the subject of constant and dynamic change and development.345 In other words, this specific knowledge remains basically in a few people’s hands as valuable tacit knowledge. It generates high human asset specificity because it would be impossible, or inefficient, to create mechanisms to store this knowledge in the form of information within the company. Hence, trust among members of the firms plays a significant role in this case. Because the absence of 340 341 342 343 344 345

See Lane/Buchmann (1998), and Ring/van de Ven (1992). See Brickley et al. (2001), pp. 54-55. See Rothwell (1992), p. 229. See Wigand et al. (1999), pp. 119-123. See also Dosi (1988) and Rothwell (1992). See Kunda (1992), p. 4-8. See Chapter 3, Section 3.2. 61

formal and continuous processes and routines, due to constant change in the production systems, the costs of specific knowledge transfer increase significantly if people perceive relevant behavioral risk, and thus, they would avoid exchanging freely with others (namely the HoldUp problem). In these cases, people’s best efforts can never materialize and such situations might threaten the company’s competitive advantage. A trust atmosphere is therefore fundamental for maintaining the innovation process when the value-added by one individual represents a significant proportion of the firm’s capital. Moreover, Wigand et al. (1999) explain the importance of trust in the economic evaluation of information. According to the authors, the economic value of information is determined through the information’s utility for problem solving and decision-making processes and the activities necessary for procuring and producing this information.346 They introduce the information paradox as a typical problem of information evaluation. An evaluation of information presupposes that the information to be procured is already known. According to the authors, ironically, due to information properties, the evaluation of information can only occur ex post, otherwise the buyer no longer has to buy it. For what is not known, and thus not testable, cannot be evaluated. As they note, the information problem might be relatively solved with trust. Instead of the explicit ex ante evaluation of information, trust in the information source often serves as an evaluation substitute.

2.7.4 Reorganization Processes Beckert et al. (1998) introduce a model (see Figure 2-11) which illustrates the increasing necessity of trust in the reorganization processes of functional structures, when these move forward to more decentralized and flexible forms. In these processes, the trust existing in interpersonal relationships becomes valuable social capital in dealing with the adaptation problem. Reorganization processes introduce high uncertainties affecting human behaviour directly. They increase the chances of opportunism and conflicts. Modern business companies constantly have to adapt their structures, and the reorganization processes assume different degrees. The necessity of trust tends to increase because the reorganization process itself naturally causes an increase in the levels of uncertainty, influencing traditional routines and possibly the distribution of property rights. The existence of some level of trust assumes growing value as it implicitly assures expectations of mutual benefits diminishing the threats of harm and loss. These are situations in which a formal contract could not cope in timely fashion and efficiently with the dynamics of the changing environment, so contracts have to rely on more relational bases.

346

62

See Wigand et al. (1999), p. 91.

Figure 2-11: Trust in the Reorganization Process Established, Stabilized, Organization form

Reorganization Process

Existent Trust

Decentralized, Horizontal, Virtual, Flexible, Self-organized, Organizations

Necessary Trust Source: Beckert et al. (1998), p. 58 (Translation: Marco Tulio Zanini). As Williamson (1985) comments: “idiosyncratic exchange relations that feature personal trust will survive greater stress and will display greater adaptability.”347 In resonance with this model, Höhmann et al. (2002) comment that, the development of trust depends basically on the environmental stability.348 It suggests that, in general, organizations established over a long period of time and working under relative external environmental stability, which requires lower adaptation (for example, in industries with high entry costs and regular demands) show a tendency to present better internal conditions for the development of trust through regular routines, processes and a more adequate corporate culture which create more stable norms and routines that favour motivation. On the other hand, companies operating under relative higher uncertainty and instability need more flexible and decentralized structures to deal with future contingencies. Decentralized companies normally work under more informal rules. Coordination and control are more personal and informal, and represent an advantage in identifying and dealing with external changes.349 Changes in the institutional environment involve changes in the organizational forms as a means of coping with the adaptation to new exogenous demands. However, precisely because adaptation requires reallocation, redistribution and redimensioning of resources, the process directly affects organizational behavior. It may considerably threaten an individual’s expectations and break the course of trust relationships. In this sense, Hardin (2002) claims, “reasons for uncertainty and even doubt at the individual level have institutional analog. Many institutional deliberations change the views of the participants and, therefore, the collective intention…the inherent problem of inconsistency over time, changing conditions that end or threaten to end an interaction or that radically change its stakes, and reasonable concealment makes distrust potentially the correct prima 347 348 349

See Williamson (1985), pp. 62-63. See Coleman (1990), p. 320, and Höhmann et al. (2002), p. 6. See Ferrell/Ferrell (2001), p. 216. 63

facie judgment in many relationships.”350 Therefore, environmental uncertainty and unpredictability makes trust a more necessary and desirable element, but it is specifically under these circumstances that the probabilities for an abuse of trust might occur, increasing the possibilities for opportunistic behavior between interactive agents. A system based on trust is not free of problems, because individuals can make use of the vulnerabilities of the system. Companies facing the challenge to make their structures more flexible and decentralized normally have to deal with the empowerment task (see Figure 212).

Figure 2-12: The Role of Trust in the Empowerment Function

Empowerment

(Confidence)

Coordination Budget responsibility Hiring & Firing Ordering supplies Mutual training Motivation Responsibility Responsability

(Trust) Source: Modified from Wellins et al. (1991), p. 26.

Decentralization also means the distribution of command and control over company units, and at the personal level, it requires the empowerment of people. Wigand et al. (1999) note: “Employees with greater flexibility and freedom to organize and shape things, have increased possibilities to influence their own work and carry a greater responsibility for work results. Altogether these processes lead to the so-called empowerment of employees.”351 Empowerment is related to self-directed teamwork.352 According to Wellins et al. (1991), “empowering…is passing on authority and responsibility… Empowerment occurs when power goes to employees, who then experience a sense of ownership and control over their jobs.”353

350 351 352 353

64

Hardin (2002), p. 95. Wigand et al. (1999), p. 410. See Wellins et al. (1991), p. 19. Wellins et al. (1991), p. 22.

As observed in Section 2.5.4, reliance and trust are distinct mechanisms to cope respectively with coordination and motivational tasks.354 They are related to the difference between the risk based on competence, when reliance is required between interacting partners, and behavioral risk, when trust is required between them. The empowerment function requires confidence in the allocation of resources based on individuals’ ability to accomplish the task. Correspondingly, it requires the attribution of responsibility based on trust over the efficient use of resources. The more relevant tasks allowing individuals to have access to company’s capital resources, confidential information and command, inevitably require more responsibility based on trust to be conferred on them. People are ‘trusted’ with functions which involve higher behavioral risk because the performance of these tasks has more significant consequences for the overall performance of the firm.355 Therefore, Figure 2-12 shows that the empowerment function requires the allocation of decision rights over resources based on two vectors: (1) confidence in individuals – considered basically for his/her skills and personal abilities to manage these resources, as well as (2) the trust invested by management in employees in the form of responsibility to manage efficiently these resources. In other words, empowerment means giving access, control and decision authority to employees over human, informational and material resources because flexible structures make organizations more efficient. The degree of empowerment should be directly related to the degree of responsibility. Responsibility will be based on a considerable level of trust invested by management in the form of autonomy. In this sense, employees should be credited to produce an outcome proportional to their own efforts and to the degree of responsibility and resources provided by the management.

354 355

See Ripperger (1998). See also Section 3.4.4. 65

2.8 Conditions for Trust Development From Game Theory, the trust problem can be understood as a cooperation problem. In order to avoid uncooperative behavior, in a more general level of analysis two possible solutions can be acknowledged and both ask for some basic conditions: the first solution is to generate reputation when environmental conditions provide the essential conditions to develop reciprocal strategies. In this perspective, in order to establish cooperative actions based on trust, the existence of repetitive encounters is necessary between interactive partners over a reasonable period of time, reasonable information about the other players and a relatively small number of players. Additionally, as emphasized by Kreps (1990), from the organizational perspective it is also necessary to punish defectors for breaking the implicit conventions because it weakens the organizations overall reputation.356 The other solution is to change the outcomes of the game in a such way that it becomes favorable for the players to act in line with the agreement, for example, in a bilateral agreement through distribution of bonuses and benefits, or by taking ‘hostages’ which are returned when the agreement has been fulfilled. Contributions from Sen (1967) and Ostrom (1990) provide us with valuable feedback to better understand that players change their behavior considerably when the production of a collective good involves a common pool of scarce resources, as within the firm.357 Following on from this, we analyze some basic properties to fulfill these conditions for trust development.

2.8.1 Mutual Interests and Incentive Structure In order to guarantee the placement of trust and ongoing trust relationships, the encapsulated-interest account does require that the trustor and the trusted have compatible interests over at least some matters, but such incentive compatibility is not sufficient. It further requires that the trusted values the continuation of the relationship with the truster and has compatible interests at least in part for this reason. Therefore necessary commitments matter, and the most common way is to structure incentives to match the desired commitments.358 Therefore, from Hardin’s (2002) definition, a crucial condition for trust development is the coexistence of (1) mutual interests between exchange partners to engage in a risk situation (even if the interests are not the same) and (2) the incentives structure to reach the desired commitments in order to promote the placement of trust and the continuity of a trusting relationship. In order to maintain ongoing relationships it becomes necessary to promote the compatibility of incentives over time.359 Hardin notes that one could assert a definition of trust that is nothing more than incentive compatibility or rational expectations of behavior of the trusted; the word

356 357 358 359

66

See Kreps (1990), pp. 126-127. See Sen (1967), p. 112, and Ostrom (1990), p. 135. See Hardin (2002), p. 5. Hardin (2002), p. 5.

trust would be otiose in such theory, however, it would add nothing to the somewhat simpler assumption of compatible interests in explaining behavior.360 Hardin (2002) argued that people might trust each other not necessarily wishing immediate rewards, but wishing some kind of benefit or advantage in the present or in the future, even if this advantage consists of just continuing the relationship because they perceive some value in it. Self-sustaining trusting relationships within the system can only take place if people perceive some benefit or advantage to engaging continuously with each other, assuming risks. Moreover, people should also perceive that risks remain at ‘acceptable’ levels. For example, employer and employee will usually sign a formal labor contract which is normally necessary to fulfill legal requirements which may initially set up general conditions and incentives to reach desired employee’s commitment, such as working hours, general principles of behavior, property rights assignments and reward conditions. However, long-lasting employment contract turns into a relationship between interactive partners. As soon as conditions change and outcomes are consummated, stakes in the relationship might change and incentives to engage continuously with each other should be continuously redefined on an incentive structure. In this case, the right application of an incentive structure provides the basis to encourage and maintain trust relationships. As observed before in Section 2.7.1, it is important to note that, exactly because previously a formal contract exists between these parties, a relational contract might develop between them. In other words, trust might emerge initially supplemented by a formal agreement that contains the risk of misplaced trust. One can assume that sometimes people might be willing to act on goodwill or self-sacrifice; however, it will not be self-sustaining in the long run if they do not perceive any advantage in doing so. The right incentive structure has to be in place in order to keep promises and ongoing cooperation sustained by trust, otherwise, self-sacrifice might easily give rise to frequent betrayals. Long-lasting incentives to reach common objectives through teamwork create possibilities for frequent interactions, and motivate people to engage with each other in trusting relationships. Mutual interest in accomplishing common objectives are also part of the design of organizational goals, related to the coordination task. In this sense, companies which have production systems based on teamwork and favor the achievement of collective objectives and long term employment perspectives will be more likely to develop trust among employees. On the other hand, companies which strongly stimulate individual performance, high internal competition and short term employment relationships, although they might perform efficiently, are unlikely to develop high levels of trust, basically because these strategies decrease interdependence and mutual interests among parties. Williamson (1985) makes a critical point when he observes that the critical dimension for describing transactions is the condition of asset specificity.361 Human asset specificity, which 360 361

See Hardin (2002), pp. 5-6. See Williamson (1985), p. 30. 67

evolves during the contract execution, usually provides a rationale for disturbing partners in the relationship. Non-redeployable specific investments make individuals behave in a skeptical manner toward the partners due to the perceived need to safeguard information. These cases which are characterized by low trust situations and arms-length contracting will not be an efficient way to conduct transactions, thus trust issues emerge. Therefore, the alignment of interests and compatibility of incentives are necessary to keep cooperation based on trust in being.362

2.8.2 Time, Interactions and Stability Relational contracts, like employment contracts, refer to long term contractual relationships.363 From the insights provided by game theory for the emergence of cooperation and trust, the existence of repetitive encounters between interactive partners over a reasonable period of time is essential. A certain probability of continuity with a random, unknown or unforeseeable end date has to be taken into consideration.364 It is the basis for reciprocal strategies which take place among parties.365 The challenge in keeping a trust environment is a problem of sustaining long term perspectives of mutual benefits against threats of short term betrayal through the termination of the interactions. Trust develops basically as a learning process through personal experiences as interactions with other people by accessing some knowledge about them from the past (reputation) and in the present situation. Generally, scholars assume that the greater the chances are for interactions, the greater the possibilities for the emergence of trust.366 Although time and interactions are basic requirements, they are not determinants for the development of ongoing trust relationships within the system. These require additionally mutual interests and the alignment of incentives to continuously cultivate the placement of trust.367 Luhmann (1980) presents some exceptional situations when trust might emerge among temporary workgroups in the short-term involving specific circumstances, like complex tasks and high interdependency.368 Furthermore, beyond time and possibility for interactions, stability of the social structure is fundamental for the maintenance of trust development. We observed that new information affects behavior. The increase in the frequency of the appearance of new information might threaten rapidly trust relationships. As Hardin (2002) notes, the sudden escalation of the stakes in an interaction might lead interactive partners to treat the next round of their interaction as though it were part of new, perhaps only one-shot, interaction.369 Therefore, stability 362 363 364 365 366 367 368 369

68

See Beccerra/Gupta (1999), and Whan/Kwon (2004). See Williamson (1985), p. 71, and Wolff (1995), p. 90. See, for instance, Axelrod (1984), Kreps (1990), Gibbons (2000), and Wolff (1996). See Axelrod (1984), p. 21. See, for instance, Luhmann (1989) and Ring/van de Ven (1994). See Hardin (2002), p. 6. See Luhmann (1980), p. 47. See Harding (2002), p. 145.

and the maintenance of the stakes matters to avoid threatening trust relationships. Coleman (1990) claims that, the stability of the social structure is fundamental for the maintenance of the social capital based on trust.370 Also Höhmann et al. (2002) note that the way trust evolves depends on the stability of the environment.371 This can be illustrated in game theory (see Figure 2.7 in Section 2.6.3) by maintaining the probability of future encounters among interactive partners over a reasonable period of time.

2.8.3 Organizational Building-Trust Variables Williamson (1975/1996) argues that ‘atmosphere’ and ‘supplying a satisfying exchange relation’ are part of the economic problems.372 These economic elements strongly influence people’s behavior and motivation to achieve the collective good. Trust is relational and it is the product of an evolutionary process that takes time within social systems. It requires the development of common values (social consensus) and the adaptation of values to new conditions.373 The trust development process does not take into account only the information which is generated between interactive partners, but also the information within a given social system which constrains behavior through norms and rules. Luhmann (2000) states: “The development of trust and distrust depends on local milieu and personal experience.”374 Thus, in Luhmann’s view routines, habits and general beliefs will be grounded on these constraints as incentives, and they will influence decisions and aptitudes within human interactions. These implicit elements will influence people’s general perceptions about trustworthiness and will influence decisions positively or negatively. Luhmann (1980) used the term “system-trust” to indicate the kind of trust at a more abstract level regarding social systems, which is independent of the trust generated between actual individuals. Although it refers to a more abstract level of trust, system-trust together with interpersonal trust is useful to access information about interactive partners. The trust development analysis offers a range of levels and dimensions in which trust might be built and sustained, according to many variables. As Levi (1998) comments, “trust is not a thing and does not have one source; it has a variety of forms and causes.”375 First it is important to observe how trust relationships develop in the very first moment. According to Luhmann (1980) complexity is the central problem, because people cannot know enough to handle everything and must therefore rely on others as agents for some matters.376 It provides reasonable explanation for the existence, rise, or maintenance of trust. For instance, let us illustrate it by taking the example of a new employee entering a firm. A new 370 371 372 373 374 375 376

See Coleman (1990), p. 320. Höhman et al. (2002), p. 6. See Williamson (1975), pp. 37-38, and Williamson (1996), pp. 270-271. See Furubotn/Richter (2001), pp. 25-26. Luhmann (2000), p. 103. Levi (1998), p. 79. See Luhmann (1980), p. 8. 69

employee who is hired by the firm is designated to a certain task, and this task requires his/her codependence with others in its accomplishment. The employee faces a situation of high complexity due to the lack of previous information about the others. However some reliance and trust of the others is minimally required from the very first moment. The new employee, facing the new complexity, has to risk in order to get some information from others and to discover with whom one can expect beneficially to interact further.377 As soon as he/she acquires some information from his/her first experiences, he/she is able to deal with the new environment. After some time, the initial complexity faced by the new employee is reduced. Therefore, over time, he/she will ‘read’ the new social norms embedded in the organization in order to adopt a certain pattern of behavior. New employee’s attitudes will be strongly influenced by the standards of reciprocity and exchange within the social system and his/her first personal experiences with particular people around him/her in working relations. Within organizations, Ripperger (1998) proposes a model for trust development based on specific and general information about people and situations (see Figure 2-13). The model presents the influence of four elements to understand the conditions for trust development: Specific Trust and Reputation refers to individual characteristics, and General Trust and Trust Atmosphere refers to the system.378 According to Ripperger these information categories are independent and their boundaries are not always clear. General trust refers to the trustor’s general perception of trustworthiness of human nature in a given system, according to his/her personality. General trust influences the trustor’s expectation of trust according to a specific system. It is a perception of the trustworthiness of people in general, not referring to a specific person in the present situation. In this case, it is assumed that the trustor takes the average level of trust that people have in the system as a reference. Specific trust refers to a particular person in the present situation. It is a subjective calculative evaluation of one particular trustee based on his/her motivations toward the accomplishment of the trustor’s interests in one particular situation.379

377 378 379

70

See Hardin (2002), p. 138. See Ripperger (1998), p. 99. See Ripperger (1998), pp. 99-105.

Source of Information

Figure 2-13: Information Category in the Formation of the Expectation of Trust

Personal Interaction as Trustor Third Party Interaction as Trustor

General Trust

Specific Trust

Trust Atmosphere

Reputation

With Third Party as Trustee

With the person of the Trustee

Object of Information

Source: Ripperger (1998), p. 99 (Translation: Marco Tulio Zanini).

Ripperger (1998) understands trust atmosphere as a more or less closed system, like an organization or any social group. The more trust experiences within a system, the more the quality of the trust atmosphere. Because trust is relational, the building trust process requires the creation of a trust atmosphere based on corporate norms, values and sanctions embedded in the corporate culture which enforces human behavior. According to Wigand et al. (1999) the transaction atmosphere, which includes value systems and mutual trust between transaction partners, considerably influences transaction costs of various coordination forms. Reputation is acknowledged as public information about how trustworthy a given actor is. The reputation of a given actor will strongly influence the trustor’s expectation of trust about him/her, however, it is not a true substitute for personal experiences. Ripperger (1998) recognizes an interdependent relationship between reputation and trust atmosphere. The question which arises is the extent to which companies are able to efficiently create a social context necessary to build the trust that is needed to maintain cooperation. Keeping a sustainable trust atmosphere is variable according to the previous investment over time. It is a time-consuming process. It requires some resources, basically time to build behavioral norms of interaction. In this sense behavioral patterns are created over time which preserves perceived mutual benefits among people by interacting through the maintenance of

71

the stakes. Therefore, it is possible to develop higher levels of perceived trustworthiness among members of the group and therefore, stimulate trust relationships. It creates what Hardin (2002) called ‘casual feedback loop’ because cooperative interactions lead to ongoing relationships and institutions that induce and support trust in the encapsulated interest account.380 Given the condition that enough people are perceived as trustworthy it leads to the causal chain producing trust getting under way. It begets trust because trust is essentially in the category of knowledge, and evidences of trustworthiness ultimately define trust.381 However, the same applies if people are perceived as untrustworthy. In this case, it would lead to self-protection which blocks relationships and institutions that would generate trustworthiness and trust, and ultimately, it would define the perceived atmosphere. The relevant functional pattern of behavior commonly is a response to the invested incentives. When evaluating trust within the system, it is important to avoid the misconception about a ‘scant expectation’ view of trust regarding the understanding of the reasons to trust.382 A trustworthy system brings a trust atmosphere where people might take trust for granted. The misconception continues the belief that trust is significant only when there are situations in which people have no reason to trust one another, when risks are relatively high, or when people have doubts about the likely performance of others. As an outcome, a trust system may rely on norms and rules that assume that people in general are trustworthy, for example, when many individuals’ reputations are recognized. In other words, high trust environments create personal reputations and favor the ‘absorption’ of risk in the general interactions among participants. On the other hand, the absence of transactions (interactions) because of the reluctance of people to be willing to engage with others might be an indication of the absence of trust.383

2.8.4 Maintenance of the Reputation System A condition for trust development is the maintenance of the reputation system. In Kreps (1990), the corporate culture is based on reputation effects. Kreps (1990) suggests an approach which extends the theory of reputation effects to the case of contractual incompleteness. It is a sketch of a theory of rational behavior in the face of unforeseen contingencies. Kreps’ (1990) argument proceeds in three stages: Firstly (1), he observes that unforeseen contingencies follow patterns. That is, we do not have their complete description but we are able to predict on the basis of past experience that they will conform to a certain pattern of particular recognizable form. Secondly (2), an agreement is established between subordinates and their superiors as general rights and principles which establish the abstract modality according to which such unforeseen contingencies should be faced. Thirdly (3), the adaptation of the 380 381 382 383

72

See Hardin (2002), pp. 146-147. See loc cit. p. 146. See loc cit. p. 73. See Levi (1998), p. 79.

contingencies to the abstract principle is a matter of judgment or interpretation from which it is impossible to eliminate a certain degree of vagueness and ambiguity.384 Kreps (1990) argues that, the problem of unforeseen contingencies can be overcome by the use of social norms and principles that can be adaptable to multiple contingencies. The price for such a solution is the degree of vagueness in the norms and judgments, and the fact that interpretations might become a subject of idiosyncratic relationships.385 Kreps (1990) argues that two basic principles must be satisfied in order to render effective the mechanism of reputation: principles must be able to eliminate a large part of the ambiguity regarding the required behavior facing foreseen and unforeseen contingencies; and the principles must be advantageous against the risk of abuse for the subordinate who enters into the hierarchical relationship. The main argument is that rules should be unambiguous and advantageous for the subordinates.386 Kreps (1990) comments: “My (limited) understanding of corporate culture is that it accomplishes just what the principle should – it gives hierarchical inferiors an idea ex ante how the organization will react to circumstances as they arise; in a strong sense it gives an identity to the organization.”387 Therefore, from Kreps’ (1990) theory we can observe some points for our purposes: First (1), it reinforces the necessity of time to develop reputations within the firm as recognized patterns of behavior to assure subordinates that unforeseen contingencies will be handled in a mutually advantageous and, in large part, predictable way. Therefore, it will encourage the development of trust relationships (but it has to be recognized that, increasing the level of uncertainties might increase the problems of ambiguity). Secondly (2), principles and social norms should translate a condition of efficiency and fairness as they will be applied to solve problems of ambiguity. Trust relationships will develop on a basis of common understanding of principles of fairness. In Kreps (1990) reputation effects operate when managers have an interest in keeping their reputations high with a view to future hierarchical transactions, not taking opportunistic advantage, and the agent who accepts a subordinate position believes that the manager will behave in this way. Therefore, hierarchical transactions rest on a trust relationship based on the reputation accumulated by the player who holds the position of authority (management).388 The effectiveness of these transactions will be based on the transparency and clarity of principles of fairness and mutual benefits.389 And thirdly (3), the reputation model is also dependent on the stability of the authority relationships.390 It is also observed by Coleman (1990) and Sacconi (2000) who observe that stability is a major environmental element to sustain social capital based on trust.391

384 385 386 387 388 389 390 391

See Kreps (1990), pp. 117-120. See loc cit. p. 124. See Kreps (1990), p. 124. Kreps (1990), p. 125. See Saconni (2000), p. 94. See Williamson (1985), p. 249. See more in Coleman (1990), p. 320, and Sacconi (2000), pp. 91-92. See Coleman (1990), p. 320, and Sacconi (2000), pp. 91-92. 73

2.8.5 Personal Variables Economic contract theory provides some solutions to the problem of Adverse Selection.392 The problem of Adverse Selection consists in a problem of hidden characteristics of prospective individuals.393 Some specific variables concerned to individual characteristics matters in the study of trust within social systems. Companies hire their employees based on some criteria and the selective parameters may also influence the task of building trust. Therefore, in order to build a trust-based system, here we observe some of them. Zucker (1986) notes that, “just as sex, or age may be used as an index of job skills by employers, they can be used as an index of trust in a transaction. They serve as indicators of membership in a common cultural system, of shared background expectations. In general, the greater the number of social similarities (dissimilarities), the more interactants assume that common back ground expectations do (do not) exist, hence trust can (cannot) be relied upon.”394 Keefer and Knack (2005) comment that, there are some reasons why socially dissimilar people may be less trusting or trustworthy.395 They comment that, within homogenous groups shame might be a potential cost of cheating, and the shared sense of altruism and the common sense of fairness might enhance trust relationships, they claim: “much conformity to social norms prescribing cooperation is motivated by a sense of fairness and reciprocity.”396 Consequently, nationality and race might significantly influence trust development.397 Sutter and Kocher’s (2003) empirical work, for example, shows a tendency to increase the levels of trust related to age. The study shows that high levels of trust based on reciprocity can be found more among adults than younger people. In addition, economic transactions also tend to be more efficient.398 However, empirical results show that socio-demographic characteristics has yielded inconsistent results. Some authors like Anderson and Derrick (1990) and Thom et al. (1999) found weak or no relationship between trust and socio-demographic characteristics.399 Others, like Sutter and Kocher (2003), report that age, gender, education, and wealth as well as race-ethnicity is related to trust.400 Some personal characteristics like perceived competence, loyalty, fairness, discretion, have the tendency to increase people’s perception of trustworthiness and thus, their willingness to make trust investments.401 The building of the trust process within organizations requires that those who have command are committed to enforce norms and rules, to promote a trust at392 393 394 395 396 397 398 399 400 401

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See Section 2.6.5. For in-depth discussions, see Milgrom/Roberts (1992), p. 154-156, Wolff (1995b), p. 86-88, and Lazear (1998), pp. 204-209. Zucker (1986), p. 63. See Keefer/Knack (2005), p. 716. Keefer/Knack (2005), pp. 716-717. See loc cit. p. 717. See Sutter/Kocher (2003). See about age and trust in Casson (1997), pp. 235-236. See Anderson/Derrick (1990) and Thom et al. (1999) See also Wholey/Sommers (2001) and LaViest et al. (2000). See Ripperger (1998), p. 105, and Hardin (2003), p. 83.

mosphere and to punish dishonest participants in order to assure that transactions among trustworthy people can take place under a relatively lower probability of individual damage when trusting each other.402 In this sense, corporate norms and values should assure the right distribution of outcomes and property rights (and duties) in order to drive organizational behavior. Moreover, the quality, transparency and clarity of the information which is sent from management to the employee are relevant. Because people rely on their first experiences to plan their following strategies, previous experiences among managers and employees should motivate employees’ expectations and motivations. Empirical evidences show that top managers are the main agents responsible for implementing a trust-based culture within organizations by fostering trust actions and creating a ‘protected zone’ for trust investments.403 Many implicit contracts among managers and employees are negotiated every day by verbal promises or simple behavior. Signals of integrity, consistency and clarity in the communication will strongly influence system-trust, building reputations and assuring trustworthiness when exchanging take place. Since trust is relational, personal variables and characteristics of those in command might strongly influence the general perception of trustworthiness within the system. For example, Kreps (1990) notes the relevance of consistency and simplicity in the communication process as being virtues of the organizational culture.404 Moreover, it is important to note a close relationship between perceived competence and trust. The trustee’s perceived competence provides a basis for the trustor’s placement of trust. For example, we are less likely to trust in young and inexperienced people to deal with important issues, like a teenager to work as a president of a country, than an older and experienced person.405 Whitener et al. (1998) present an exchange relationship framework based on agency and social exchange theory that identifies organizational, relational, and individual factors which encourage or constrain the employees’ perception of trustworthy managerial behavior. The authors identify five variables which are behavioral consistency, behavioral integrity, sharing and delegation of control, communication and demonstration of concern.406 The authors also consider some other variables that finally will influence the employees’ perception which are people’s perceived competence, group similarity, task independence and propensity to trust. This Section provides valuable insights to our empirical survey (See Chapter 4). Individual characteristics analysis becomes important information to better understand the social context in which the trust-building process develops.

402 403 404 405 406

See Whitener et al. (1998). See, for instance, Detecom (2004), pp. 77-78. See Kreps (1990), p. 127. See Hardin (2002), p. 8. See Whitener et al. (1998). 75

2.9 Trust and Institutional Uncertainty

2.9.1 General Concept of Trust and Uncertainty As Coriat and Guennif (1998) note “the reasons for the emergence of the concept of trust in economics are easy to formulate. It was developed as a response to the problem of uncertainty in the relationship between economic ‘agents’. From a theoretical point of view, trust is, above all, a consequence of uncertainty.”407 Therefore, it is especially important in this work to understand the relationship between trust, uncertainty and risk. In order to better define and delimitate trust, we analyze the framework in Figure 2-14 from Ripperger (1998), which provides a comprehensive understanding of different economic concepts.408 According to Ripperger’s scheme, one has first to distinguish between uncertainty and risk. Economists understand risk and uncertainty as classifications of imperfect information. Knight (1921/1965) distinguishes uncertainty from risk by associating it with possible outcomes, about which so little is known that no calculation of an actuarial type is possible. When events occur under high levels of uncertainty, they can give rise to profit or loss because they cannot be rationally predicted to decide upon entry into or exit from markets. As Bridgewater (2000) claims, uncertainty is immensurable without the possibility of assigning probabilities, and it is caused by many factors with unpredictable outcomes.409 Risk is defined as a measurable (often-financial) effect of uncertainty when it is possible to calculate probabilities.410 Eiteman et al. (2001) define risk as “the possibility of suffering harm or loss, or a course involving uncertain danger or hazard.”411 Pindyck and Rubinfeld (2005) argue that, “uncertainty can refer to situations in which many outcomes are possible but the likelihood of each is unknown. Risk then refers to situations in which we can list all possible outcomes and know the likelihood of each occurring.”412 It can be assumed that high levels of uncertainty will increase risk.413 The greater the uncertainty; the higher the risk and unpredictability associated with future profits. However, situations involving uncertainty might become risk situations as soon as people become able to calculate them by anticipating any reaction. For instance, it happens in the study of diseases when doctors discover a new relationship between the risks of some habits and human health.414

407 408 409 410 411 412 413 414

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Coriat/Guennif (1998), p. 48. See Ripperger (1998), p. 40. See Bridgewater (2000), p. 345. Bridgewater (2000), p. 345. Eiteman et al. (2001), p. 56. Pindyck/Rubinfeld (2005), p. 154. See, for instance, Aharoni (1966), Miles/Snow (1978) and Miller (1992). See Wolff (2000), p. 3.

Figure 2-14: The General Framework of the Concept of Trust UNCERTAINTY

CONFIDENCE

RISK

EXOGENOUS RISK

HOPE

ENDOGENOUS RISK

COORDINATION

MOTIVATION

Risk based on Competence

Intentional Behavioral Risk

RELIANCE

TRUST

Source: Ripperger (1998), p. 40 (Translation: Marco Tulio Zanini). Moreover, two different kinds of risks have to be acknowledged: exogenous and endogenous risks. Exogenous risks are those where interactive partners cannot influence the results, while endogenous risks are those where the result comes directly from their own behavior. For those events that cause feelings of insecurity in daily life hope is the general reaction, for instance, when people fear situations that might cause them damages (e.g. an unpredicted earthquake or an unpredictable fatal illness). For those, there is a casual hope about life. Wolff (2000) illustrates it:415 Suppose that one person A is invited by person B to present a speech in a congress. Suppose that A allocates his own resources, like time and energy, preparing his presentation instead of spending his free time with his family (opportunity cost). Nevertheless, the potential benefit for A is to have his work known by interested congress participants. However, it could happen that the congress is canceled because all important guests, at short notice, turn down the invitation. This is characterized as exogenous risk because B could not be blamed for the situation. However, if B intentionally canceled the invitation of all interested congress participants, it is a result of his behavior. This is characterized as endogenous risk. Here we can differentiate between two aspects; whether B intentionally wanted to harm A or whether it was because of B’s mistake or bad luck. For example, if B has failed to order enough seats required for all participants, and therefore, B had to cancel mistakenly some invitations for those most interesting congress participants, this is an example of risk based on competence. However, if B intentionally cancelled the invitations of those guests with whom he knows that A would like to exchange ideas in the congress, this is an example of intention415

This illustration is a rephrase of Wolff (2000), p. 3. 77

al behavioral risk. In this case A’s trust in B has been misplaced. B opportunistically harmed A against A’s expectations. Such difference between the risk based on competence, when reliance is required between interactive partners, and the behavioral risk, when trust is required between them, is reflected in the theory of economic organizations as coordination and motivation tasks.416 As observed in Section 2.5.4, the allocation of input rights (such as capital, command and information resources) is understood as the coordination task while the allocation of output rights (such as sharing of profits according to individual’s efforts) is seen as a motivation mechanism. The difference we observe between uncertainty and trust is based on a cognitive perception of behavioral risk.417 It cannot be characterized as risk without circumstantial risky alternatives for conscious actions against harm or loss. In this sense, trust is a subclass of those situations involving risk. It involves the perception of potential harm or damage on those situations when conscious and voluntary decisions might be taken by interactive partners. As Coleman (1990) notes: “they are situations in which the risk one takes depends on the performance of another actor.”418 It states a possibility to avoid or, at least, to anticipate an alternative action. Trust is a possible reaction for specific behavioral risky situations. Thus, the concept of trust involves the objective possibility as well as the subjective consciousness of predictable harm, loss or damage.419

2.9.2 Trust and the Institutional Framework Scholars like Chester Barnard (1938) and Douglass North (1990) have provided contributions on the coexistence of ‘formal’ and ‘informal’ institutions in a co-dependent situation. Institutions are “the humanly devised constraints that structure political, economic, and social interactions”420 defined as the “rules of the game”421 and they provide constraints to structure human interaction with respect to a particular set of activities. According to Ostrom (2005), institutions are fundamentally shared concepts, and they exist in individuals’ minds very often as shared implicit knowledge rather than in an explicit and written form.422 Institutions reduce uncertainty by establishing a stable, not necessarily efficient, structure for human interaction.423 They consist basically of informal constraints, formal rules, and the enforcement characteristics of both. Formal institutions include political, economic, and judicial systems of rules and organizations, whilst informal institutions refer to values, norms, conventions and

416 417 418 419 420 421 422 423

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See Milgrom/Roberts (1992), p. 25, Wolff (1995a), p. 20, and Wolff (1999), p. 43. See Ripperger (1998), p. 36. Coleman (1990), p. 91. See Ripperger (1998), pp. 36-37. North (1991), p. 97. See North (1990), p. 4. See Ostrom (2005), pp. 823-824. See North (1990), p. 6.

codes of conduct that are deeply embedded in the culture. The evolution of informal rules is seen as the force that in the end may lead to institutional change.424 The institutional level views the behavior of firms at the micro-level as a form of adaptation to specific relevant external environmental conditions. Enterprise behavior results from a dynamic inter-relationship between internal and external conditions. External factors are important because they shift to continuously provided new parameters, and change the comparative costs of governance, and individual behavioral assumptions.425 New Institutional Economics, through the three-level schema of Williamson (1996) explains that management decisions (Corporate Governance) are affected by two major factors: institutional frameworks and individuals’ characteristics (see Figure 2-15).426

Figure 2-15: Framework Effects and Sources of Risk Institutional Framework Explicit

Implicit

Shift Parameters

Source of Exogenous Risks

Strategic

Source of Endogenous Risks

Corporate Governance Behavioral Attributes

Endogenous Preferences

Source of Exogenous Risks

Individual Characteristics

Source: Inspired by Wolff (2005), from Williamson (1996), p. 326.

The macro (institutional environment) and micro features (individual level) represent sources of exogenous risks and uncertainties (as constraints), and influence the efficiency of alternative mechanisms of governance, namely explicit and implicit modes of contracting. At a more micro-level, the development of informal rules in a formal organization is generally of great importance. Barnard (1938) has argued that “formal organizations are vitalized and conditioned by informal organizations…there cannot be one without the other”427 According to 424 425 426 427

See Furubotn/Richter (2001), p. 19. See Williamson (1996), p. 223. See Williamson (1998), p. 326. Barnard (1938), p. 120. 79

Wigand et al. (1999) three factors can be evaluated in order to select governance mechanisms: human factors, environmental factors (specially the characteristics of the services to be coordinated) and the transaction atmosphere.428 Arrow (1969) notes that, “the efficacy of alternative modes of contracting will thus vary among cultures because of differences in trust.”429 In this sense, markets, hierarchies and hybrid forms (such as long-term cooperation) present possible coordination forms.430 Trust is a complementary implicit control mechanism to coordinate transactions which can be selected according to relevant environmental circumstances. How levels of trust change across different institutional arrangements and support differently economic exchange has being the core issue for many scholars and researchers.431 Trust is affected by both formal and informal institutions, such as legislation and law enforcement of social norms and codes of conduct.432 However, trust itself acts as an informal institution reducing transaction costs through providing information and means to enforce contracts, so the possibility of opportunistic behavior diminishes. While societal trust works through the institutional environment, within corporate hierarchies, system trust is the outcome of the existing organizational culture designed to drive interactions among individuals as part of the collective action.433

2.9.3 Industry-Specific Institutional Frameworks North (1990) notes that price and the interaction between institutions and organizations are the main factors for institutional change.434 In this sense, he observes that competition is the key element to institutional change.435 Organizations are created to take advantage of the opportunities created by institutions like policies and laws, state of technology and prices.436 According to Williamson (1985) the larger context influences differently the efficient modes of governing social and transaction costs, like the nature of goods and services, demand, social context (customs, mores, habits, etc.).437 For instance, Hrebiniak and Snow (1980) found in their empirical survey that characteristics of industries affect the perception of managers regarding type of uncertainty and appropriate responses to it. They observed different types of uncertainty across four industries and concluded that the degree of environmental uncertainty, intraorganizational influence, structural decentralization vary by industry.438 Earlier, Duncan 428 429 430 431 432 433 434 435 436 437 438

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See Wigand et al. (1999), p. 37. See Arrow (1969), p. 62. See Wigand et al. (1999), p. 37. See, for instance, Yamagishi/Yamagishi (1994), Fukuyama (1995), Sako/Helper (1998) and Keefer/Knack (2005). See Zucker (1986), p. 64, and Höhmann (2002), p. 5. See Luhmann (1980) and Wolff (1996). See North (1990), p. 7. See North (2005), p. 22. See North (1990), pp. 7-8. See Williamson (1985), pp. 22-23. See Hrebiniak/Snow (1980), pp. 750-759.

(1972) found that uncertainty appears to be greater in more rapidly changing industries, technical fields or relatively recent technology, and in which information is less well developed or less widely known.439 In this study the term industry-specific institutional framework is used to characterize different institutional and organizational arrangements regarding different industries. It can be assumed that industry-specific institutional frameworks set different institutional constraints which change the comparative costs of governance among different industries. Corporate governance structures within hierarchies basically consist of an authority system and enforcement mechanisms, which have to deal with the adaptation for changing circumstances. Thus, management faces decisions about different modes of governance structures. In this way, industry-specific institutional frameworks shift specific parameters to governance structures which might restrict the development of some governance mechanisms and favor some others. In this sense, Gordon (1991) proposed a diagram where the ‘industry imperatives’ impose limiting conditions for company’s survival and prosperity. In his view, organizations are founded on industry-based assumptions about customers, competitors and society, which form the basis of the company culture.440 Accordingly, to a certain degree, these factors will provide common constraints and define common behavioral patterns within a given industry. Gordon (1991) pointed to the nature of the industry as a major influence on corporate culture.441 Observing economic activities through a cross-industrial analysis, an industry-specific institutional framework poses a set of common characteristics (such as constraints) for managerial decisions based on common variables related to specific market dynamics. This set of industry-specific institutional constraints might be based on a combination of institutional variables like specific political and legal constraints for a given industry, the state of technology, market dynamics and cultural parameters embedded in the industry. Therefore, the level of competition, the set of legal rules and governmental policies, market entry barriers, availability of substitutes, market price of products/services, nature of the production systems, transaction atmosphere or required specialization degree of human resources represent variables which ultimately influence the efficiency of the forms of governance. For example, Anderson and Gatignon (2005) observe that technological innovations diffuse differently among industries according to some factors, like overall competitiveness, reputation, market intensity, demand uncertainty and professionalization.442 Consequently companies from the same industry share a set of common opportunities and risks to define their strategies according to industryspecific institutional framework. Ultimately, the set of institutional constraints bring a certain degree of environmental uncertainty based on the kind and frequency of changing variables 439 440 441 442

See Duncan (1972), pp. 324-325. See Gordon (1991), pp. 401-403. See Gordon (1991), p. 413. See Anderson/Gatignon (2005), p. 420. 81

which define different efficient modes of governance structures. Here it is important to consider that between those industry-specific constraints and the options for governance structures there is a limited “managerial free space” where managers might adopt (a limited range of) different governance mechanisms according to the adopted management ‘style’. It means, even considering the common framework constraints, companies from the same industry might choose different combinations of governance structures according to their strategy in markets and managerial preferences. However, we argue that the industry-specific institutional framework provides the main constraints for governance decisions based on common variables of political/legal, technological and economic frameworks which ultimately represent sources of uncertainty and risk. Thus, a combination of formal and informal governance mechanisms should be designed in order to govern the system according to these external variables. Ceteris paribus, the most efficient set of governance mechanisms should be designed to reduce transaction costs to an efficient level. Institutional constraints have a direct influence on the shape of human interaction.443 Hence, it is to be expected that different institutional arrangements affect organizational behavior differently. We argue that different industry-specific institutional frameworks may favor or constrain the development of trust as an alternative control mechanism of governance. The analytical framework from Newstrom and Davis (1997) on the key forces that affect organizational behavior (see Figure 2-16) helps us to understand the cause-and-effect relation between institutional elements and behavioral consequences.444 The macro political, legal and economic environment sets parameters in regard to market conditions, the use of technology and the culture, which influences the structure of incentives, jobs and relationships within the organizations, setting parameters to organizational behaviors. For example, employees’ behavior might change significantly influencing preferences in industries where traditionally tradeunions play a significant role.445 Trust becomes an alternative strategy to deal with the adaptation problem in function of external environmental conditions and endogenous preferences because it allows greater organizational flexibility.446 However, we argue that, even if trust is highly desirable, it requires some institutional conditions to be developed and sustained efficiently among different industries, like relative environmental stability, long-term relational interaction and socialization among members within organizations.

443 444 445 446

82

See North (1990), p. 22. See Newstrom/Davis (1997), p. 6. See Casson (1997), p. 23. See, for instance, Beckert et al. (1998), pp. 58-59.

Figure 2-16: Key forces Affecting Organizational Behavior People - Individuals - Groups

Environment - Government - Competition - Societal pressures

Structure - Jobs - Relationships

Organizational Behavior

Technology - Machinery - Computer Hardware / Software Source: Newstrom and Davis (1997), p. 6.

In line with Gordon’s (1991) work, we argue that industrial imperatives constrain differently the development of corporate cultures among different industries, and consequently the development of trust within social systems. People trust each other based on the acquired information from the past and from specific situations in the present.447 From the insights of game theory, a reasonable stability, time and interactions among interactive partners are necessary to acquire information from each other and develop trust-sustaining reputations.448 Thus, different institutional constraints might strongly hinder the development of trust or make it an inefficient investment as a mechanism of governance.

2.9.4 Effects of Uncertainty and Instability on Trust Development At this point we assume for our purposes that risk and uncertainty mean the same thing. As emphasized by many scholars, as in Hirshleifer and Riley (1992), Knight’s distinction between risk and uncertainty to some extent and for some purposes seems to be a sterile one. It becomes better to leave the ‘objective’ classification of these elements and to deal with a ‘subjective’ probability concept, as a degree of belief. In this case, it is assumed that decisionmakers are always in the world of uncertainty. This alternative approach assesses probabilities on the basis of subjective degree of belief. As presented before, we can also understand these types of uncertainty related to the types of risk. 447 448

See Ripperger (1998) and Hardin (2002). See Section 2.9.4. 83

Koopmans (1957) noted that uncertainty is the core problem of the economic organizations of society.449 Institutional uncertainties which influence the system might affect human behavior by changing the stakes of interactions, and therefore influence expectations about interactive partners. Nooteboom (2002) notes, good prior intentions can always change when unforeseen circumstances occur.450 Parties may change between available options during the time the contract is in force. It can be illustrated by observing how cooperative games might change under uncertainty.

Figure 2-17: Cooperative Games under Uncertainty C

Outside Opportunity

C

20/20 B’

-5/15

Trust

No Trust

No Trust

B

B

Trust

A

No Trust

-5/15

0/0

10/10

Trust

A

No Trust

B

Trust

Trust

10/10 A

No Trust

-5/15

B

10/10 A

No Trust

A’

15/30

Outside Opportunity D

D

Source: Modified from Kreps (1990), p.100.

From Figure 2-5 in Section 2.5.3 we present Figure 2-17, which illustrates how cooperative games might change under uncertainty. Figure 2-5 shows that rational players A and B will continue to play the game according to the long run perspectives when the probability of continuing to play the game is sufficient. The higher the expected number of interactions of the game, the lower becomes cheating as dominant strategy, as it is in one-shot game like Prisoners Dilemma.451 Both players are punished with fewer payoffs once one player chooses to always cheat. In this sense people will learn that cooperation in the long run is in their own interests. However, as soon as new information arises in the form of environmental uncertain449 450 451

84

See Koopmans (1957), p. 147. See Nooteboom (2002), p. 134. See Ricketts (2002), pp. 20-23.

ty, decreasing the probability of continuing to play the cooperative game, rational players A and B will consider outside opportunities and they might choose to end with the previous game. Figure 2-17 shows that outside opportunities might offer better payoffs (players C and D). In this case, rational players A and B will change the game to get a better payoff Ȇ’. In this sense: Ȇ’ (A’+B’) > Ȇ (A+B). It is particularly useful for our purposes to make the distinction between endogenous uncertainty and exogenous uncertainty. Sako and Helper (1998) make a similar distinction between behavioral uncertainty (the source of which is in the interactive partner in a bilateral relationship who may increase the degree of uncertainty by behaving in a unpredictable and/or opportunistic manner) and environmental uncertainty (the source of which is other than the interactive partner, such as costs imposed by new market rules or the future trajectory of new technology).452 In our definition, endogenous uncertainty refers to those general uncertainties inside the firm, not only regarding collective behavior that might be directly influenced by institutional changes. For instance, the increasing knowledge-based production system has introduced many endogenous uncertainties. Anderson and Gatignon (2005) refer to ‘internal uncertainty’ regarding the difficulty of assessing performance using output measures.453 Taking the firm as our reference, we can also understand exogenous uncertainty as environmental uncertainty, meaning those uncertainties caused by changes in the institutional arrangements rather than those ‘internal’ variables of the firm. The definition of environmental uncertainty has been evolving since uncertainty was first recognized as an external force in organizational life.454 It can be acknowledged as a lack of predictability in the external changes to the organization emanating from a real and objective external environment. Environmental uncertainty might take many forms, like demand uncertainty, technological uncertainty, competition uncertainty or regulation uncertainty.455 Many other categorizations have been proposed. For example, Thietart and Xuereb (1998) developed a study about uncertainties and complexity in new product development. These uncertainties arise from three major areas: customer, technology and competition. Therefore, in their view, the innovation process involves three categories of uncertainties: uncertainties about user’s needs, uncertainty about the technology to use, and uncertainty about competitors’ moves.456 According to Wigand et al. (1999) environmental uncertainty is expressed in the number and extent to which unforeseeable task modifications occur. They comment: “in an uncertain environment, the settlement of a contract is complicated through recurrent changes in scheduling. Prices, conditions and quantities requiring frequent contract modifications, and hence the acceptance of higher transaction costs.”457 As external uncertainty increases, integration favors ‘sequential, adap452 453 454 455 456 457

See Sako/Helper (1998), p. 394. See Anderson/Gatignon (2005), p. 402. See, for instance, Chandler (1962) and Cyert/March (1992). See Robertson/Gatignon (1998), pp. 521-525. See Thietart/Xuereb (1998), p. 2. Wigand et al. (1999), p. 39. 85

tive decision-making’458 imposing ‘adaptation and information processing problems.’459 The problem of economic organizations is how to best deal with the adaptation problem, promoting a change in the organizational design in order to provide a proper fit with the new conditions. The degree of competition plays a significant role in defining the required degree of flexibility in the governance structures. Risk is a central feature of competition and it introduces a greater possibility of losses.460 Knight (1921/1965) noted that risk is another cost of doing business. As risks are known probability distributions of event outcomes, companies should take into consideration the costs of risk in their decision-making process as any other cost of production.461 The higher the risks are for doing business, the higher are the “internalized” costs within the firm. Basically it will affect frequently the ‘equilibrium’ of a firm’s resources. Knight attributed to uncertainty important characteristics of social organization, mainly the forecasting abilities of producers to anticipate consumer’s wants, command within the firms and the whole industrial wage system. A relevant consequence of uncertainty was earlier noted by Cyert and March (1992). They noted that the main way of dealing with uncertainty is by avoidance, by focusing on the short term. Instead of planning for an uncertain future, management uses short term strategies to deal with current disturbances.462 Consequently it has direct consequences on organizational behavior. As we observed before, high levels of uncertainty will increase risk.463 An increase in the level of exogenous uncertainty affects directly the levels of endogenous risks because the future becomes more unpredictable under multiple scenarios. Very commonly, short term strategies are adopted under a rapidly changing environment which requires a constant necessity of redimensioning and reallocating the company’s resources and changes in the production systems. It also has direct effects on human resources allocation and replacement, and, as we will observe later, it might create an environment of high employment instability. In general, businesses facing a high degree of uncertainty demand more flexibility and decentralization in order to provide faster response to the market. Internally, it demands constant internal reorganization processes, like constant changes in the production processes and the allocation resources (informational, physical or human) – it means a change in the allocation of property rights and in the structures of governance. Especially considering the new competitive market economies, exogenous uncertainties create needs for the reallocation of scarce resources in a short term perspective. The absence of accurate information, or, when new information very frequently arises within the firm, requires internal changes affecting organizational behavior. Accordingly, Milliken (1987) defined uncertainty as “an individual’s perceived inability to predict something accurately because the lack of information or an inability to discriminate 458 459 460 461 462 463

86

See John/Weitz (1988), p. 338. See Heide/John (1990), p. 27. See Sawyer/Shapiro (2002), p. 50. See Knight (1921/1965), pp. 268-295. See Cyert/March (1992), p. 121. See, for instance, Aharoni (1966), Miles/Snow (1978) and Miller (1992).

between relevant and irrelevant data.”464 It suggests a change in the way that people interact, their expectations and contributions in the processes. People might be reallocated or even replaced in order to cope with the new external demands. Moreover, as soon as those changes become more frequent the internal environment becomes more instable.465 Instability refers to the frequency of the changes within the environment. Mayo (1945) argues that instability of employment, which upsets the long socialization period necessary, is the chief enemy of the development of social norms as a form of control.466 In means, constant change in routines, customs, traditions, and conventions as informal constraints which shape peoples’ life and direct informally social systems.467 Instability might vary according to different institutional frameworks affecting the possible development of trust differently. Höhmann et al. (2002) notes possible differences in the levels of trust among different institutional arrangements regarding the degree of instability: “the way trust evolves depends on the stability of the environment. In this context, we might expect differences between established market economies and transition economies.”468 Also Zucker (1986) argues that business instability disrupts trust built within the social system.469 In opposition, stability reduces exploitative and short-term maximizing behaviors, and provides a trustworthy environment reducing the risk of harm and damage. Yamagishi (2003) comments, “the stable nature of social and organizational relations reduces social uncertainty and provides security inside such relationships.”470 Under environmental uncertainty, it is expected that levels of trust within organizations change because the stake of our interactions can change, or interactions may seem soon to be at an end. Hardin (2002) comments about uncertainty: “All of these reasons for uncertainty and even doubt at the individual level have institutional analogs. Many institutional deliberations change the views of the participants and, therefore, the collective intention.”471 He comments that inherent problems of inconsistency over time, strategic misrepresentation, changing conditions that end or threaten to end an interaction radically change its stakes, and it makes distrust potentially the correct prima facie judgment in many relationships.472 These problems may reduce assurance in the expectations of what parties to the relationships will do when their moments for trustworthiness come. Hardin comments: “Indeed, they must often cloud even good, trusting relationships.”473 Walker and Weber (1984) noted that environmental uncertainty predisposes agents to behave opportunistically when there are relation-specific investments.474 Also Wigand et al. (1999) argue that “transaction problems arise when oppor464 465 466 467 468 469 470 471 472 473 474

Milliken (1987), p. 136. See institutional change and instability in Furubotn/Richter (2001), pp. 23-24. See Mayo (1945), p. 56. See North (1990), p. 83. Höhman et al. (2002), p. 6. See Zucker (1986), p. 54. Yamagishi (2003), p. 360. Hardin (2002), p. 94. See Hardin (2002), p. 94. Hardin (2002), p. 95. See Walker/Weber (1984). 87

tunistically acting economic subjects endowed with bounded rationality enter transaction relations with a high degree of uncertainty and when information and knowledge is asymmetrically distributed among the transaction partners.”475 We argue that environmental (exogenous) uncertainty in the form of absence or frequent appearance of information affects human behavior, and therefore restricts the trust development within business companies due to the increasing behavioral uncertainty. Paradoxically, as noted by Coleman (1990), when exogenous uncertainty is high the value is not precisely calculated, enforceable contracts cannot easily be used and other social arrangements are necessary.476 The usual arrangement is the incorporation of risk into the decision of whether or not to engage in the action.477 Therefore, the higher the environmental uncertainty, the higher the need for incorporation of risk into decisions, and the higher is the necessity of trust. As Sako and Helper (1998) note, “the greater the degree of environmental uncertainty, the greater the benefit from being able to trust a trading partner, because trust facilitates decision making in unanticipated circumstances.”478

475 476 477 478

88

Wigand (1999), p. 37. See Coleman (1990), p. 91. See Coleman (1990), p. 91. Sako/Helper (1998), p. 394.

3. The New Economy (NE) The objective of this Chapter is to define and characterize the New Economy and present the impact of these new institutional settings on the levels of trust within the companies operating in the New Economy, which has changed substantially the ways of governing relational contracts. Therefore, this Chapter is structured in the following way: Section 3.1 introduces the definition of New Economy; Section 3.2 is focused on the key factor of productivity in the New Economy: knowledge; in Section 3.3 we present the dynamics of the institutional innovations in the New Economy identified as macro technological, political and economic institutional arrangements; Section 3.4 illustrates some paradigmatic differences between the Old Economy and the New Economy; Section 3.5 presents the general effect of these institutional innovations on the organizations operating in the New Economy; Section 3.6 introduces and characterizes the companies operating in the New Economy, especially the New Telecommunications Industry. In Section 3.7 we discuss the main institutional sources of uncertainties under the New Economy, namely technological uncertainty, demand uncertainty and regulation uncertainty. In Section 3.8, we present the impacts of these institutional and organizational uncertainties and instabilities on employment conditions and labor contracts. And finally, in Section 3.9 we present the case of the Brazilian Telecommunications Industry.

3.1 Definition The New Economy can be defined as a set of institutional innovations and a new macroeconomic configuration that has as its means and motor the advancement of information and communication technologies. The New Economy is characterized by the impact of macro political, economic and technological institutional changes, throughout the whole economy, affecting all industries in different levels.479 It has substantially changed the market dynamics towards a more competitive worldwide model, mainly due to the liberalization and privatization processes; it has established new flexible network-based forms of production as a response to institutional uncertainties, like alliances, subcontracting networks, joint ventures and clusters of interconnected firms; and it has affected the work environment, shifting the traditional labor contracts from a relational contract model to a more transactional model.480 The New Economy is often characterized as a technological ‘revolution’ involving the information and communication technologies (ICT) which affects almost all aspects of the economy, business, and societies.481 As Argandona (2003) notes, “the New Economy expresses the impact of the technological revolution developed around information and communications technologies.”482 However, the development of information and communication 479 480 481 482

See Argandona (2003), pp. 3-4. See Burton-Jones (1999), p. 53. See Argandona (2003), p. 3, Castells (1996/2000), pp. 28-76, and Zadek et al. (2001), p. 14. Argandona (2003), p. 4. 89

technologies is a means, not an end in itself. ICT works as the basic infrastructure which allows flexible and timely information-sharing and explicit knowledge transference processes. In this sense, the role of the information and communication technologies is therefore to facilitate the growth of the knowledge economy.483According to The Kiel Institute of World Economics, in essence, the New Economy is an economy where both final output and intermediate input consist predominantly of information.484 As Argandona (2003) notes, the core activities in the New Economy consist in “the fact that it is based on the acquisition, processing, transformation, and distribution of knowledge and information.”485 Zadek et al. (2001) add other elements to the knowledge component of the New Economy, such as the shifts in the speed of change, innovation and communication, and proximity.486 In the economics literature, attempts to approach the nature of the technological change, the entrepreneurial and innovative activity related to the rise of the New Economy, were earlier provided by Schumpeter (1942) and Galbraith (1956), who had attributed the role of large enterprises approaching markets as the main agents of innovative activity.487 In the last decades this approach has shifted to small entrepreneurial firms.488 The New Economy attributes a new role to knowledge as a main productive factor that adds value to the classical trilogy: physical capital, labor and natural resources. While these traditional inputs still play a role in the New Economy, knowledge has emerged as the most important factor of production. Knowledge and innovation have always driven the economy, and there are a number of characterizations of the economic phenomenon that the contemporary economies are going through resulting from innovations in information and communication technologies.

3.1.1 Conceptual Origins Cohen et al. (2000) note that, the ongoing transformation of our economy has been given many names: a ‘post-industrial society’, an ‘information society’, an ‘innovation economy’, a ‘knowledge economy’, a ‘network economy’, a ‘digital economy’, a ‘weightless economy’, and an ‘e-conomy’.489 They all have their merits in emphasizing the different aspects of the structural change; however, they are also vulnerable to misinterpretation. We use the term New Economy which is derived from the almost synonymous and loosely defined term Infor-

483 484 485 486 487 488 489

90

See Burton-Jones (1999), p. 3. See Kiel Institute of World Economics (2004). Argandona (2003), p. 4. See Zadek et al. (2001), p. 14. See Schumpeter (1942) and Galbraith (1956). See, for instance, Rothwell (1989) and Scherer (1991). See Cohen et al. (2000), p. 4, and The New Economy Index (1998), p. 3.

mation Economy,490 to distinguish primarily the knowledge-based economic activities related especially to the group of companies of the ICT industry, as the new economic agents which have emerged mainly in the 90’s due to the configuration of a new institutional scenario in the last decades. In this research we acknowledge these terms as synonymous, relative to the rise of a set of institutional innovations which have principally impacted on the ICT industry. We can identify some differences between the terms Information Economy and New Economy. (1) The term Information Economy can be widely observed in connection with the concept of Information Society, better characterized by theorists like Bell (1976), Castells (1996/2000) and Webster (1995, 1996). According to Webster (1996), definitions of information society can be analyzed under five criteria: technological, economic, occupational, spatial, and cultural.491 The technological definition is concerned with the applications of information technologies in society. The economic definition goes back to the pioneering work of Machlup (1962), Boulding (1966), Arrow (1979), and Porat (1977). These authors observed some economic aspects of the Information Society, or Post-Industrial Society,492 based on the increasing role of information activities and information industry (such as the production of goods and services based on information and communication technologies). In this sense, The School of Information Management of Berkley defines the Information Economy as “the economics of internet, information goods, intellectual property and related issues.”493 Related issues are, for instance, regulation, network economics, policy and law. On the contrary, (2) the term New Economy was most concerned with a particular period of economic growth in the USA which occurred in the middle of the 90’s supported by the globalization and the ICT revolution. The term ‘New Economy’ was generally adopted in the business and financial press. It seems that the Business Week magazine proposed the term ‘New Economy’ for the first time in 1994494 in reference to the temporary but long-lasting period of high growth that occurred in the USA in the 90’s, with the accelerated increase in productivity, followed by low inflation, function of productivity earnings, without inflationary pressures or signs of exhaustion of the work force, and with low levels of unemployment. It was a new dynamics of emerging economic growth in the USA when the new ICT industry arose as a driving force of the American Economy, and simultaneously spilled over into the international economy. The acceleration of the economic growth was assumed to lie behind a new kind of macroeconomic development where long term growth goes on undisturbed by inflation and uninterrupted by recessions. The superior economic structure that was expected to arise as an outcome of these 490

491 492

493 494

According to The New Economy Index (1998), p. 3, and Kiel Institute of World Economics (2004) almost synonymous names for the same phenomenon are the “Information Economy” and the “Knowledge-based Economy.” See Webster (1996), pp. 8-21. See Burton-Jones (1999), pp. 3-5. The theory of information society or post-industrial society has been in existence for over a quarter of a century. According to this theory, the production of goods would decline in favor of services, knowledge would become the basis of economic growth and productivity, and occupational growth would occur mainly in white-collar managerial and professional jobs. See The School of Information Management (2001). See Argandona (2003), p. 3. 91

forces was coined as ‘New Economy’ in the business press when the stock market boomed, powered by ICT and ‘dotcom’ companies.495 For instance, an increasing demand for Internet services occurred in the US. The Internet economy’s total size more than doubled just in the period 1996-1997, from US$ 15.5 billion to US$ 38.8 billion.496 Some explanations were given to clarify the rise of the New Economy in the 90s. Firstly, a technological breakthrough seems to have occurred in the mid-1990s in semiconductor manufacturing as this industry shifted from its product cycle.497 Secondly, increase in network computing due to the rapid diffusion of a widespread information infrastructure – the Internet. It is in fact the first truly global market place and hence the factor that links together the two broad trends defining the New Economy, namely the globalization of business and the revolution in information and communication technologies (ICT). It has integrated markets and linked people together across all kinds of traditional boundaries. Thirdly, labor productivity appears to have picked up in the United States in the mid-1990s. For instance, according to Castells (1996/2000), the growth of output per hour worked in the non-farm business sector accelerated from around 1.4 per cent per annum before 1995 to 2.6 per cent in the period 1995-1999.498 According to Castells (1996/2000), service industries seem to have accounted for much of this acceleration. Wholesale and retail trades as well as telecommunication services have all had increases in labor productivity, which are greater than for the economy as a whole.499

3.1.2 Adopted Perspective In this work we adopt the approach of Castells (1996/2000), Audretsch and Thurik (2001), and Argandona (2003) which allows for a better description of the shifts between the New Economy and Old Economy. Audretsch and Thurik (2001) view the New Economy as the shifting between a managed economy model which has come from the post-war era towards an entrepreneurial economy model, which brings together technological innovations and many innovative policies such as deregulation, privatization and labor market flexibility.500 In their view, the fundamental macro political issue behind these two models is the trade-off between concentration and efficiency on the one hand, and decentralization and democracy on the other hand. Castells (1996/2000) understands the shifting by focusing on the production systems between two economic models.501 The author observes that the new information economy 495 496 497 498 499 500 501

92

See Shepard (1997), p. 4. See The New Economy Index (1998), p. 29. See Jorgenson (2001), p. 3. See Castells (1996/2000), pp. 90-91. See Castells (1996/2000), p. 92. See Audretsch/Thurik (2001), pp. 2-3. See Castells (1996/2000), pp. 16-17.

represents a rupture between post-industrialism and informationalism. The latter referring to new production systems based on principles of maximizing knowledge-based productivity through the development and diffusion of information technologies.502 Castells states that the New Economy consists in itself of a disrupting process between the traditional industrial process based on intensive capital and scale economies, and the new informational process guided by a continuous process of information and communication technology innovation, based on information and knowledge as the chief means of the production of wealth. According to Castells the core process of the new informational economy is the transformation of information, processing, and communication technologies, penetrating the economic production systems not as an exogenous element to organizations, but as the process itself where their economic activities perform, and may also produce new products.503 He notes that these general-purpose technologies boost the efficiency of conventional activities and pave the way for creating entirely new activities and products as commercial ‘solutions’ based on information on communication technologies. Basically it establishes a new “informational” way to the generation of wealth in the capitalist systems. According to Castells (1996/2000), the revolution of the ICT and its diffusion in all spheres of social and economic activity is the most distinctive, in historical terms, between the economic structures of the first and second half of the twentieth century. As Argandona (2003) notes “the distinguishing feature of the New Economy is not merely a change in production and costs, or the use of the new technologies throughout the economy, but rather the nature of the “new” knowledge-intensive goods.”504 Along this line of reasoning, these authors sustain the existence of three basic features of the New Economy:505 (1) A knowledge- and information-based technological change; (2) Which operates in real time on a global scale (globalization); (3) With a new, flexible, network-based business organization. Castells (1996/2000) notes two broad trends which have been under way for some time in the world economy.506 The first is the globalization of business with the spreading of capitalism around the world after the collapse of socialism. New markets have been introduced, political and legal conditions have been changing countries’ institutional environment worldwide to accommodate the new requirements of a new worldwide economy through privatizations, regulation of competition and trade among many private groups and companies. Trade and capital flows have been deregulated. International trade and investments now play a greater role in each country’s economic policy than two decades ago. The second trend is the material basis, which has made it possible, the revolution effected by information and communication technologies. Its driving forces are the rapid improvement in the quality and sharp decline in the prices of ICT equipment and software, the convergence in communication and computing technologies and the swift growth in network computing. 502 503 504 505 506

See Castells (1996/2000), pp. 219-210. See Castells (1996/2000), p. 50. See Argandona (2003), p. 4. See similar statements in The New Economy Index (1998) and Kiel Institute of World Economics (2004). See Argandona (2003), p. 3, Audretsch/Thurik (2001), p. 2, and Castells (1996/2000), pp. 77-78. See Castells (1996/2000), pp. 77-78. 93

Moreover, some have speculated about the need for a new economic approach, and consequently a presumed change in the rules by which the economy operates, some of which may cease to be applicable (for example, the rule that high growth leads to inflation).507 However, it has been widely argued and agreed by many scholars that the phenomenon itself consists in changing parameters for new forms of production through the development of information and communication technologies and knowledge-based intensive production processes, which has strongly influenced the market dynamics, favored the rising of new organizational forms and changed the nature of human work.508 Thus, there is no ‘new’ economic theory.509 Economic laws continue to be the same. However, certain specific problems linked to network economies - high entry costs and virtually zero marginal costs, new competitive models, etc., arise.510 Nevertheless, it is surprising to find how scant the research on the impacts of the New Economy really is, especially outside the United States. There is limited empirical research into the changes that have occurred in labor relationships, mainly approaching relational contracting.

3.2 A Knowledge-Based Economy

3.2.1 Knowledge and the Production Function Before we introduce the factor ‘knowledge’ in the New Economy perspective, it is important to understand the historic evolution of the relevance of knowledge in the perspective of the economic production function. In the neo-classical view, economic growth was heavily dependent on an exogenous variable. The growth rate of output per worker was dependent on the rate of labor-augmenting improvement technology, which is determined by factors not contained in the model. The Neo-classical model implies that all economies that use similar technology, which could improve over time, should have converging productivity growth rates. In Cobb and Douglas’s (1928) model, and later in Solow’s (1956) model, knowledge was an exogenous variable related to the rate of technological progress which changes over time. These models focused exclusively on the traditional factors of production, capital and labor. They always assume some underlying long-term rate of productivity increase. The component of growth not well explainable by an accumulation of reproducible capital stock and human capital stock was usually attributed to a stock of technological ‘knowledge’ that grows smoothly (and without costs), of its own accord. According to Ayres (2005), apart from a number of other questionable simplifications, the standard Solow theory suffers from a crucial and recognized deficiency: “it cannot explain the main driver of economic growth. Unfor507 508 509 510

94

See Shepard (1997), p. 3. See, for instance, Burton-Jones (1999), Shapiro/Varian (1999) and Argandona (2002) and The New Economy Index (1998). See Argandona (2002), p. 2. See Argandona (2002), p. 4.

tunately there has never been any real theory to explain technical progress…. There are serious problems with the neoclassical growth-in-equilibrium assumption. It assumes that technical change is exogenous, uniform and smooth.”511 In this perspective, neoclassical development economists began thinking about other possible ways to ‘endogenize’ the standard theory without making drastic changes. Therefore, an endogenous mechanism could explain a part of this residual, i.e. beyond that which is accounted for by labor and capital accumulation. The part that can be explained without radical (structure changing) technological innovations is due to learning, scale, and the accumulation of knowledge that leads to cost savings and product improvements. Two approaches to endogenous theory of growth can be acknowledged in response to the problems left by neoclassical models: (1) the ‘human capital’ approach and (2) the ‘knowledge creation’ approach.512 (1) According to the ‘human capital’ approach, the newer version capital K is taken to include ‘human capital’ (labor force). In this fashion, Arrow (1962) criticized the absence of the variable ‘knowledge’ in the classical production function and proposed its analysis as an endogenous element as a ‘learning-by-doing’ process.513 In Arrow (1962), knowledge is a public good, the product of experience. Learning by repetition of a problem is subject to diminishing returns. Therefore, he proposed a continuous learning process in which one needs to continually meet new problems, and the cumulative output will be an index of experience. In Arrow’s (1962) model, knowledge (or technical change) is the by-product of experience gained in the production of goods. The mechanism in question is a simple positive feedback between increasing consumption, investment, increasing scale and ‘learning-by-doing’ or ‘learning by using’ at the societal level.514 This feedback results in declining costs leading to declining prices. Lower prices for goods and services stimulate further increases in demand and investment to increase the supply capacity. Increasing capacity gives rise to further economies of scale, which drive costs down. Moreover, production experience itself yields efficiency gains due to learning. According to Romer (1990), the problem of Arrow’s model is that it takes the strict proportionality between knowledge and physical capital or knowledge and education as an unexplained and exogenously given feature of the technology.515 (2) Alternatively, the second approach to endogenous growth theory emphasizes active and deliberate knowledge creation. This is presumed to occur as a result of inventors and innovators (e.g. R&D). Ayres (2005) observes: “Knowledge is assumed to be inherently subject to spillovers and dependent on the extent to which benefits of innovation can be appropriated by rent-seeking Schumpeterian innovators. Most models assume that inventors and innovators 511 512 513 514 515

See Ayres (2005), p. 5. See Ayres (2005), p. 5. See Arrow (1962), p. 155. See Ayres (2005), p. 6. See Romer (1990), p. 77. 95

have negligible success at appropriating the benefits of their efforts. In other words, spillovers are essentially immediate and automatic. This assumption appears to be realistic.”516 In this fashion, Romer (1990) proposed another growth model approach which is driven by technological change that arises from intentional investment decisions made by profit-maximizing agents. He postulated a tradeoff between current consumption and investment in ‘knowledge’, which he assumes could be monopolized long enough to be profitable to the discoverer, but yet almost immediately becomes available as a free good (spillover) accessible to others. Initially, Solow’s (1956) neoclassical model had emphasized that technological change – in the form of knowledge or the ‘effectiveness of labor’ – such as improvements in the instructions for mixing together raw materials – lies in the heart of economic growth.517 However, in Solow (1956), knowledge (or technical capital) is assumed to be independent of both the capital and labor inputs and nonrival and non-excludable goods, which are free for all business (an exogenous provided public input). It appears as a multiplier with labor, denoting that knowledge contributes by ‘augmenting’ labor and not affecting capital. In this case, the final output equals the growth of income per worker. Resembling Solow’s (1956) model, Romer (1990) assumes two other premises. Firstly, technological change arises by market incentives, in large part because of intentional actions taken by people who respond to these incentives. Secondly, and the most important, instructions for working with raw materials are inherently different from other economic goods.518 He observes: “once the costs of creating a new set of instructions has been incurred, the instructions can be used over and over again at no additional cost. Developing new and better instructions is equivalent to incurring a fixed cost. This property is taken to be the defining characteristic of technology.”519 Accordingly, technology is understood as an input, it is neither a private nor public good; rather it is a nonrival and partially excludable good. Therefore, because of the nonconvexities introduced by a nonrival good, price competition cannot be supported. He concludes that “the stock of human capital determines the rate of growth.”520 In Romer (1990), “economic goods are both rivalrous and excludable. They are privately provided and can be traded in competitive markets.”521 The vast majority of new designs of goods results from the research and development activities of private, profit-maximizing firms. In this sense, Romer notes, a design is nonrival. Once the design is created, it can be used as often as desired, in as many productive activities as desired. However, he notes that the person (human capital) who adds is rivalrous because he/she cannot use his/her ability in more than one place at the same time, nor solve many problems at once. Therefore, rivalry leads to a presumption that human capital is also excludable, and it can be privately provided and traded in competitive markets. He also observes that a nonrivalry good (e.g. design) can be accumulated and its costs of replication are trivial, whereas riva516 517 518 519 520 521

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Ayres (2005), p. 7. See Solow (1956), p. 85. See Romer (1990), pp. 72-73. Romer (1990), p. 72. Romer (1990), p. 71. Loc. cit. p. 74.

lry goods (e.g. human capital) cannot.522 Thus, he presumably shifts the unit of observation from firms to individuals as entrepreneurs who create firms looking to appropriate the value of knowledge. And therefore new entrepreneurial firms enter in the market. These authors (like Romer) focus on investment in knowledge itself (e.g. education, R&D) as a core concept. According to Ayres (2005), the development of endogenous growth theory along neoclassical lines seems to have culminated, for the present, with the work of Aghion and Howitt (1998). They pioneered a ‘neo-Schumpeterian approach’ emphasizing the research-driven displacement of older sectors by newer ones.523 This is essentially equivalent to the process of creative destruction originally described by Schumpeter (1949).

3.2.2 The Evolutionary Economics Approach The evolutionary approach, inspired by Schumpeter’s early works, emerged as a distinct branch of economic theory in the 1980s. Whereas in standard neoclassical economics, competition in an exchange market near equilibrium is mainly driven by inherent comparative advantage (e.g. location) or bargaining skill, in Schumpeter’s world, by contrast, competition is driven by competitive advantage resulting from innovation by ‘first movers’, taking advantage of returns on experience and scale, returns on adoption, imperfect information, and (in some cases) legal monopolies during the life of a patent.524 In the evolutionary approach, markets seldom reach equilibrium, and if they do so, it is a path dependent at the industry level.525 Ayres (2005) comes to the conclusion that the main difference between evolutionary economics and the neoclassical mainstream is that: “neoclassical theory postulates ‘representative’ firms operating on the boundary of a well-defined region in factor space, whereas evolutionary economics lays great stress on the existence of diversity.”526 In the line of the evolutionary approach, Nelson and Winter (1982a) note that there are two key dimensions involved in the process of technological change: diversity and selection. Ayres (2005) notes: “In fact, the mechanism that drives the economic system, in the evolutionary view, is a kind of conflict between diversity and selection…In economics, diversity is the result of diversity of talents and ideas among entrepreneurs, together with diversity of competitors, institutional constraints, cultures and other external circumstances.”527 Accord522 523 524 525

526 527

See Romer (1990), p. 75. See Romer (1990), p. 7. See Schumpeter (1934), pp. 43-46. See Anderson/Gatignon (2005), p. 402. For in-depth discussions, see also Furubotn/Richter (1991), pp. 462467, who state that the basic neoclassical model is not particularly helpful in analyzing problems of economic adjustment in a system characterized by positive transaction costs and imperfect information. They claim that, in a world of frictions, bounded rationality and uncertainty, information getting and decision making takes real time, and both because of positive discontinuing and constant environmental change, therefore, information becomes quickly obsolete. Ayres (2005), p. 9. Ayres (2005), p. 9. 97

ing to Nelson and Winter (1982a), selection is essentially equated to survival into the next period as a viable competitor in the market. These authors have shown that a plausible growth process can be simulated by postulating a population of firms (not in equilibrium), displaying bounded rationality, and interacting with each other on the basis of probabilistic rules.528 Nelson and Winter (1982a and 1982b) share with mainstream economists a widespread view that the specific features of technological change are essentially unpredictable, except in the statistical sense that investment in R&D can be expected to generate useful new ideas.529 Ayres (2005) observes that the contemporary orthodox view is reasonably well summarized by Heertje (1983) who notes: “Technical knowledge, being the product of a production process in which scarce resources are allocated, can be produced. We do not know exactly what will be produced, but we are certain that we will know more after an unknown period.”530 In this sense, Nelson and Winter (1982a) assume that the probability of a successful innovation is a function of R&D investment and more-or-less independent of past history or other factors. Firms react to uncertainty by developing routines that reflect the path of their singular history. Therefore, they conclude that, if discovery, invention and innovation were really so random, technological progress would be much smoother than it actually is.531

3.2.3 Knowledge in the New Economy Audretsch and Thurik (2001) approached some aspects of the New Economy. They comment on Nelson and Winter’s (1982a) model that, in their model, the technological competence of each firm results in a particular technological trajectory. In this perspective, the innovative activity is generally within the boundaries established by the firm’s core competence and its technological trajectory. Such innovative activity within the technological paradigm established by the firm’s core competence provides the basis of continuity which characterizes an attribute of the Old Economy.532 In contrast, they observe that one of the main tradeoffs between the managed economy (Old Economy) and the entrepreneurial economy (New Economy) is that in the latter, a small number of firms, or clusters of firms divide up the output of the industry which promotes technological advance and provide a diverse number of productive approaches to technological innovation. As Cohen and Klepper (1992) pointed out, large firms have a greater incentive to invest in R&D because they are better able to appropriate the returns through greater output and sales. At the same time they do not have a large incentive to try to extend innovative activity beyond the boundaries imposed by their technological trajectories.533 Audretsch and Thurik (2001) comment that, in the entrepreneurial economy (New 528 529 530 531 532 533

98

See Nelson/Winter (1982a), p. 54. See Ayres (2005), p. 9. Ayres (2005), p. 9. See Nelson/Winter (1982a), p. 76. See Audretsch/Thurik (2001), p. 8. See Cohen/Klepper (1992), p. 2.

Economy), decentralized decision-making in an industrial structure comprised of smaller firms will lead to a greater diversity of approaches.534 Accordingly, this diversity generates greater opportunities for breaking out of the boundaries imposed by the lock-in along technological trajectories and ultimately to achieve success. The managed economy was characterized by concentration of knowledge resources in just several firms resulting in a concentration of innovative activity within just several technological trajectories. By contrast, allowing knowledge to run freely by letting loose several independent agents (deconcentration), better characterizes the entrepreneurial economy. It results in a greater diversity of approach across a broad range of technological trajectories. Innovation is present under both change and continuity. Therefore the locus of innovative activity differs considerably between the managed economy (Old Economy) and the entrepreneurial economy (New Economy). This difference is shaped by a distinction between incremental and radical innovations. According to Audretsch/Thurik (2001), “innovations can be considered to be incremental when that they are compatible with the core competence and technological trajectory of the firm…The implementation of such incremental innovations does not require significant change in the firm or its personnel. By contrast, a radical innovation can be defined as extending beyond the boundaries of the core competence and technological trajectory of the firm.”535 They note that in economic terms, knowledge is mostly regarded as an asset. The fundamental assumption of standard microeconomics is that economic systems are based on rational choices made by individual agents. Thus, how much and what kind of information agents have about the world in which they operate and how powerful is their ability to process the information are crucial issues. Here knowledge appears both as an input (technical competence) and output (innovation) in the production process. In this sense, Argandona (2003) comments on the New Economy that, new technologies specification have altered the demand for other production factors, such as new labor skills, new management systems, need for support infrastructures, etc.536 Therefore, Audretsch (2003) proposes to add the variable entrepreneurship to Romer’s (1990) model, concluding that in the New Economy knowledge spillovers exist and account for industrial clustering for both production and innovation.537 He notes that boundaries of firms are but one means to organize and harness knowledge. Nevertheless, geography may provide an additional platform upon which to effectively organize knowledge production.

534 535 536 537

See Audretsch/Thurik (2001), p. 8. Audretsch/Thurik (2001), p. 9. See Argandona (2003), p. 4. See Audretsch/Thurik (2001), p. 9. 99

3.2.4 Characteristics of Knowledge in the New Economy We adopt Burton-Jones’ (1999) definition on information and knowledge.538 Information is defined as data which are intelligible to the recipient. Knowledge is defined as the cumulative stock of information and skills derived from the use of information by the recipient. BurtonJones (1999) notes that “Where the recipient is a human being, knowledge thus reflects the processing (thinking and cognition) by the brain of the ‘raw material’ supplied in the form of information.”539 In this sense, knowledge is valuable and meaningful information which provides a reliable basis for action. The following Figure 3-1 illustrates his definition. In Arrow (1962, 1974), knowledge differentiates basically as a function of uncertainty, asymmetry and transaction costs.540 Knight (1921/1965) and later Arrow (1962) emphasized that new economic knowledge is anything but certain.541 Not only is new economic knowledge inherently risky, but also information asymmetries exist substantially across agents.

Figure 3-1: Knowledge Production High

Knowledge

Value

Meaning

High

Information

Data

Low

Low Source: Burton-Jones (1999), p. 6.

As emphasized by Arrow (1974), Burton-Jones (1999) sees the value of the information as dependent on the recipient’s prior knowledge, thus if we have no previous knowledge of a particular subject (as investments), it is usually difficult if not impossible to make sense of data related to the subject.542 Consequently, the more we know about the subject, the better capable we are to evaluate and use data about it. Thus, knowledge subsumes information 538

539 540 541 542

100

See Burton-Jones (1999), p. 5. These definitions of the terms knowledge and information are aligned with the original definitions proposed by theorists on information society, respectively by Bell (1973), p. 175, and Porat (1977), p. 5. Burton-Jones (1999), p. 5. See Arrow (1962) and Arrow (1974). See Knight (1921/1965), p. 268, and Arrow (1962), p. 624. See Arrow (1974), pp. 39-40, and Burton-Jones (1999), p. 5.

which represents both input to knowledge development and the form in which knowledge is transferred. In this sense, the value of knowledge will be related to the meaning that this knowledge inherently has in order to generate an economic value greater than its previous investments in production and transaction costs. Moreover, knowledge has a distinct property. It is not a commodity that can be simply bought like more tangible resources; this is because the value of knowledge as a feasible object of trade often vanishes at disclosure, making it difficult to set a price on it. Two kinds of knowledge can be differentiated from the transferability perspective.543 Burton-Jones (1999) distinguishes between explicit knowledge and implicit or tacit knowledge.544 Explicit knowledge refers to the kind of knowledge that can be codified and transferred which enable it to be understood by a broad audience. In this sense, the commercial applications of ICTs have enhanced the development of the knowledge economy (as transferable explicit knowledge). Burton-Jones (1999) provides an illustration about explicit knowledge, he notes: “Information systems (IS), a branch of IT (information technology), use system analysis and design tools to represent the ‘real world’ (as perceived by users), the main aim being to achieve as accurate and complete a representation of it as possible. In this way a complex process, which perhaps has been the idiosyncratic knowledge of a particular individual, can be transformed into more generalizable knowledge, or decomposed into items of information which can be accessed and, if required, reassembled at low costs.”545 However, if knowledge cannot be explicit, it must remain tacit thus difficult or impossible to transfer. Tacit knowledge in particular, requires active disclosure and transfer assistance on the part of the knowledge provider.546 While an open sharing of knowledge between parties is likely to enhance learning, the fear of free riding may inhibit informal knowledge disclosure even if both parties had formally agreed to engage in a collective learning effort. One has to observe that, even if there is a formal agreement between parties, tacit knowledge is assumed to be a non measurable asset and it requires a certain level of trust between agents because its effective transferring process is dependent on agents’ consent. Knowledge in the form of know-how refers to skills, as abilities to do something, and it plays a crucial role in important economic activities, especially in the entrepreneurial economy (New Economy). One of the most important reasons for network formation is exactly the need for firms to be able to share and combine elements of know-how, and the creation of a trust atmosphere is one of the main attributes to

543

544 545 546

Often in the New Economy studies, knowledge can also be seen also in public/private dimensions. In the economic theory, ‘public’ means that its benefits can be enjoyable by many users concurrently as well as sequentially without being diminished, and it is costly for the provider to exclude unauthorized users. Therefore public knowledge can be assessed by anyone and here there is no incentive for rational private agents to invest in its production. In opposition, private knowledge refers to an asset that can be bought or sold in the market like a commodity which has some economic value which is reduced once its benefits have been assimilated. See Burton-Jones (1999), pp. 6-7. Burton-Jones (1999), p. 8. See loc. cit. p. 7. 101

promote efficiency.547 As Burton-Jones (1999) notes: “knowledge acquisition (learning) and creation (invention, innovation) can only occur to any significant degree in the human brain.”548 However, according to Burton-Jones, a firm’s knowledge capital is ‘reflected’ in other ways such as in its workforce, its customer’s demand and preferences, its systems, products, processes and capabilities. Thus, the author notes that the knowledge assets of a firm may thus significantly exceed the value of its tangible assets, as shown by the stock market evaluation of firms such as Microsoft and Netscape.549 Knowledge consists of the core feature of the New Economy as it influences the change in the nature of production, human work, jobs, the firm, the market and many other aspects of economic activity.

Figure 3-2: Service Sector Growth

Source: The New Economy Index (1998), p. 9.

According to Castells (1996/2000), technology and the management of technology involving organizational change, seem to have diffused particularly from information technology manufacturing, telecommunications and financial services, as the original sites of technological revolution and the primary purchasers of information and communications technologies.550 Therefore, in the knowledge-based economy, the service sector is taking on a new role, emphasizing the value of technology and the quality of human capital. According to The New Economy Index (1998) report, R&D spending by the service sector has been growing faster than that of manufacturing and it has accounted for a quarter or more of the total in the

547 548 549 550

102

See Wigand et al. (1999), pp. 216-217, and Section 2.8.3. Burton-Jones (1999), p. 6. See Burton-Jones (1999), p. 6. See Castells (1996/2000), pp. 90 and 96.

major OECD countries (see Figure 3-2).551 Most net job gains in the past decade have come from service industries, with particularly rapid growth in business and professional services. Moreover, knowledge-intensive employment has increased more than any other type of employment.552 In the business environment of the New Economy, the costs of acquiring information (as explicit knowledge) are lower, barriers to entry have been reduced, “natural” monopolies have being eliminated and new products and services are being created rapidly. According to the ILO, governmental policies worldwide have aimed to increase the access of enterprises, particularly smaller ones, to venture capital, technological advice and to improving workforce skills.553 Technology networks with private sectors have brought together clusters of firms with similar requirements, usually through computer and communications links. Information technology has speeded up the codification of information, transforming it into a market commodity: large masses of information can be codified and transmitted over computer and communication networks. These computers can be linked nationally and internationally through the world-wide Internet. Through computer networks, information is more accessible to a wider group of people and cheaper to acquire. However, the simple access to information does not consist of substantial knowledge exchange. According to Audretsch and Thurik (2001) and Audretsch (2003) tacit knowledge cannot be acquired or accessed and geography still plays an important role in the New Economy in the sense that knowledge tends to be developed in the context of localized production networks embedded in innovative clusters of firms and small groups of specialists.554 According to the authors, it means that a paradox lies in the distinction between knowledge and information. While the marginal costs of transmitting information (as explicit knowledge) may be invariant to distance, presumably the marginal costs of transmitting knowledge, especially tacit knowledge, rise with distance. Thus, while the cost of obtaining information has been drastically reduced, the cost of obtaining knowledge remains largely unchanged. Under the Old Economy, the traditional factors of production (land, labor and capital) are predominant as sources of competitive advantage; in the New Economy the competitive advantage is based on innovative activity through the production of knowledge, and an important source of this innovative activity is knowledge spillovers that cannot be easily diffused across geographic space. Local characteristics and idiosyncrasies provide a rich source of new knowledge in the New Economy.555 In summary, in Section 3.2, we acknowledge knowledge as one of the most important institutional features in the New Economy. The increasing importance of knowledge in the economic production function illustrates it. Therefore, knowledge is itself the basis of the innovation activity and appears both as an input (technical competence) and output (innovation) in 551 552 553 554 555

See The New Economy Index (1998), p. 9. See OECD (2001), p. 14. See ILO (2001), pp. 6-10. See Audretsch/Thurik (2001), pp. 6-8. See Audretsch/Thurik (2001), p. 8. 103

the production process. In the line of the evolutionary approach, we noted two key dimensions involved in the process of knowledge-based technological change: diversity and selection. Diversity in the sense of competing technologies, together with diversity of competitors, institutional constraints, cultures and other external circumstances; and selection equated to survival into the next period as a viable competitor in the market. We observed that tacit knowledge becomes a critical asset in the New Economy and its effective transferring process is dependent sensibly on agents’ consent. It brings a relevant observation to this study: as noted by Adler (2001), because trust is a crucial ingredient both in high commitment and knowledge-sharing processes, as knowledge becomes increasingly important, we should expect high-trust institutional forms to proliferate556, however a paradox seems to exist. The existence of diversification and selection in the technological innovation process inherently brings a considerable level of uncertainty, therefore new economic knowledge becomes anything but certain. Not only its trajectory becomes inherently risky, but it also substantially increases information asymmetries across agents.

3.3 Institutional Innovations

3.3.1 Institutional Changes Institutional innovations consist of a set of elements that affect the national and international economies, such as the opening of captive markets to foreign investment in several countries (deregulation), the world capital flow, the privatization of state companies, the expansion of multinational companies, the continuous innovation of new information and communication technologies, and a high international competition. The association of such factors brought the emergence of new market opportunities, new technologies, new products and services, new organizational forms, and a new human labor dynamics. In order to better understand these institutional innovations affecting human behavior in the New Economy, firstly it is important to consider the question of how institutions change. It gives us reasonable understanding about the new business environment characterized by high uncertainty and instability in the New Economy. As North (1990) observed, “the major rule of institutions in society is to reduce uncertainty.”557 North comments that our lives are made up of stable routines in which the matter of choices appears to be regular, repetitive, and clearly evident, so that most of our actions in a day do not require much reflection. According to North (1990), “it happens due to the imbedded set of institutions that has made it possible for us not to have to think about problems or to make such choices. We take them for granted, because the structure of exchange has been 556 557

104

See Adler (2001), pp. 215-220. North (1990), p. 6.

institutionalized in such a way as to reduce uncertainty.”558 North further explains that, although institutions can be very inadequate or far from optimal in any sense of the term and all our decisions based on incomplete information, institutions provide us regularized patterns of human interaction in the face of complexities. Institutions change when relative prices (economic and political) lead parties to an exchange to perceive that either or both could be better with an altered agreement or contract. Competition is the key to institutional change forcing organizations to invest continuously in new skills and knowledge to survive.559 It implies a change in the former ‘rules of the game’, being simply ignored or replaced by another. Therefore, problems affecting human behavior and exchange among people will arise. In North’s perspective, the agent of change is the entrepreneur (political or economic). North (1993) notes: “The entrepreneur and his/her organization will invest in acquiring knowledge, coordination and ‘learning-by-doing skills’ in order to enhance the profitable potential.”560 Similarly, in Schumpeter’s view the entrepreneur is someone who carries out ‘new combinations’ by such things as introducing new products or processes or creating new types of organizations. In this sense, the entrepreneur leads the way in creating new industries, which in turn precipitate major structural changes in the economy.561 In this way, North observes that institutions may change basically through two processes. (1) An incremental process in which short run profitable opportunities cumulatively create the long-run path of change, but the long run consequences are not the interest of the entrepreneurs but the direction of their immediate investment. (2) A discontinuous institutional change does occur in the form of revolution.562 By revolution, North understands the establishment of formal rules which alter the policies and economies. This point specially highlights the presence of political and economic agents in the process of building and promoting structural policies such as market liberalization and deregulation worldwide, which has ultimately provided the basic structural elements to support the spread of technological revolution and made the rise of the New Economy possible.563

3.3.2 The New Creative Destruction Process The process through which the New Economy arises might find its best theoretical support in the classic Schumpeterian argument of the ‘creative destruction’ process of the capitalism system. Schumpeter (1942) characterized modern capitalism as constant ‘creative destruction’, as a precondition to competition.564 Schumpeter considered competition and innovation as intrinsic characteristics of capitalism; therefore, on a greater or smaller scale, every company is in some way subject to such dynamics that has as its driving force innovation, informa558 559 560 561 562 563 564

North (1990), p. 22. See North (2005), p. 22. North (1993), p. 255. See Schumpeter (1942), p. 46. See North (1993), p. 256. See Wigand et al. (1999), pp. 349-350, and Burton-Jones (1999), p. 4. See Schumpeter (1942), p. 83. 105

tion, and knowledge.565 The New Economy is characterized by an exponential rise in such dynamics. As observed by Castells (1996/2000) and Audretsch and Thurik (2001), the New Economy consists in itself of a disrupting process between paradigms.566 In this sense, North (1990) has observed the “adaptative efficiency” of institutions to innovate, continuously learn and productively change. North (1994) in his acceptance lecture to win the Nobel Prize for economics observed that “it is adaptive rather than allocative efficiency which is the key to long run growth.”567 By ‘adaptative’ efficiency he meant something close to Schumpeter terms. For the purpose of this research, the core of the difference between the companies chosen to represent the New Economy and those of the Old Economy is in the intensity and dependency of the rupture that the technological changes might create for such organizations. For instance, steelworks, mining and petrochemical companies, though under the increasing pressure for competition based on the application of knowledge, suffer slower and smoother ruptures from the fact that their products can count on a relatively stable demand. Very often long term contracts with a few worldwide consumers provides relative assurance for future demands. Generally innovation follows a continuous and incremental trajectory over existent technological paths. Although they might have a frequent application of knowledge in the production processes, it is not as susceptible to sudden loss of competitiveness due to technological innovation as it is in the New Economy. The same continuous and incremental trajectory does not occur in the new telecommunications and computer industry companies, where the appearance of technological innovations can definitely eliminate, by substitution, such companies from the market. These differences among industries are strongly related to the intensity and dependency of the innovative activity, which are ultimately related to industry-specific characteristics like entry barriers, level of competition and environmental uncertainty. Audretsch and Thurik (2001) understand that, in the base of the New Economy (as an entrepreneurial economy), there is an increasing role of new and relatively smaller enterprises and individual actors taking advantage of the new institutional arrangements. Contrary to the Old Economy, the business environment in the New Economy stimulates the process of generating new ideas, both within and outside the boundaries of firms (R&D laboratories) which creates a diversity of opinions about the value of new ideas. Audretsch and Thurik (2001) note “The diversity of new ideas and experiments with their commercialization manifests itself externally as well as internally to incumbent firms. The selection of between viable and non-viable ideas is then the result of the market process and not restricted to internal decisions imposed by decision-making hierarchies. The drive to appropriate the expected value of knowledge embodied in individual economic agents results in commercialization of ideas in the form of 565 566 567

106

See Schumpeter (1942), p. 83. See Castells (1996/2000), p. 226, and Audretsch and Thurik (2001), pp. 2-3. See North (1994), p. 363. See also reference in The New Economy Index (1998), p. 6.

new firms. But not all of these start-ups are successful.”568 They also note that: “Combined with the bureaucratic organization of incumbent firms to make a decision, the asymmetry of knowledge leads to a host of agency problems, spanning incentive structures, monitoring, and transaction costs. It is the existence of such agency costs, combined with asymmetric information that not only provides an incentive for agents with new ideas to appropriate the expected value of their knowledge externally by starting new firms, but also with a propensity that varies systematically from industry to industry… the degree to which agents and incumbent firms are confronted with knowledge asymmetries and agency problems with respect to seeking out new economic knowledge and (potential) innovative activity would not be expected to be constant across industries. This is because the underlying knowledge conditions vary from industry to industry. In some industries new economic knowledge generating innovative activity tends to be relative to a routine and can be processed within the context of incumbent hierarchical bureaucracies. In other industries, however, innovations tend to come from knowledge that is not of a routine nature and therefore tends to be rejected by the hierarchical bureaucracies of incumbent corporations.”569 Therefore, in the Old Economy, the relative lower dependence on the technological innovation activity seems to inhibit technological developments. Possible divergences relating to the potential value of technological innovations present no incentives for entrepreneurial activities. In this case, innovation requirements are efficiently handled in the R&D laboratories within the boundaries of the firms. On the other hand, in the New Economy, the continuous innovation activity based on intensive knowledge application plays a more significant role, mainly because it becomes the essential feature for a firm’s survival. It fosters the creation of divergent and competing technologies. Audretsch (2003) presents a model which well illustrates technological trajectories in the companies of the New Economy and Old Economy (see Figure 3-3). In this sense, Rothwell (1992) observes the effects of different types of innovation trajectories on organizational forms: “while an incremental innovation might be introduced using existing structures and procedures, a radical technological innovation might, and frequently will, require concomitant and significant organizational and procedural adaptations if it is to be successful.”570 In the Old Economy, technological innovations are developed through a cumulative process within R&D laboratories of large-size incumbent firms (B), which tend to generate routines of incremental technological improvements over existent technologies. In contrast, the New Economy has fostered new technological innovations through the development of diversified and competing technologies, internally or externally to the boundaries of firms, that ultimately are submitted to the market selection mechanism (A).

568 569 570

Audretsch/Thurik (2001), p. 14. See ‘incumbent’ and ‘entrant’ in the Section 3.6. Audretsch/Thurik (2001), p. 19. Rothwell (1992), p. 223. 107

Figure 3-3: Technological Innovations Trajectories Performance - Returns - Wages

Survival Trajectory

Incumbent Firm B New Entrepreneurial Firm A

Failure Trajectory

Time

Source: Modified form Audretsch (2003), slide 21.

Therefore, the entrepreneurial activity will be inherently marked by higher uncertainty and risk of failure.571 The analysis of Figure 3-3 suggests that in the knowledge-based innovationdriven industry, people start firms to pursue new but uncertain ideas. The only way they can discover if these ideas are viable is through the trial-and-error experience provided by the market, and therefore, they consequently learn through experience, whether or not the idea is available. Audretsch and Thurik (2001) found out that one third of the U.S. manufacturing firms are less than six years old but they respond for only 5 per cent of total manufacturing employment. They comment: “Taken together, this evidence provides a view of the entrepreneurial economy as being remarkably turbulent, in that a large number of firms are started each year, while only a few of the firms actually survive beyond a decade, and an even fewer number of those new firms grow sufficiently to challenge the incumbents.”572

3.3.3 Change in the Relative Prices The rise of the New Economy represents a significant institutional change and it can be well observed through the rapidly and substantially decreasing technology exchange prices which leads to a reduction in transaction costs and provides new technological instruments for the economic global exchange. Regarding this point, North (1990) notes that relative prices are the most important source of institutional change.573 North (1993) notes: “Institutions play an 571 572 573

108

See Dosi (1998), p. 222, and Rothwell (1992), p. 227. Audretsch/Thurik (2001), p. 15. See North (1990), pp. 7 and 84.

even more important role in the production of goods and services since institutional structures affect both production and transaction costs; the latter via the direct connection between institutions and transaction costs…the former by influencing the technology employed.”574 According to Freeman (1988), one technological and economic paradigm consists in a collection of technical, organizational, and administrative innovations, whose advantages have to be acknowledged not only by a set of new products and systems, but also and above all, by the dynamics of the structure of relative costs of all possible inputs of production.575 In this sense Freeman (1988) notes that, on each new paradigm, a specific input or a set of inputs can be described as a “key-factor” of it, characterized by the decrease of relative costs and universal availability. Freeman (1988) also states that, the paradigmatic contemporary change can be analyzed as a technological transference of one technology based on inexpensive information inputs from the technological development of microelectronic and telecommunications.576 In the same way, Castells (1996/2000) points out that one of the driving forces of the information and communication technologies revolution (ICT) is the sharp decline in the prices of ICT equipment and software.577 The following figures illustrate these differences regarding the new paradigm through high entry data transmission and microprocessor costs, and virtually zero marginal costs over recent decades (see Figures 3-4 and 3-5).

574 575 576 577

North (1993), pp. 249-250. See Freeman (1988), p. 10. See Freeman (1988), p. 10. See Castells (1996/2000), pp. 69-71. 109

Figure 3-4: Data Transmission Costs Fallen

Source: The New Economy Index (1998), p. 19.

Figure 3-5: Microprocessor Price Trends

Source: The New Economy Index (1998), p. 18.

Therefore, one can acknowledge the rapid and substantial decrease in exchange prices of information and communication technologies which leads to a reduction in transaction costs and provides new technological instruments for economic global exchange. It ultimately de110

monstrates a considerable institutional change moved by competition and technological innovation in the ICT industry. In summary, in Section 3.3, we observed that New Economy’s institutional environment is marked by relatively recent and continuous institutional changes and uncertainty. We observed that in the Old Economy, technological innovations are developed through a cumulative process within R&D laboratories of large-size incumbent firms, which tend to generate routines of incremental technological improvements over existent technologies. In contrast, the New Economy has fostered new technological innovations through the development of diversified and competing technologies, internally or externally to the boundaries of firms, that ultimately are fostered by high competition. Contrary to incremental innovations, which do not require significant change in the firm or its personnel, in the New Economy, radical technological innovations spills over and can be defined as extending beyond the boundaries of the core competence and technological trajectory of the firm, which brings a higher level of uncertainty. The relative product prices confirm a considerable institutional change in the New Economy’s institutional environment.

3.4 New Economy and Old Economy Despite the differences that were inevitably introduced before, in this section we attempt to draw attention to some major differences between the Old Economy and the New Economy. The New Economy is not mutually exclusive with the traditional manufacturing industrial economy (Old Economy). Thus, the paradigmatic shifts that contrast basically the managed economy with the entrepreneurial economy are not symmetrical.578 Table 3-1 presents a summary of the paradigmatic shifts between the Old Economy and the New Economy.579 The table shows a tendency in the New Economy towards network forms of organization, global scope of competition and higher competitive market dynamics. The New Economy is remarkably driven by innovation, knowledge-based activities and highly flexible production systems in order to deal with the highly competitive and environmental changes.

578 579

See Castells (1996/2000), p. 100, and Audretsch/Thurik (2001), p. 3. The New Economy Index (1998), p. 7. 111

Table 3-1: Keys to the Old Economy and New Economy ISSUE

OLD ECONOMY

NEW ECONOMY

Markets

Stable

Dynamic

Organizational Form

Hierarchical, Bureaucratic

Networked

Organization of Production

Mass Production

Flexible Production

Key Drivers of Growth

Capital/Labor

Innovation/Knowledge

Economy-Wide Characteristics

Industry

Key Technology Driver

Mechanization

Digitization

Source of Competitive Advantage

Lowering Cost Through Economies of Scale

Innovation, Quality, Time-To-Market, and Cost

Relations With Other Firms

Go It Alone

Alliances and Collaboration

Policy Goal

Full Employment

Higher Real Wages and Incomes

Skills

Job-Specific Skills

Broad Skills and Cross-Training

Requisite Education

A Skill or Degree

Lifelong Learning

Nature of Employment

Stable

Marked by Risk and Opportunity

Workforce

Source: The New Economy Index (1998), p. 7.

According to Table 3-1, the nature of the employment is marked by opportunities for better educated workers, and general risk and uncertainties.580 On the Contrary, the Old Economy is characterized by capital or labor-intensive industries. It means productive processes that require large sums of financial resources or workers to produce a particular good. Those companies have their economic activities most related to economies of scale and mass production systems. They produce ‘commodities’ for the market. Although they might have a frequent application of knowledge in the production processes, it is not as susceptible of sudden loss of competitiveness due to technological innovation as it is in the New Economy. In the Old Economy, companies have relatively stable demands and few changes in standardized products. Old Economy companies are traditionally characterized by having industrial plant and assembly lines, with their economic activities related to economy of scale and/or mass production systems. In order to provide a comprehensive understanding of these main paradigmatic shifts towards to the New Economy, based on the literature, we selected seven keyfactors for our analysis: (1) Production Factors; (2) Environmental Conditions; (3) Network Formation; (4) Competitive Dynamics; (5) Changes in the Work Conditions; (6) Governmental Policies; (7) The Role of Venture Capital.

580

112

See ILO (2001), p. 310.

(1) Production Factors towards Knowledge and Flexibility: As observed before in Section 3.1, scholars in general pay special attention to the role of knowledge in the New Economy. As represented by the neoclassical production function, activities in the Old Economy result mainly from land, labor and capital inputs. While these traditional inputs still play a role in the New Economy, knowledge has emerged as the most important factor of production. In Castells’ (1996/2000) view, an informational economy is a further stage in economies, coming after the agricultural and industrial phases.581 Castells observes that the rise of a new global and informational economy results from the interaction of some processes (e.g. political deregulation, technological revolution and multinational expansion) that provides the new material bases for the information economy.582 In his view, information technologies have become an indispensable infrastructure for the implementation of new socioeconomic institutional restructuring. According to the Kiel Institute of World Economy (2004), the transition to the New Economy is associated with fundamental shifts in the relative scarcity of factors: in the agricultural economy, land was scarce and labor was abundant. In the industrial society, physical capital was (is) scarce and raw materials (including environment) are abundant. In the New Economy, information is abundant. Under the new paradigm the new scarce factor is not clearly defined.583 The traditional accumulation of capital was based on the economy of scale by reduction of unitary costs, intensive-capital application, and market demands forecasting based on the production of regular products and services for massive consumption. According to The New Economy Index (1998), while the Old Economy was fundamentally organized around standardized mass production, the New Economy is organized around flexible production of goods and services.584 According to Audretsch and Thurik (2001) “The dominance of scale economies no doubt contributed to the emergence and dominance of large corporations in heavy manufacturing industries such as steel, automobiles, and aluminum.”585 Stabilizing strategies are more efficient if there are only few environmental changes or little variability in demand.586 Due to the high uncertainty and variable demand, the logic of the New Economy has changed this perspective considerably towards flexible specialization and contracting. It is based on knowledge as the capacity to process information in order to generate product and services innovation in a continuous process. Technological flexibility referring to the emergence of certain technologies, such as numerically computer-controlled machine tools facilitating flexible production, which have reduced the importance of the economies of scale. Flexibility can also be introduced in the organization of production. While in the Old Economy the organization of production was centered upon mass-production during the first decades of this century, flexible production consists of producing smaller series of specially designed goods of a specific quality for a niche market. Such goods typically com581 582 583 584 585 586

See Castells (1996/2000), pp. 15-17. See Castells (1996/2000), pp. 95-99. See Kiel Institute of World Economy (2004). The New Economy Index (1998), p. 9. Audretsch/Thurik (2001), p. 23. See Wigand et al. (1999), p. 344. 113

mand a higher price and cannot be so easily spread to lower-cost production locations.587 Therefore, Audretsch and Thurik (2001) observe five key elements in industry centered in flexible specialization: 588 ƒ

A reliance upon multi-purpose equipment – General purpose equipment enhances the flexibility to change product specifications rapidly to meet specific customers demand. This requires high levels of human capital and skilled labor;

ƒ

Continual innovative activity – Both the nature of the product(s) as well as production and organization methods are continually improved;

ƒ

Clustering – Grouping of enterprises, in both product as well as geographically provide a seedbed for exchange of new ideas. Not only does physical proximity tend to facilitate the transmission of knowledge, but it also enhances the development of institutions and makes them more effective;

ƒ

Networking – Formal and Informal links between enterprises, including subcontracting relationships facilitate both increased economic specialization external to the firm as well as better access to information;

ƒ

Spillover Effects – Knowledge created within an enterprise spills over for use by other enterprises. Conversely, enterprises and individuals have access to external knowledge.

Moreover, it is observed by the authors that flexibility also refers to the ability of production to absorb demand fluctuations. Observing the trade-off between efficiency, as measured by the costs of producing a given level of output, and flexibility as measured by the costs of adjusting output, large firms with capital investment achieve a large scale of output at a lower marginal cost than a small labor intensive enterprise. However, the labor intensity of the relatively small firms enables them to adjust their current level of output at lower cost than their larger counterparts, which are capital and not labor intensive. Another type of flexibility, according to Audretsch and Thurik (2001), refers to the ability of economic activity to respond to qualitative changes in market demand. As demand tends to proliferate across a broad spectrum of product class niches, variations in customer demand span product types and over time create a continuously changing set of product niches. (2) Environmental Conditions toward Instability and Change: According to Audretsch and Thurik (2001), the managed economy of the post-war period was characterized by remarkable stability. This stability is characterized by product homogeneity and durability of demand, resulting in a constant population of firms, and a low turnover rate of both jobs and workers.589 They comment: “This stability was conducive to mass production. Just as Taylorism provided a managerial mechanism for ensuring the stability and reliability of workers in the 587 588 589

114

See Audretsch/Thurik (2001), p. 23. See Audretsch/Thurik (2001), pp. 23-24. See Audretsch/Thurik (2001), p. 13.

production process, competition focused on the dimension of prices but not necessarily product differentiation….the entrepreneurial economy is characterized by a tremendous degree of turbulence.”590 What one can observe is the rise of an entrepreneurial economy model which has shifted rapidly in the last years these elements of the managed economy, creating high uncertainty, demand uncertainties, restructuring of organizations, rising of new organizational forms, and ultimately produced high job and worker turnover rates. Audretsch and Thurik note: “It is an economy in motion, a massive number of new firms entering each year, but only a subset surviving for any length of time, and an even smaller subset that can ultimately challenge and displace the incumbent large enterprises.”591 The authors attribute the source of this turbulence to the possibility of the commercialization of new ideas. For both New and Old Economy, the creation of new ideas is important, however, the difference between them is the selection mechanism. While in the Old Economy, large corporations organize research activities scheduled in departments devoted towards novel products and services,592 in the New Economy the process occurs within and outside the R&D laboratories in a diverse and unpredictable manner. This entrepreneurial activity is noted by Fukuyama (2000) in the birth of the new high-tech companies in Silicon Valley.593 This spontaneous and flexible way of organizing the technological creation and development was disseminated rapidly throughout the new ICT industry. The formation of formal and informal networks became a common way for the companies operating in the New Economy to organize production, to get the knowledge-capital and to enter the market quickly. Another inherent trade-off analyzed by Audretsch and Thurik (2001), lies between change on the one hand and continuity on the other hand.594 Audretsch and Thurik note that while the managed economy is dependent upon continuity, the entrepreneurial economy thrives on change. This aspect is closely related to the innovative activity driven by competition involving a great number of firms developing new technological services. The trajectories of technological development take different paths. In the Old Economy, such innovative activity remains within the technological paradigm established by the firm’s core competence which provides the basis of continuity.595 In the New Economy, decentralized decision-making in the industrial structure comprised of relatively smaller firms leads to a greater diversity of approach. It generates greater opportunities for breaking out of the boundaries imposed by the technological trajectories. Deconcentration in the New Economy results in greater diversity of approach across a broad range of technological trajectories. Audretsch and Thurik (2001) 590 591 592

593 594 595

Audretsch/Thurik (2001), p. 13. See loc. cit. p. 14. See Schumpeter (1942), pp. 132-133. Schumpeter noted that innovation has been reduced to routines. He noted that the innovation tasks were addressed to teams of specialists who turn out what is required and make it work in predictable ways. See Fukuyama (2000), pp. 218-220. See Audretsch/Thurik (2001), pp. 8-10. See Cohen/Klepper (1992), p. 2. 115

comment “If the degree of uncertainty is relatively low, then concentrating knowledge results may result in greater technological change. But as the degree of uncertainty increases, a diversity of approaches, represented by a multiplicity of technological trajectories, becomes more important.”596 (3) Networks Formation: Earlier Knight (1921/1965) noted that low uncertainty combined with transparency and predictability of information makes intra-firm transactions efficient relative to markets.597 Coase (1937) and Williamson (1975) claimed that uncertainty and imperfect information increase the costs of intra-firm transactions.598 These are consistent with the well-documented increase in vertical integration.599 However, in the New Economy this trend has been reversed.600 In an industry where uncertainty is high and information is imperfect, market exchanges tend to be more efficient than firms.601 The Old Economy is characterized by a relatively high degree of certainty and predictability of information, therefore transactions with firms tended to be more efficient than market exchange. In the New Economy the balance between market exchange and firm transactions leads to new firms and network-based organizations. Because the expectation of profits is high, and entry barriers are low, it became possible for many small entrepreneurial firms to go into the market with new ideas through many network forms of organizations. Wigand et al. (1999) observe the dynamics behind network formation: “In an uncertain and competitive environment, a corporation’s core competencies which were used to build its competitive position can quickly lose value. Therefore, the corporation has to build up new core competences constantly to ensure its long-term entrepreneurial success.”602 According to Wigand et al., the question arises as how such networks of incomplete contracts and bundles of diluted property rights are to be held together. Problems regarding corporate identity, corporate culture and corporate constitution should be observed. These lead to questions of whether or not corporations can still be explained through the existence of property rights and control rights.603 In this sense, Williamson (1975) also emphasized the tension between hierarchical bureaucratic organizations and entrepreneurial initiatives.604 The tension to foster a creative activity and produce innovation within the firms or to create a network of many small suppliers around the incumbent seems to lie in the principle that new ideas and added-values provided by particular firms in the market are costless when compared with the agency costs under uncertainty and asymmetric information. Moreover, asset-specificity is generally regarded as 596 597 598 599 600 601 602 603 604

116

Audretsch/Thurik (2001), p. 8. See Knight (1921/1965). See Coase (1937), and Williamson (1975). See, for instance, Levy (1985), MacMillan et al (1986), and Walker/Weber (1984). See Harrigan (1985b), Harrigan (1986), Carlsson/Taymat (1994), Brousseau / Quélin (1995), Robertson/Gatignon (1998), and Lajili / Mahoney (2005). See Audretsch/Thurik (2001), p. 18. Wigand et al. (1999), p. 217. See Wigand et al. (1999), p. 220. See Williamson (1975), pp. 201-206.

the main influence on the dissolution of the traditional corporate boundaries.605 What has made hybrid forms particularly distinctive is the importance of pooled resources – the conjoining of activities based on inter-firm coordination. In this case hybrid forms develop because markets are unable to adequately bundle the relevant resources and capabilities, while integration would reduce flexibility, create irreversibility, and weaken incentives.606 Brousseau and Quelin (1996) approaching the network formation in new telecommunications industries argue that, the design of an organizational arrangement that can be used to coordinate scarce resources owned by potential partners is related to the degree of substitutability of these assets owned. They note: “When a firm owns assets that are less substitutable than those of the others, it becomes the core of a network of suppliers and subcontractors.”607 The combination of high human asset-specificity, time to market and increasing competition under uncertainty for value-added services allowed many network-based organizational forms in the new ICT industry.608 For Wigand et al. (1999) networks are alternative forms for markets and hierarchies. The authors note that the dissolution of corporate boundaries in the business world is related to the integration through symbiotic arrangements and networks relations based on mutual trust with external partners.609 In this case integration creates reciprocal dependencies based on long-term relationships to avoid or at least limit one-sided opportunistic exploitation. (4) Competitive Dynamics: According to The New Economy Index (1998), competition is increasing and the old sources of competitive advantage — access to raw materials, transportation routes, or customer markets, low costs, and a large labor pool — are becoming less important. The report states: “In an economy in which less than 20 percent of economic activity consists of creating, processing, or moving physical goods, access to raw materials, transportation, and markets mean less. As an increasing proportion of economic inputs and outputs are in the form of electronic bits, the old locational factors diminish in importance. And when an increasing proportion of firms is gaining competitive advantage from innovation, quality, and productivity-driven cost reductions, the old advantages of low wages, low taxes, and low input costs are less important.”610 In the New Economy, markets become unpredictable to the extent that they are variable, and their variability increases with their competition.611 The more competitive the market for the product, the more variable the sales and profits of the firms that supply it.612 Competition shifts those sales and profits as well as reduces the amount that any particular firm can make 605 606 607 608 609 610 611 612

See Wigand et al. (1999), p. 38. See Ménard (2005), p. 295. Brousseau / Quelin (1996), p. 1. See Brousseau / Quelin (1996), and Burton-Jones (1999). See Wigand et al. (1999), p. 209. See The New Economy Index (1998), p. 14. See Sawyer/Shapiro (2002), p. 50. See loc. cit. 117

on the product, and when the competition is technological, it alters the product as well as its price, changing the requirements of its production and those of its market. Therefore in the New Economy the constant innovative activity for the differentiation of products and services becomes relevant and uncertain. New Economy’s market structures provide a considerable degree of volatility and uncertainty due to constant technological changes, entry opportunities and rapid shifts in prices. Normally the New Economy framework favors positive productvariety externalities because customers get some consumer surplus by the introduction of new products in the markets, however, it favors also many negative business-stealing externalities because firms lose customers and profits rapidly from the low entry barriers for new competitors. In addition to these dynamics, as observed before, the properties of information as economic goods are significantly dissimilar from the properties of typical goods produced by the Old economy. According to the Kiel Institute of World Economics (2004) information is considered here a public good (no consumption rivalry), is an experience good, in contrast to inspection goods, and it is subject to extreme economies of scale in production (negligible cost of duplication and dissemination) and in consumption (network externalities). Consequently, there is ample space for many kinds of market failures and uncertainties to arise. Moreover, in the Old Economy, competition and cooperation are viewed as being substitutes. It happens because firms are vertically integrated and compete primarily in product markets. Cooperation between firms in standard product markets reduces the number of competitors and lessens the degree of competition. In the New Economy, firms are vertically independent and highly specialized in the product market. It allows independent players to compete or cooperate according to the opportunities created among organizational arrangements. It also acts as an efficient market mechanism for adoption to counteract the unpredictability of the ICT industry. Therefore in the New Economy both cooperation and competition between firms exists simultaneously. An increase in competition may increase the level of cooperation in the search for knowledge spillovers and reduce transaction costs by sharing investments. 613 (5) Changes in the Work Condition: According to the ILO Report 2001, in the 1990s an increasing share of companies abandoned the Old Economy ways of organizing work in favor of giving workers more autonomy and the ability to work in self-managed teams.614 At the same time, many manufacturing companies have deployed advanced production technologies. Both practices lead manufacturers to employ people with more education. It has been observed that there is a considerable increase in contingent labor contracts, more levels of explicit control and monitoring of employees, and an increased sense of insecurity among employees.615 The rise of new ICT industries has meant the rise of new jobs, while new technology and new ways of organizing work have transformed many existing jobs. The most valuable input for many firms is the skills and talent of their workforce, a pool of skilled workers is 613 614 615

118

See Audretsch/Thurik (2001), p. 21. See ILO (2001), p. 282. See ILO (2001), pp. 282-283.

the most important factor. In the Old Economy, companies prospered by having workers who were skilled with their hands and could reliably work in repetitive and sometimes physically demanding jobs. In the New Economy, companies will prosper if they employ knowledgeskilled workers and stimulate their human capital since knowledge-based jobs are the driving forces.616 Many of these jobs are held by workers dealing with information technology in managerial, professional, and technical positions. Therefore, according to these reports, the New Economy exhibits an average increase in the level of employee education. Continuous requirements for new learning capabilities, mobility, flexibility and entrepreneurial profile have created the tendency within the companies operating in the New Economy to hire a young and nonpermanent work force.617 Argandona (2003) noticed that this characteristic of the New Economy combined with other environmental elements have radically changed the work conditions towards more conflicts in the work environment, higher internal competition, breaking of loyalty and unethical behavior.618 In the organizations of the Old Economy, the predominance of formal control and hierarchical relations could create cooperative ways of efficient production. However, the New Economy has gone through a process of profound restructuring characterized by higher management flexibility, decentralization of companies and network forms of organization, internally and among other companies, and the individualization and diversification of the work relationships. The concept of New Economy is also based on network production systems with the increase of co-dependency relationships between specialists and organizations. Organizations are continuous innovation-driven systems, flexible and decentralized, in order to adjust their productive structures for increased mutant externalities. The required flexible production allows customization and adaptation for environmental changing and allows companies to respond faster to the externalities. More companies become more knowledge-based, instead of resource-, labor-, or capital-based. High flexibility, holistic tasks, creativity, innovation and specialization requirements suggests higher empowerment of the employees in the New Economy.619 Wigand et al. (1999) observe, “Complete centralization ends in self-sufficiency; complete decentralization implies the transfer of all tasks to independent entrepreneurs.”620 The model of the organizational architecture in the New Economy tends to be more decentralized. According to Ferrell et al. (2001), under these circumstances, coordination and control tends to be very informal and personal. The strength is the adaptability and early recognition of external changes. The weakness is the capacity to respond quickly to internal policies and procedures established by management.621 Even considering benefits of flexibility and empowerment, new conflicts arise in these companies of the New Economy impacting directly 616 617 618 619 620 621

See The New Economy Index (1998), pp. 40-43. See ILO (2001), p. 292, and Argandona (2003), p. 15. See Argandona (2003), pp. 13-15. See Wigand et al. (1999), p. 410. Wigand et al. (1999), p. 346. See Ferrell et al. (2001), p. 27. 119

in the form of loss of formal control and in the coordination task. Decentralized orientation with multitask work activities based on knowledge production, and a very dynamic innovation process in industries where it has not been possible to develop an adequate corporate culture have lost the capacity of monitoring and implementing formal rules.622 Accordingly, Wigand et al. (1999) state that one of the new roles of managers is the capacity to build trust showing empathy and sensitivity and empowering employees.623 (6) Governmental Policies towards Stimulation: The governmental policies in the Old Economy which emerged from the post-war period (characterized here as a managed economy) were remarkably constraining in nature. Policies like antitrust (competition policy), regulation and public ownership were restrictive to firm’s freedom to contract.624 These policies were based on state intervention to avoid market power. The policies which have arisen from the institutional innovations of the New Economy show strong tendencies to redirect concern about excess profits and abuse of market domnance, to international competition, growth and employment. Audretsch and Thurik (2001) note “The concern about corporations is not that they are too successful and too powerful but that they are not successful enough.”625 The increase of small firm’ start-ups and newly emerging high-technology industries have demonstrated a shift from regulation towards stimulation, promoting technological development and fostering entrepreneurial initiatives. (7) The Role of Venture Capital: The New Economy requires a different system of finance from that in the Old Economy. Of particular importance is the venture capital which has traditionally been for the finance of high-risk innovative new firms and the informal capital market. Audretsch and Thurik (2001) claim: “Since the managed economy was based on certainty in outputs as well as inputs, a strong connection between banks and firms fostered growth. Certainty has given way to uncertainty in the entrepreneurial economy, so that financial institutions also change.”626 In the New Economy, firms start up quickly, financed initially with venture capital and then by public offerings on the stock market.627 The financing venture capital is strongly associated with the market euphoria which came with the Internet bubble of the 1990s.628 Venture capital has been related to short term expectations and stock market speculations by investing in new projects. Howells (2005) notes “If the public lose their collective financial sense and become willing to buy underdeveloped projects with a solid record of losing money, venture funds can profit by providing what the market wants.”629 The potential for short-term funds to make their money by selling their projects either to established firms or to the public though an IPO (Initial Public Offering). Venture funds in many cases 622 623 624 625 626 627 628 629

120

See Argandona (2002), p. 20. See Wigand et al. (1999), p. 385. See Audretsch/Thurik (2001), p. 25. Audretsch/Thurik (2001), p. 25. Audretsch/Thurik (2001), p. 30. See Argandona (2002), p. 14. See Howells (2005), pp. 174-175. Howells (2005), p. 175.

financed the start-up of many ICT companies, and it developed a general orientation to the ICT market behavior. In the New Economy, venture capital has become an important source of funding for new, fast-growing entrepreneurial companies.630 According to Howells (2005) venture capital can be acknowledged as an alternative to enhance R&D corporate hierarchy activities.631 For Howells, the development of the early venture capital industry is witness to the inability or incapacity of existing firms to recognize and develop in house new products and services. The management of substitution threats is fraught with uncertainty at every stage. Howells (2005) comments: “There is a problem of recognizing the scale, extent and timing of the developing substitution threat when substituting technology is unfamiliar to established firms’ experience and is evolving in a manner not deterministically understood by the innovating firms.”632 Howells (2005) comments that there is no magic solution to eliminate the threat of a new technology development such as knowing how to recruit better people, avoiding false development paths and new waves of substituting technology. He notes: “The systematic cultivation of spin-offs by established firms is known as ‘corporate venturing’ and does not have a very wonderful track record from the evidence of the 1980s.”633 For example, Wilson (1985) reviews many examples of corporate venturing in the late 1980s and they largely failed.634 Therefore, although venture capital has fostered the establishment of new firms, it is inherently risky and committed to short term returns.

3.5 Effects of New Economy Characteristics on Organizations In this section we focus on some specific trends which have affected organizations and organizational behavior, most probably affecting the levels of trust within the companies operating in the New Economy. As observed before, the business environment of the New Economy is remarkable uncertain and turbulent due to its instability. It is characterized by volatile elements to assure regular demands, stable production and resources allocation. Tosi et al. (1994) characterizes such an organization model as ‘organic’, referring to the companies which operate under high technological and market volatility (see Figure 3-6).635 Such an ‘organic’ model is characterized by more flexible and decentralized organizational structures, operating under an environment of strong change and tending towards the creation of greater conflicts among people. Such companies are defined by the authors as job-shop-oriented, in which jobs are available according to the reorganization of the production elements. According to the authors the structure, relationships, and jobs are more loosely defined to facilitate the process 630 631 632 633 634 635

See The New Economy Index (1998), p. 35. See Howells (2005), p. 175. Howells (2005), p. 104. Howells (2005), p. 104. See Wilson (1985). See Tosi et al. (1994), p. 40. For the ‘organic’ organizational model, see also Rothwell (1992), pp. 228-229. The original model of an ‘organic’ firm (in a rapidly changing environment) in contrast to a ‘mechanistic’ firm (in a relatively stable commercial and technical environment) was first developed by Burns/Stalker (1961). 121

of adapting to the changing environment, so various production elements can be rearranged as the market or technology changes.636 Organic companies will have almost no formal means of monitoring, a high dependence on individual skills, and the measuring of individual performance based more on ‘subjective’ data, and less on ‘objective’ measures.

Figure 3-6: The basic Relationship between Environment and Types of Organizations

VOLATILE MARKET DOMINATED MIXED

ORGANIC

MECHANISTIC

TECHNOLOGY DOMINATED MIXED

M A R K E T

STABLE

TECHNOLOGY

VOLATILE

Source: Tosi et al. (1994), p. 40.

Tosi et al. (1994) note that the degree of change in the environment has major implications for the internal structure of the organization, the type of individual who is likely to join it and the perceptions, attitudes, and values of those in the organization. Such degree of change is a continuum: at the opposite ends are stability and volatility.637According to the authors, in a stable environment, changes are relatively small, occurring in small increments, leading to a small impact on the structure, processes, and output of the organization. Environmental changes affect the size of the organization more than the kind of product, and the number of employees may change. It leads to reducing or increasing the workforce rather than focusing solely on significant changes in the product or in the method of production. As Tosi et al. (1994) comment: “Changes in technology may come rather than slowly, but steadily. If there is a drop in demand, then the organization will probably not seek new products but lay off workers.”638 We understand that Tosi et al. (1994) present a valuable but a more general ten636 637 638

122

See Tosi et al. (1994), p. 40. See Tosi et al. (1994), p. 37. See Tosi et al. (1994), p. 37.

dency to observe companies which operate under high technological and market volatility. We shall now identify and comment on three important characteristics of the organizations operating in the New Economy connected to the relatively high instability and uncertainty for work conditions: (1) a new business environment, (2) new organizational forms of production, and (3) a new work dynamics.

3.5.1 A New Business Environment Under the New Economy it can be observed there is a configuration of a new business dynamics due to high technological and market volatility. This new dynamics happens in a highly competitive, uncertain and risky environment and time is a very critical resource. Technologies are offered to the market as ICT ‘solutions’, not clearly characterized, as they were traditionally, by products or services. In order to obtain success in new markets, such solutions require a better perception of the value perceived by the clients, through the possibility of cost reduction and/or service quality improvement, thus provoking the immediate supersession of the previous solution. For those companies operating in the New Economy, the competitive differential may often reside in the knowledge of new solution development from the existing technologies, or simply on the substitution for new technologies or similar technologies, which may offer a better perception of value (incremental innovations). However, such a perspective exists for a relatively short period of time bringing along a paradox: just as the technologies become the chief means, the motor of New Economy, they can be easily reproduced and worn out, no longer constituting a competitive differential for securing economic sustainability to the supplier companies. In this way, the process of technological development is ruled by competition through the anticipation of future demands, requiring from the supplier companies intensive technological innovation, quickness and flexibility in the productive processes.639 Much of their activity is focused on the creation of new markets by commercializing new products. Therefore, Anderson and Gatignon (2005) comment, in this context, new product development (NPD) is essential to firm performance. They note: “NPD is inherently uncertain: new markets frequently do not materialize, nor do anticipated profits.”640 Additionally, the presence of a highly competitive environment constantly speeds and stimulates the commercial and marketing activities, which in many cases become the main agents towards such companies’ survival, especially in mass markets, such as cell phone and Internet services.641 Such a dynamic process of the market quickly exhausts the possibilities of technological life cycle extension, causing a demand for a continuous process of technological innovation. It is widely 639 640 641

See Anderson/Gatignon (2005), p. 401. Anderson/Gatignon (2005), p. 402. See Anderson/Gatignon (2005), pp. 401-403, observe that, many innovations are not radically new, but rather incremental. Mere marketing activity creates new markets, and does so even with established products. 123

observed by many authors that there exist short life cycles in the technological products and services in the New Economy.642 Figure 3-7 below shows the tendency in the average of product life cycles in the New Economy.

Figure 3-7: Product Development Cycle

Source: The New Economy Index (1998), p. 17.

Fierce competition coupled with a new wave of innovation and technology-based products and services have shortened cycles between their market introduction and eventual replacement by superior products and services. The ability to innovate and get to market faster is becoming a more important determinant of competitive advantage. In some sectors, the pace of innovation causes such rapid obsolescence that firms have to run just to stay in the same place. Computer components, for example, lose about 1 percent of their value per week.643 In other sectors, such as automobile manufacturing, global competition has led to compressed product development cycles. The competitive advantage in such markets will be very tied to human capital, in the management capacity to stimulate an intensive and continuous, knowledge-based innovation process, with a high sensibility for the competitive market. This requires a skill to conciliate the management of distinct temporal processes, such as the solution development time and the time for its commercialization, requiring a full coordination of specialized tasks in internal and external networks. The growing complexity of the solutions offered requires not only a type of specific knowledge, but also a corpus of information on converging technologies. In this way, such companies are often led to form partnerships and association networks with 642 643

124

See The New Economy Index (1998), p. 17, Kotabe/Swan (1995), and Roberts (2000). See The New Economy Index (1998), p. 17.

other purveyor and distribution companies.644 The quickness in strategically synchronizing the development of technological solutions, forming and keeping alliances and partnerships, and the capacity to negotiate with clients and suppliers in due time are success factors that may secure such companies’ survival. Such dynamics often occur in an environment of high uncertainty regarding future demands and the potential extent of the solution’s life cycle, and unsuccessful cases are frequent. What can be noticed is the short term transference of the transactional perspectives of market dynamics to the internal organization of such companies. As Dantas (2002) states, such companies are often committed to short term investment and perspectives for returns due to the nature of risk capital (venture capital), historically used a lot in the development of technology companies.645 Additionally, the strategies adopted by such companies follow the same dynamics. Cyert and March (1992) note that, scenarios of greater uncertainty as to the future suggest the adoption of short term strategies.646 Moreover, as a result of the variance of costs, the new telecommunications market in the last years, for example, has been usually marked by many movements such as fusions, mergers and acquisitions. In economic terms, the rapid changes in product prices and costs of production as well as the decrease in profits have led to many advantageous “combinations” and “integrations” as variety of organizational forms.647 All the aspects discussed above create two great problems for such companies: firstly, it leads to many internal conflicts and instable work conditions for many employees.648 To the company it becomes very difficult to measure individual results and to design a fair system of rewards for individual production. It is also difficult to sell products in time according to the market-customized requirements and to deliver and design new products and services, marketing strategies, etc. For example, the sales force has difficulties in aligning its efforts with reasonable results in the short-term under high competition. The general results are job dissatisfaction and high stress.649 Ties that used to bind employees to companies no longer have positive effects. Moreover, most of the companies operating in the New Economy have relatively young staff and high employee turnover rates due to new job profile requirements and constant redesign and reallocation of internal resources and restructuring.650 In the New Economy, a very short product life cycle means also impact on short-term prospects of remaining in the job, and short term relationship between company and employee. When technology changes constantly, new human resources are necessary to cope with new external demands. Due to the high employee turnover, the prospects of remaining employed in the same firm decrease significantly.651 644 645 646 647 648 649 650 651

See Brousseau/Quelin (1995), pp. 8-9. See Dantas (2002), p. 140. See Cyert and March (1992), p. 121, and pp. 166-167. See Coase (1988), pp. 46-47. See Argandona (2003), p. 17. See Garcia (2004), p. 791. See ILO (2001), p. 292. This observation is in harmony with the repeated-games approach. See Figure 2-5 in Section 2.5.3. 125

Secondly, the evolution of such technologies is usually out of proportion with these companies’ capacity to adapt. The need for quick reorganization, re-dimensioning, and redisposition of resources both internally and externally is constant.652 The decision process in the choice of a certain technology has an impact on the choice and contracting of suppliers, on the quality and quantity of the contracted resources, and on the investments for the development and launching of new products. The result is an organizational management through constant restructuring and layoffs of the workforce and constant new recruiting. Such practices establish a less co-dependent employer-employee relationship with more short term perspectives and, consequently, affect the internal relations based on trust which can be built with the passing of time. What occurs simultaneously is a loss of monitoring capacity and the implementation of formal and informal rules due to their constant reorganization. Here we see a paradox, especially when we know that such companies have work routines in which individuals must constantly interact and share tacit knowledge under the form of sensitive information, common ideas and tasks as part of the productive process. That suggests a greater dependence on relationship-based, informal contracts. However, in that context, we believe that trust becomes a rare element for the promotion of spontaneous cooperation.

3.5.2 Network-based Organizational Forms The productive activities of New Economy companies are strongly characterized by coordination in formal and informal networks.653 Coordination through the networks is a response to the need for constant adaptation by the organization and optimization of productive structures facing high uncertainty business environments. The networks provide a great flexibility of the means of production and availability of information. Ménard (2005) notes that, what has made hybrid forms particularly distinctive and alternative is that markets are unable to adequately group the relevant resources and capabilities, while integration would reduce flexibility, create irreversibility, and weaken incentives.654 Besides, coordination in networks is part of the very origin of the innovation process in the information and communications technology industry, through which it came to be developed in recent decades. This is because coordination in networks has a strong relation to organizational transformation models from vertical bureaucracy into horizontal corporations, due to the need of rapid adaptation to the unpredictable conditions of economic and technological changes.655 According to Fukuyama (2000), the importance of informal networks, defined as social groups with common rules and values, is that they provide alternative channels for the information flow inward and throughout the

652 653 654 655

126

Internally, for instance, by the reallocation, redimensioning of resources; externally, for instance, through the formation of partnership networks. See, for instance, Castells (1996/2000), Wigand et al. (1999), Brousseau/Quelin (1992 and 1995), and Van den Broek (2000). See Ménard (2005), p. 295. See Castells (1996/2000), p. 184.

organization.656 Because of the increasing importance in knowledge-intensive ICT industry of combining knowledge inputs, sourcing knowledge for this purpose, and keeping sourcing options open, knowledge-based networks increasingly become the relevant dimension for understanding the organization of economic activities in the New Economy. According to Foss (2001) such networks typically cut across the legal boundaries of the firm, for example, in the sense that inter-firm channels or that inter-firm coordination requirements are more demanding between firms than within them. He comments “the boundaries between markets and firms are fading into insignificance as generalized reciprocal knowledge exchange in communities of practice and other forms of networks, as well as hyper-competitive conditions, make knowledge protection issues less relevant. What will matter for long-run competitive advantage will not be the extent to which, for example, technical capabilities can be protected from imitation, but the dynamic capability to continuously source, integrate and recombine diverse knowledge inputs.”657 Through the use of networks, the companies from the ICT industry allow easy access to, storage, processing, and distribution of information, inside and outside the company. What distinguishes a simple material supply contractual relation, or outsourcing, from activity coordination through informal networks, is that the latter will be developed under less formal, more interdependent, and cooperative relations. Regardless of the existence or not of formal contracts, individuals try to establish informal relations that go beyond their company limits. That happens because the specific knowledge that is needed for the offer of solutions often requires the presence of different specialists in different supplier or partner companies. A great part of such knowledge is tacit knowledge and cannot be easily reduced to convenience goods, which can be purchased and sold in an intellectual property market. Thus, such interpersonal relationships guarantee the constant improvement, the customization, and the technical problems solution to provide service to customers.658 In addition, relationship networks function as an employment guarantee in the face of work instability. However, coordination in networks brings along more complex problems for the most traditional management models. Network-based organizational forms of production in the New Economy are flexible and changing, and they impose constant review of the relational contracts between stakeholders.659 Such an environment with high organizational flexibility also brings new side effects concerning coordination, loyalty, control and monitoring.660 As Argandona (2003) points out, in a certain way, the network configuration transfers the authority and decision-making center and promotes a general change in the costs, integrating and separating agents.661 Operation is decentralized and configured around nodes. The decision656 657 658 659 660 661

See Fukuyama (2000), pp. 218-220. Foss (2001), p. 4. See Castells (1996/2000), Burton-Jones (1999), and Wigand et al. (1999). See Argandona (2002), pp. 14 and 17. See Argandona (2003), p. 12. Argandona (2003), p. 12. 127

making units are transferred to each project, and such projects are usually combined with a number of other companies and individuals, thus creating a complex relationship network among clients, partners, and suppliers of projects developed through several contractual and organizational forms. Another singular characteristic is that decision power is often transferred to customers who receive a large part of the information generated, and within the company, to the employees who interact with the customer (empowering people). That suggests a greater dealing through tacit knowledge and informalities, and consequently a greater need of trust relationships for such transactions to happen.

3.5.3 A New Work Dynamics The third characteristic to be analyzed is the emerging of a new work dynamics, based on intensive knowledge and high specialization, as characterized by Castells (1996/2000) through a comparative analysis between the industrialism and the Informationalism paradigms. Castells (1996/2000) states: “what is specific to the informational mode of development is the action of knowledge upon knowledge itself as the main source of productivity. Information processing is focused on improving the technology of information processing as a source of productivity, in a virtuous circle of interaction between the knowledge sources of technology and the application of technology to improve knowledge generation and information processing.”662 Informationalism aims at technological development, i.e. the accumulation of knowledge and greater complexity levels in information processing. Although higher levels of knowledge can usually result in better levels of production per input (as in industrialism), Castells (1996/2000) states that the search for knowledge and information is what best characterizes the function of technological production in Informationalism.663 Thus, knowledge is generated and applied within the very process of technological development, thus creating a work dynamics ‘in spiral’, in the application of knowledge of the technologies towards their continuous improvement. Such dynamics characterize the efficiency of production systems in the informational age. Therefore, the key value in the New Economy is the talent gained from the emergence of a self-programmable, flexible labor that is technically equipped and well-trained to adapt to different tasks, contexts and needs.664 The nature of the knowledge-intensive work in the New Economy creates a number of problems concerning employment relationships. Grandori (1997) notes that it has been ‘welldocumented’ in organizational studies that “authority is not very effective in managing uncertainty.”665 The author claims: “whatever its basis, authority is a feasible governance mechanism only if information and competence relevant to solving economic action problems can be transferred to and handled by a singule actor, a positive “zone of acceptance” exists, the ac662 663 664 665

128

Castells (1996/2000), p. 17. See Castells (1996/2000), p. 17. See Argandona (2002), p. 16. Grandori (1997), p. 37.

tions of other supervised actors are observable, and if the system is not as large as to incur an overwhelming communication channel overload and control losses.”666 Foss (2001) poses some questions related to the limits of authority relations in the knowledge economy, such as: What happens if the employer does not possess full knowledge of employee’s actions, so that the employee can take actions about which the employer has no knowledge? What happens if the employee is better informed about the efficiency implication of alternative actions than the employer to how certain tasks should be optimally carried out? And what happens if employees control knowledge assets that they cannot, or will not, alienate (sell, transfer), and which may give them substantial bargaining power so that they cannot automatically be assumed to obey instructions?667 Because of the increased importance of specialist workers and the increased knowledge-intensity of production, it becomes crucial for organizational economics to understand the problem of what happens to the classical notion of authority668 when agents might be better informed than principals about how certain tasks should be carried out, the principal is ignorant about certain actions that the agent may take, or agents have considerable bargaining power because of their control over knowledge assets (see Section 2.5.5).669 Moreover, the innovative process in the New Economy emerges exactly in the sequential accumulation of shared experiences and interactions mainly through teamwork composed by specialists.670 The intentional behavior of these individuals within the firm to voluntarily cooperate with each other to reach organizational goals defines the process in which the organization develops its distinct intellectual competence in the market.671 Hayek (1989) emphasized that dispersed knowledge poses an organizational problem because it is prohibitively costly to centralize all relevant knowledge. He claims “the problem which any attempt to bring order into complex human activities meets: the organizer must wish the individuals who are to cooperate to make use of knowledge that he himself does not posses.”672 Roberts and Van der Steen (2001) understand that the increase importance of knowledge and the human capital might suggest that the providers of this capital should have more representation in the processes of corporate governance because they are providing more of the total capital and such investments may need protection.673 Furthermore, to the extent that competition is increasingly knowledge-based, the use of the traditional authority systems within bureaucracies might become a self-defeating strategy.

666 667 668 669 670 671 672 673

Grandori (1997), p. 35. See Foss (2001), pp. 10-12. See, for instance, Coase (1937), Williamson (1975, 1985 and 1996). An employment contract is basically an implicit-relational one which states that one of the parties has the authority to tell the other what to do. See, for example, in Akerlof (1970), about the used car conditions. See Dosi (1982), p. 149. See Selznick (1949), and Selznick (1957). Hayek (1989/1998), p. 296. See Roberts/Van der Steen (2001), p. 128. 129

These characteristics above lead to motivational problems. The creation of motivation and cooperation becomes a fundamental issue to be solved in order to continuously stimulate the required dynamic process of innovation, as competitive advantage. Since tasks become more knowledge-based and co-dependent of employees’ willingness, Audretsch and Thurik (2001) note that there is a fundamental shift in the essence of management techniques from control to motivation. According to them, while the essence of management in the Old Economy consists of command and control of labor, it becomes less effective in the New Economy. 674 In the New Economy as tasks become increasingly specialized, the skill level required of workers under the mass-production regime become less important. As the competitive advantage becomes highly centered in knowledge, what matters less is to establish a set of standard activities. It is more focused on motivating workers to facilitate the innovative process based on discovering and implementing new ideas. Audretsch and Thurik (2001) comment “The type of work environment fostering creativity apparently is radically different from one simply harnessing the brute labor input of workers.”675 According to the authors, a central feature of work is dealing with uncertainty. Since uncertainty replaces predictability as the main characteristic of the work environment, workers who can deal with uncertain situations are more valuable in the New Economy.676 Such a new work dynamics presents other problems, for example, the emergence of issues related to the property rights over the work. How knowledge distribution should be controlled? Or even, to whom does knowledge belong? According to Argandona (2003) such a problem can be easily solved when knowledge is externally provided, for instance, through information in a database. Nevertheless, the problem becomes much more complex when such knowledge (as well as skills, attitudes, and values) is detained by people or groups.677 Another problem is the great difficulty to measure individual performance (internal uncertainty).678 That is because individual contributions and results cannot be clearly defined in this process. The New Economy work profile is characterized by multifunctional and variable tasks and it often involves several specialists. How to measure individual contributions in the creative process based on knowledge and on the relationships between agents, as in the development of technological solutions or in the implementation of complex information processes, becomes a managerial challenge. The result is the inefficiency of applying traditional payment structures based on results. According to Ouchi (1980/1998), it may provoke a loss in employee satisfaction and commitment.679 Both cases suggest a predominance of informal contacts to cope with the problem through the alignment of individual and organizational interests, and the presence of trust becomes an even more critical and desirable element. Another 674 675 676 677 678 679

130

See Audretsch/Thurik (2001), pp. 17-18. Audretsch/Thurik (2001), p. 18. This point may explain why popular literature on management in the last years emphasizing leadership, reengineering, managing chaos, etc. See Argandona (2003), pp. 13-14. See Wigand et al. (1999), pp. 153-157, and Anderson/Gatignon (2005), p. 402. See Ouchi (1980/1998), pp. 250-251.

problem comes in the form of a paradox. On the one hand many organizational tasks in the New Economy companies are highly complex and unique, and require higher creativity and innovative contributions of employees in order to add value to the current services, and therefore, such work dynamics requires motivating employees in order to get their acquiescence in the work through providing their best. On the other hand it becomes clear that employment in the New Economy is highly uncertain and risky.680 The problem is how to motivate people to provide the best of their knowledge when they face threats of job loss? Moreover, how to keep a trustworthy atmosphere within these companies? Perhaps it is one of the main dilemmas between the existing and necessary trust environment in the industries operating in the New Economy. All the situations described above suggest the application of social mechanisms like trust.

3.6 The New Telecommunications Industry Companies operating in the New Economy can be better characterized by their role and nature of economic activity. According to Castells (1996/2000) they can be identified as the original place of the ‘technological revolutions’, which have later impacted on organizational forms among different industrial activities. The role of the development of the organizations operating in the New Economy can be better observed through the general indexes of productivity, mainly from the electronic and new telecommunications industries.681 Castells sees the telecommunications and information technology production companies as the original locality where the organizational changes occurred, and as the main subjects under the effects of the institutional innovations. In the process of political-institutional restructuring that occurred during the 80’s and 90’s through market deregulations, these corporate agents were responsible for connecting valuable market segments within a global network. In this sense, Castells comments, there is a strong relationship between the new telecommunications Industry and the financial industries. The capital needed extreme mobility, and the companies worldwide needed higher capacities of information and communication to expand their businesses. Castells (1996/2000) points out that, “the first and most direct beneficiaries of the economic and technological restructuring process were those economic actors themselves: high technology and financial companies.”682 They have permitted the global interconnection and integration of financial markets worldwide since the beginning of the 80’s through the new information technologies, working strategically to build the material basis for the rising of the New Economy. Accordingly, during the 80’s high investments on communications/information infrastructure occurred in order to allow market deregulation and financial globalization. He also points out that the companies most directly affected by these dramatic transformations were microelectronic, microcomputers, telecommunications, and financial enterprises. They pre680 681 682

See ILO (2001), p. 210. See Castells (1996/2000), pp. 90-97. Castells (1996/2000), p. 97. 131

sented in general during the 80’s and 90’s high profitability and productivity growth. Therefore, although the New Economy is not considered a sectorial phenomenon, but it is rather related to a fundamental product and technological production redrawing and restructuring throughout the economy, it can also be said that the New Economy expresses the impact of the new technological revolutions developed around information and communication in different degrees among different industries.683 Argandona (2003) discusses how the New Economy has affected, in different degrees, the economy as a whole, with different intensity among industries (see Figure 3-8).

Figure 3-8: Impact Intensity of the New Economy on Different Industries

NEW ECONOMY (1) ICT Industry

(2) Industries Consumers of ICT Goods and Services as Production Capital

(3) Other Industries

OLD ECONOMY Source: Argandona (2003), p. 4. According to Argandona (2003), the group of companies greatly characterized by the New Economy effects is responsible for the production of goods and services based on the information and communication technologies. He highlights: “Strictly speaking, the new economy expresses the impact of the technological revolution developed around information and communications, first (1) in the industry that produces ICT (information and communication technology) goods and services; second (2), in the industries that use these goods as production capital; and third (3), in the other industries and in the economy as a whole.”684

683 684

132

See Kiel Institute of World Economics (2004), and Argandona (2003), p. 4. Argandona (2003), p. 4.

The ICT industry comprehends a diversity of technological segments. However, because the spreading of the ICT throughout the whole economy in past years have been concentrated in the new telecommunications operators and suppliers, these companies from the first group (1) are mainly the new telecommunications industry. They work on information production, storage, and distribution and they have as their end-activity the offer of technological solutions, specifically in the computer and telecommunications sectors. Some of those companies were state monopolies that have recently gone through profound restructuring through the privatization processes which occurred in several countries (‘incumbents’), others emerged recently due to the establishment of a new competitive model through the deregulation and the opening of new markets (‘entrants’), and still others emerged supported by the development of new technologies which have created new market opportunities.685 They were the main economic agents responsible for the building of the necessary infra-structure for the development of networks, communication systems and the introduction of new technological innovations.

3.6.1 Privatization: ‘Boom and Bust’ The Telecommunications Industry’s liberalization era began in the middle of the 1980s when Japan, the United Kingdom and United States took the first major steps towards opening their telecoms services markets to competition. The privatization process was inaugurated in November of 1984 in the UK, and it opened a new era for the expansion of the telecommunications industry worldwide. In 1996, the Telecommunications Act in the US laid the foundation for the privatization of US Telecom industry. The union of the historical process of technological development, the political processes to globalize economies in many Western countries and the development of the multinationals scope throughout the world brought the basic institutional elements for the rise of the New Economy. A combination of technological, political and economic elements gave birth to a new market worldwide supported by the continuous technological innovation as a source of competition. Similarly, it created a favorable business environment for the rise of new corporate agents which were responsible for building the necessary infrastructures to interconnect other business structures worldwide. Other countries followed this tendency, for example, Brazil had its telecom privatization process started in 1998. The basic argument for the privatization process in countries adopting it was to improve the efficiency of public-sector enterprises by the transference of the ownership (shares) from the state to the private-sector. In this sense, the introduction of competition was viewed as the most important mechanism for maximizing consumer benefits, and for limiting monopoly power.686 Shared prices provide also more objective measures of performance than have been available hitherto and it has been possible to provide higher-powered incentives to managers and workers in privatized enterprises. In fact, after the privatization processes in 685 686

See Fransman (2002), pp. 2-3. See Bishop et al. (1995), p. 8. 133

many countries, the development of the information and communications infrastructure worldwide had the benefit of many incentives. It has forced an increase in the quality of the services provided, more efficient organizational structures and it has supported the development of many other industries by spreading many goods and services of information technology. However, the development of the industry itself is characterized by great triumph and collapse in the last ten years.687 The development of the new telecommunications industry (and related industries) is a remarkable economic phenomenon supported by institutional innovations which have led to a transformation in the whole economy. Fransman (2002) characterized these telecom related companies as ‘Infocommunications’ Industry, which brings together telecoms services and equipment, computers, software, semiconductors, the Internet, e-commerce and some of the media. Fransman (2002) comments “this is the industry that has been the most important engine of growth in the world economy since the Second World War. It is also the Infocommunications Industry that has created the opportunity for the emergence of new postwar firms (such as Cisco, Intel, Microsoft, Nokia, and Vodafone), new industrial districts (such as Silicon Valley and its lesser counterparts), and new industrializing countries (including Japan, Korea and Taiwan).”688 However, Fransman (2002) also points out that the new telecommunications model would come to be known for the most remarkable collapse in postwar industry. Fransman (2002) characterized the telecommunications event “boom and bust” from 1996 to 2002 in his study.689 Moreover, some events like the Stock Market Bubble introduced considerable instability in telecom companies’ performance. The author comments: “the figures supporting this claim make impressive reading. Between 1996 and 2001 syndicated bank loans to telecom companies totaled $ 890 billion, private equity and stock markets contributed a further $500 billion, while bond markets provided $ 415 billion of debt, making a total of $ 1,805 billion. In March 2000, at the height of the telecom boom, the total stock market value of all telecom operators and equipment suppliers was 6,300 billion; by September 2001 the value had fallen in all the Asian markets combined in the Asian crisis of 1997/8 amounted to 813 billion.”690

3.6.2 The Competitive Model The new telecommunications industry follows a vertical specialization model of seven hierarchically structured, but functionally interdependent technological layers.691 A layered 687 688 689 690 691

134

See Fransman (2002), p. 7. Fransman (2002), p. 2. See Fransman (2002), p. 7. Fransman (2002), p. 8. It introduces one of the properties of the institutional innovations, the modularization. See more about the layers in Wigand et al. (1999), pp. 125-126, and Fransman (2002), pp. 17-22. See the economic and organizational implications of modules and networks in Langlois/Robertson (1995), Wigand et al. (1999) and Godefroy/Pénard (2002).

modularized architecture creates a powerful potential for innovation precisely because it facilitates the division of knowledge and technological diversification. Initially the new telecom industry comprised the basic two layers corresponding to the equipment and network layers to build the basic infrastructure for telecommunications. However, with the emergence of the Internet, the telecom industry was fundamentally transformed into a Value Added Service Industry (VAS).692 Figure 3-9 shows the layer model of the new telecommunications industry:

Figure 3-9: The Layer Model of the New Telecommunications Industry Layer

Activity

VI

Customers

Example Companies

V

Applications Layer, (e.g. Web design, on-line information services, broadcasting services, etc.)

IV

Navigation & Middleware Layer (e.g. browsers, portals, search engines, directory assistance, security, electronic payment, etc.)

III

Connectivity Layer (e.g. Internet Access, Web hosting)

IAPs and ISPs

Network Layer (e.g. optical fiber network, DSL local network, radio access network, Ethernet, frame relay, ISDN, ATM, etc.)

AT&T, BT, NTT, WorldCom, Qwest, Colt, Energis, etc.

Bloombergs, Reuters, AOL-Time Warner, MSN, Newscorp, Yahoo, Netscape, etc.

IP Interface II I

Equipment & Software Layer (e.g. switches, transmission equipment, routers, servers, CPE, billing software, etc.)

Nortel, Lucent, Cisco, Nokia, etc.

Source: Fransman (2002), p. 18.

The industry incorporated the other layers: the connectivity layer (Internet access and web hosting), navigation and middleware layers (portals, security, and electronic payment, etc.), and applications layer (on-line information services, web design, broadcasting services, etc.). It was brought into the systems of firms from other industries previously considered to be separate from the telecom industry. This process was known as ‘convergence’, creating the idea of ‘hybrid’ services though the technological convergence of traditional separate services, like voice and data transmission. In this way, traditional telecom industry incorporated services from computer, semiconductor, and software industries. This aspect highlights an important feature of the new telecommunications industry. New telecommunications companies (NTCs) have attempted to develop structures and practices in an effort to combine the resource related benefits of large firms in innovation with the behavioral advantages of small entrepreneurial firms. It might take the flexible forms of more independent business units 692

See Brousseau/Quélin (1995), p. 4. 135

and/or of network relationship. Networks and independent business units enable NTCs to access necessary assets and to react in a timely manner to the requirements of technological innovation in the market. Therefore, diversified ICT products and services have been concentrated and commercialized by the new telecommunications companies. Those ICT products and services are created and developed within company’s R&D units, smaller entrepreneurial firms and research centers. Uncertainties related to technological diversification and the tendency to technological convergence of many ICT products and services by continuous technological innovations have found in the NTCs a better potential for commercialization on a larger scale through NTC’s geographic coverage according to the state regulations. Due to many uncertainties regarding future demands and technological trajectories, in many NTCs the adoption of an extensive ‘menu’ of ICT products and services submitted to the market selecting mechanism and the alliances with smaller entrepreneurial firms and research centers have allowed those companies to reduce risks of investments finding potential sources of profitability. As a result, even competitors products are commonly commercialized by the telecom companies (e.g. traditional telephony services and IP telephony). As we observe in the following Section 3.6.3, this feature is also an explanation to the network-based forms of organization in the industry in order to support the development and commercialization of those diversified ICT products and services based on different technologies. In order to understand the general concept of the competitive model which is a little more complex involving companies and corporate groups, specialized services and mixed services (hybrids), we would summarize the new competitive model in the new telecommunications industry, which is basically two categorizations of telecom operators:693 1) By the origin of the company: former state-owned privatized companies ‘incumbents’, like AT&T, NTT, Deutsche Telecom, Telecom Italia, France Telecom, etc. or newly established competitors ‘new entrants’, like WorldCom, Global Crossing, Qwest, Level3 in USA, and COLT and Energis in Europe. 2) By the specialized service provided: fixed network operators, like Deutsche Telecom, Telecom Italia, France Telecom, WorldCom and Global Crossing; specialist telecom equipment suppliers like Lucent, Siemens, Alcatel, Nortel and Cisco; mobile network operators, like Vodafone, AT&T and SBC Communications; and mobile equipment suppliers, like NEC, Ericsson, Nokia, and Motorola.694 The problems which have arisen from this model have been basically about regulatory, demand and technological uncertainties. According to Fransman (2002), due to the lack of regu693

694

136

According to the privatization process and regulation model of each country, it is possible to have differences in the model and a mix of services provided per telecom operator. Moreover, due to the economy-wide business cycles and losses in the sector in the last years, companies had to concentrate on those more profitable services to survive. Thus we provide general categorizations rather than a full description of specific aspects of service provision. Fixed networks operators could also be divided into local and long-distance operators (including international). Moreover, service providers should also be considered.

lations for entry, demand estimates and property rights definitions, the rapid entry of new competitors was facilitated, which has led to intense competition, falling prices, and reduction in the growth of revenue and profits in the affected market segments.695 These trends have been one of the causes of the fall in share prices from around 2000, mainly in fixed longdistance and international data and voice services, observable among the incumbents and new entrants. The economic crisis in 2000-2001 intensified the mistakes in demand predictions and excessive supply of telecom services. It meant cutbacks in telecom operators’ expenditures by final business customers and decreasing the derived demand for telecom equipment. Moreover, the collapse of dotcom companies in mid-2000 decreased significantly the demand for internet services provided by network operators. As the telecom bust deepened, an increasing number of network operators collapsed, like GTS ad Viatel in US, and Atlantic Telecom in UK.696 Furthermore, other companies like Global Crossing and XO Communications teetered on the brink by the beginning of 2002.697 It also had a lot of impact on the equipment suppliers like Nortel, Cisco, Siemens and Alcatel, which had dramatic consequences due to the decrease of demand.698 According to Fransman (2002), the common sources of pain were the falling revenue and profit from core voice services, high investment costs, falling share prices, and the vulnerability to the attack of new entrants. Due to scarce demand and excessive supply of telecom services, the result was a worldwide tendency for alliances, fusions, mergers, joint-ventures and acquisitions in order to save investments. What is important here is to observe the relative high instability of the telecom business in the period from the privatization processes to recent years, namely the 90s until the present date, due to many uncertainties.

3.6.3 Network-Based Organizational Forms The new telecommunications industry brings a variety of combinations of organizational forms through networks of suppliers, partners, customers and subcontractors.699 New telecommunications firms form networks for many reasons: to enter emerging markets rapidly, to acquire specific knowledge quickly in order to build and commercialize value-added products, to acquire brand name value, to increase market-share, to share necessary investment in infra-structure, to expand commercial activities into other geographical areas, to monitor market continuously through the acquisition of market information (consulting), to build information systems (CRM, etc.), to enhance internal channels of information, etc. Many telecommu695 696 697 698

699

See Fransman (2002), p. 25. See Fransman (2002), p. 25. See loc.cit. pp. 25-27. According to Fransman (2002), pp. 28 and 109, on 24 October 2000 Nortel’s share prices fell by 23 per cent in one day when the company failed to meet Wall Street’s expected sales growth rate of 125 per cent. Moreover, in October 2000 British Telecom had a fall of 52 per cent in its share prices, Deutsche Telecom 48 per cent, AT&T 47 per cent, France Telecom 21 per cent, Vodafone 19 per cent and Telefónica 9 per cent. See, for instance, Brousseau/Quélin (1995), Van den Broek (2000), and Fransman (2002). 137

nications services provided by these companies require the pooling of the assets of several firms. Therefore, it is known as a Value Added Services (VAS) industry, as informationbased services provided through telecommunications networks.700 The Value Added Services market is the result of a combination of technical ‘functions’.701 The production of these different functions relies on the use of specialized assets. Brousseau and Quélin (1995) comment: “Most firms in the new telecommunications services do not own the complete set of assets necessary to produce VAS. As a result, this business is typically one where assets owned by different firms need to be combined to produce marketable output.”702 It happens because no single firm in the industry is able to produce all the functions on its own because the VAS supply requires specialized capabilities and convergence of different technologies. Different firms own the know-how to control these diverse functions. The type of the assets owned by these firms has an impact on their bargaining power. Moreover, the level of risk involved for the participants when entering into a relationship, as a result of uncertainty, plays an important role in determining the form of network, as whether or not a market will be found for the new product or service, whether or not the technology will be sufficient and collaborative partnerships will function. Therefore, networks assume different forms according to the type of assets owned by the firms, the level of specialization of the marketable output and the level of uncertainty. When a firm owns assets that are less substitutable than others, it becomes the core of a network of suppliers and subcontractors. Moreover, the unequal capacity to substitute partner’s assets is also a strong determinant of organizational arrangements. The specificity asymmetries between firms encourage a coordination process similar to contracts on the market or through long-term contracts.703 Burton-Jones (1999) classifies the telecommunication networks according to the power asymmetry. He classifies networks basically into two different models: star, or hub and spoke and many-to-many networks (see Figures 3-9 and 3-10). While the former involves a single large corporation and its suppliers or distributors, the latter involves small business networks characterized by peer to peer, broadly symmetrical in terms of power, organized on a communal basis rather than controlled by one participant. Burton-Jones (1999) comments, peer to peer forms are typically designed to facilitate many to many transactions.704

700 701 702 703 704

138

See Brousseau/Quélin (1995), p. 3. See loc. cit. p. 2. Brousseau/Quélin (1995), p. 3. See Brousseau/Quélin (1995), p. 5. See Burton-Jones (1999), pp. 137-138.

Figure 3-10: Star or Hub and Spoke Supplier A

Supplier C

Firm Supplier D

Supplier B

Figure 3-11: Many to Many Business A

Business E

Business D

Business B

Business C

Source: Burton-Jones (1999), p. 138.

139

Figure 3-12: Types of Organizational Arrangements in Telecommunications Subcontractors Alliance

a

a

Homogenous Alliance

b

a

b

Commercial Supply

a

b

b

b

Complementary Alliance a

a

b

b

c

b

d

Commercial Supply

Commercial Supply

____ Non-market governance mode ------ Market mode of coordination

Strategic Alliance a

Owner of an “a” type of asset

Source: Brousseau/Quélin (1995), p. 9.

Differently, according to the asset specificity analysis, Brousseau and Quélin (1995) propose three basic forms of networks (alliances) in the new telecommunications industry: the core of sub-contractors, the homogeneous alliance and the complementary alliance705 (see Figure 3-11). These network arrangements are formed according to identified needs involving two or many companies through strategic alliances, joint ventures or formal and informal cooperation agreements that make it possible for those companies to acquire certain market advantage, saving investments and therefore reducing risks. According to Brousseau and Quélin (1995), the type and value of the asset specificity to produce a certain VAS will ultimately define the conditions for network formations.

3.7 Institutional Uncertainties

3.7.1 Sources of Uncertainties and Instability The consequences of these institutional innovations which better characterize the New Economy is the configuration of a new business environment under high levels of environ-

705

140

See Brousseau/Quélin (1995), p. 15.

mental uncertainty and risk, requiring from the companies a continuous need for adaptation to many exogenous and endogenous changes. We identify three major sources of inter-related environmental uncertainties (see Figure 3-13): (1) The uncertainties relative to the market conditions: characterized by deregulated entry barriers, high competition, uncertain and irregular demands, and the management of increasingly more complex technologies in a short period of time. (2) The uncertainties created by legal and political institutional change: removal of barriers to the mobility of capital, goods and services, market liberalization and deregulation, (privatizations), state of the regulation process of competition between companies after the privatization process. Very often, due to the regulation process, such companies operate under market rules that are undefined or undergoing definition. (3) The uncertainties relative to the constant technological changes, the continuous technology innovation process and possible trajectories and diversifications of technology. Considering here also those uncertainties referring to knowledge–intensive technological production.706

Figure 3-13: Sources of Institutional Uncertainties in the New Economy

-

Market High competition Demand uncertainty Lower entry barriers ‘Entrant’ newly establishment

NEW ECONOMY Institutional Uncertainties

Political and Legal - Privatization - (De)Regulation - Ongoing definition of rules

Technology - Fast change - Highly perishable - Cheap-to-buy - Easy-to-copy

Institutional uncertainties in the New Economy have diverse sources and have been approached in different ways. For example, Thietart and Xuereb (1998) develop a study about ‘uncertainties’ and ‘complexity’ in the innovation process, namely new product development (NPD). These uncertainties arise from three major areas: customer, technology and competition. Therefore, in their view, the innovation process involves three categories of uncertain706

See Dosi (1988), p. 222, and Rothwell (1992), p. 227. 141

ties: uncertainties about user’s needs, uncertainty about the technology to use, and uncertainty about competitors’ moves.707 For our purposes in this study, the categories of uncertainty were summarized as demand, technological and regulation uncertainty.708 In the new telecommunications industry, institutional uncertainties can be substantially increased due to the combination of those aforementioned sources of uncertainties, like 1) the approach of emerging markets in a global scale; 2) a variety of new technologies which allow the development of diversified new products and services; 3) products and services with short life-cycles; 4) establishment of new companies, many financed by short-term venture capital funds; 5) the ongoing and often misguided process of regulation; and 6) failures in demand estimates. Fransman (2002) notes that “mistakes are an inevitable consequence of the irreducible uncertainty which always shrouds complex events such as those which occurred in the Telecom Industry in the Internet Age from 1996 to 2002.”709 In order to understand the institutional changes in the new telecommunications industry, we analyze three main categories of environmental uncertainty related to the new telecommunications industry: demand uncertainty; technological uncertainty; and regulation uncertainty. In addition we would also analyze an event which remarkably reflected and introduced instability to the companies operating in the New Economy: the stock market bubble of 2000-2001.

3.7.2 Demand Uncertainty Demand uncertainty is a kind of environmental uncertainty concerned with fluctuation and unpredictability of demand.710 It has several effects on companies’ organizational form, production systems, and consequences to organizational behavior. Demand uncertainty is a source of risk which increases transaction costs affecting organizational forms, a continuous redesign and reallocation of resources and needs for reorganization of processes internally. For example, some scholars have found that demand uncertainty increases the likelihood of vertical integration under low competition and internal integration of production.711 However empirical evidence on demand uncertainty related to vertical integration is not irrefutable.712 Harrigan, particularly (1985b, 1986) found a negative relationship between demand uncertainty and vertical financial ownership. Lajili and Mahoney (2005) found that recent changes in information technology are changing the nature of transaction costs leading to a more efficient management through electronic integration solutions, thus favoring contracting and outsourcing as the preferred organizational form choice.713 They emphasize that the prodigious 707 708 709 710 711 712 713

142

See Thietart/Xuereb (1998), p. 2. We also consider competition uncertainty, complexity and uncertainty about product development inherently related to these categories. Fransman (2002), p. 33. See Robertson/Gatignon (1998), p. 518. See Levy (1985), MacMillan et al. (1986), and Walker/Weber (1984) See Robertson/Gatignon (1998), p. 516. See Lajili/Mahoney (2005), pp. 23-26.

advances in information technology, especially in the past decade, have comparatively favored lower transaction costs of markets over hierarchies. Demand uncertainty has favored the rise of network forms of production in the New Economy. The technological evolution of ICT products and services brings a peculiar example of economic organization through kinds of networks, like alliances and joint ventures.714 The costs of ‘in-house’ product development in the ICT industry are high, and information and communication technologies ever since the initial phases of the so-called ‘technological revolution’ have required alternative modes of organizing production, mainly through networks of companies and specialists.715 Although the ICT industry has been characterized by high competition due to the worldwide process of privatization and the emergence of new competitive markets, integration seems to be inefficient way when additional factors like frequent technology change, human asset-specificity and demand uncertainty are considered. Demand uncertainty in this case is also regarded as competition among new technological companies which bring new products and services based on divergent technological trajectories into emerging markets. Demand uncertainty was assessed by John and Weitz (1988) as predictability and volatility of sales. Klein et al. (1990) assessed external uncertainty by ‘volatility’ and ‘diversity’.716 Walker and Weber (1987) assessed demand uncertainty as expected volume of fluctuations and uncertainty of volume estimates.717 Demand uncertainty has been one of the main sources of instability and losses in the new telecommunications industry. It happened basically because of the mistakes in supply and demand expectations. For example, Audretsch and Thurik (2001) comment that when consumer demand is heterogeneous (referring to the New Economy) and fickle, demand tends to proliferate across a spectrum of product class niches and the variances in consumer demand across product types and over time create a continuously changing set of product niches.718 They comment: “Knowledge about these niches is uncertain for two reasons. First, the niches are difficult to observe and are changing. Second, the set of economic agents evaluating potential opportunities is heterogeneous.”719 Examples of demand uncertainties are abundant in the new telecommunications industry, for example, earlier an explosive future demand for bandwidth was predicted to build the internet infrastructure as bandwidth-intensive applications such as video-enabled web sites, video conferencing and video-on-demand over the Internet. Later, companies realized that those predictions were too optimistic. Although the de714 715

716 717 718 719

See Brousseau/Quelin (1995). See Castells (1996/2000), pp. 128-129, and Fukuyama (2000), p. 225, who argues that the information age has weakened hierarchies. Fukuyama comments the birth of many ICT companies in the Silicon Valley through kinship networks. See Klein et al. (1990). See Walker/Weber (1987). See Audretsch/Thurik (2001), p. 24. See loc. cit. p. 24. 143

mand for bandwidth at the time was increasing rapidly, predictions were too optimistic. It is reported by Fransman (2002) that supply saturation occurred and many innovative new services forecasted such as video-enabled web sites was based more on wishful thinking.720 In the field of mobile communications similar interpretative ambiguity surrounded projections of likely demand for third-generation mobile services, a key factor of the auction price that mobile operator bidders for 3G licenses were prepared to pay. Similarly, the extent to which commercial transactions would migrate online, thus benefiting the dotcoms, and the speed at which this would happen, was bedeviled by interpretive ambiguity. As the industry moved further into the first years of the new millennium, estimates of these demand magnitudes became progressively more pessimistic.721 The increase in competition also brought many suppliers to the market arena, thus decreasing considerably expected revenues and profits. Other examples of demand uncertainty in the new telecommunications industry were the exorbitant predictions of dotcoms demands leading to the Stock Market Bubble in 2001 and subsequent bankruptcies of many dotcom companies. Another example was the so-called Low Earth Orbit Satellites (LEO) constellations, like Iridium, Globalstar and Orbcomm. They were originally designed to provide global voice and short data messages communications services; however they failed in the market going bankrupt due to the impossibility of predicting future demand and technological substitution, for example, the expansion of cell phones.722

3.7.3 Technological Uncertainty Technological uncertainty refers to the probability of improvements in technology. It arises from high rates of technical change, increase in product complexity, and risks of obsolescence.723 The generation of new technologies which might render obsolete the current technology development effort.724 Not only is new economic knowledge inherently risky, but also asymmetries exist substantially across agents, both between and within firms. As Audretsch and Thurik (2001) note “the expected value of new ideas, or potential innovations, is likely to be anything but unanimous between the inventor of that idea and the decision maker, or group of decision makers of the firm confronted with evaluating proposed changes or innovations.”725 Day and Kimberly (1995) also point out that, “Any new technology with the potential to open new markets or to penetrate existing markets more deeply carries certain risks for its producers. These risks are born of the uncertainty that is inevitably associated with newness – how well will the technology perform? How great an improvement over existing alter-

720 721 722 723 724 725

144

See Fransman (2002), pp. 32-33. See Fransman (2002), p. 33. See Caceres (2002). The declared bankruptcies of Iridium was in August 1999, Orbcomm in September 2000 and Globalstar in February 2002. See Quinn/Hilmer (1994), p. 44. See Robertson/Gatignon (1998), p. 519. Audretsch/Thurik (2001), p. 19.

natives does it represent? How big is the potential market?”726 Technological uncertainty is viewed in this research as an exogenous variable highly stimulated by market competition. The overall technology uncertainty which the new telecommunications industry face is basically a function of competition. When technology is volatile as in the New Economy, new concepts and ideas are rapidly generated. These new ideas affect either the way that the production process is carried out or the nature of the processes themselves. Tosi et al. (1994) illustrate their argument with the dynamics of the electronics industry, with breakthroughs in integrated circuits, transistors, and general miniaturization showing how technology changes could affect the nature of a product as well as marketing strategies.727 The survey carried out by Baily and Lawrence (2001) conclude that IT innovations have been driven by the demand for improved technologies of other consumer industries and that in the United States competition in the service industries, often on a global scale, has encouraged them to seek out continuously new technologies to improve their own productivity. Technological uncertainty has several consequences in organizational forms, product diversity and production flexibility. For example, Balakrishnan and Wernerfelt (1986) have demonstrated empirically that the possibility of technological obsolescence reduces internal integration, especially if the degree of competition is high. Similarly, Harrigan (1986) demonstrated that technological uncertainty is negatively related to vertical integration.728 The rationale is that flexibility and lower asset exposure are preferred when the risks of technological obsolescence are high. It therefore creates plausible arguments to understand the preference for network forms of organizations in the new telecommunications industry.729 Perhaps more dramatically, researchers have argued that breaks in technology, as paradigmatic shifts, destroy existing competences and encourage the use of alternative forms of organization due to high uncertainties.730 According to Klein et al. (1990), the positive relationship between technological uncertainty and R&D networks is that flexible organizations are necessary to respond quickly to changes in the environment because integrated organizations are too insulated from their environments. As observed, organizational forms based on trust are viewed as more flexible mechanisms to adapt to external changes in technology and to facilitate the transfer of knowledge between economic agents, mainly when this specific knowledge has a relatively short life.731 Alternative forms of organizing production in the ICT industry seem to be a mechanism to share the risk of potentially rapid technological obsolescences. The analysis of technology uncertainty plays a significant role in prescribing recommendations for alternative modes of organization. Williamson (1991), for example, proposes that in analyzing organizational forms, we should consider additional problems in conjunction with the devel726 727 728 729 730 731

Day/Kimberly (1995), p. 225. See Tosi et al. (1994), pp. 37-38. See Harrigan (1986). See Brousseau/Quelin (1995), p. 9. See, for instance, Pisano (1990), Shan (1990), and Teece (1992) See Dodgson (1993), p. 79. 145

opment of innovations.732 According to Dosi (1982), there are two important dimensions to be considered in combination: timeliness and learning-by-doing.733 Today’s technological environment of ICT industry is strongly characterized by the rapid introduction of new technologies and paradigmatic shifts. According to Hamel (1991), shorter product development cycles require non-permanent forms of organizations, such as alliances, which allow faster response to a change in the technological environment by “short-circuiting the process of skill acquisition”.734 In this sense, flexible and alternative organizational forms compared to traditional hierarchical organizations are justified by the potential benefits stemming from timely market reactions and early mover advantage. Pisano (1990) argued that in industries experiencing rapid technological change, “it is unlikely that a single company has the range of expertise needed to bring advanced products to markets in a timely and cost effective fashion.”735 This is certainly the case of the recent evolution of the new telecommunications industry. Walker and Weber (1987) access technological uncertainty through the frequency of changes in product specifications and probability of technological improvements. Harrigan (1986) also measured technological uncertainty by years of obsolescence of products.736 Examples of technology uncertainty in the new telecommunications industry are abundant. For example, in the mobile communications the variety of standards reflected high technological uncertainty among available choices: CDMA, TDMA, and GSM (for instance, Europe and Japan adapted W-CDMA, in the US there was a patchier acceptance of this standard).

3.7.4 Regulation Uncertainty Privatization programs and regulation processes are also sources of uncertainty. In the new telecommunications industry the privatization programs have had the role of integrating the supply and demand with projections that were being made earlier and to control the entrance of new competitors in the market. The ‘rules of the game’ in the hands of the governments played a crucial role as they liberalized telecom service markets and attempted to increase competition between telecom network operators through measures such as the regulation of interconnections charges and requirements. According to Bishop et al. (1995) the United Kingdom privatization program was pioneer and had an influence on economic policy throughout the world. Privatization programs were initiated in Asia, South America, and Africa, as well as in Europe and USA.737 Privatization programs had direct impact in decreasing wages, weakening of unions and increasing the bargaining position of management. It was observed that there was a widespread use of performance-linked pay to attenuate the agency problem (and to induce more effective performance) which arises from the separation of own732 733 734 735 736 737

146

See Williamson (1991), p. 273. See Dosi (1982), p. 148. Hamel (1991), p. 95. Pisano (1990), p. 30. See Harrigan (1986), pp. 551-552. See Bishop et al. (1995), p. 1.

ership and control. Accordingly, one of the most striking consequences of privatization is the extent to which it has made the behavior and performance of privatized companies more transparent. As a consequence, companies have more reasons to clearly define their objectives and goals for managers and workers. As Bishop et al. (1995) state, “share prices provide more objective measures of performance than have been available hitherto and it has been possible to provide higher-powered incentives to managers and workers in privatized enterprises. Cost cutting has also been a feature of several privatized firms even where competition has been quite limited.”738 However, Bishop et al. (1995) also report that the privatization program had a significant negative impact on employment.739 It was reduced by about 25 per cent on average in UK industries due to this fact. The authors also found that where market share fell, implying increased competition, wages also tended to fall. They conclude that the privatization objectives have led to large-scale labor shedding as companies have become more profitoriented. Where market power has fallen as a result of liberalization, relative wages have been reduced. Additionally, they comment: “If we think of efficiency as unit labor cost then efficiency is determined by wages divided by productivity. As far as wages are concerned the above findings suggest that increased competition reduces wages. But we also find that ownership (by changing objectives) affects wages.”740 As a general conclusion from the ILO Employment Report 2001, life at work in the New Economy becomes risky and uncertain depending on many changing variables.741 Greater job instability specifically in the ICT sector was already noted in a previous ILO report in 1998 . The ILO (1998) reports: “In the communications sector, labour relations as a whole have deteriorated in the 1990s as a result of the structural and regulatory changes brought about by liberalization, privatization, and globalization. Employees and their trade unions, accustomed to the stability of the public-sector monopoly or a private sector in which competition was distorted by the regional division of markets and entry barriers, have reacted rather negatively to the reorganizations and job suppressions.”742 Bishop et al. (1995) also analyzed the nature of changes to internal organization which have been introduced by regulation reform and role of organizational change in enabling enterprises to respond to the changed regulatory environment. They note three important elements: management remuneration, reorganization and ‘culture change’.743 In Brazil, for example, the privatization of the ICT industry followed the same tendency. From a 50 ICT company sample, employment increased from 1984 to 1989 about 70 per cent (before privatization) but then (after privatization) dropped from 1989 to 1999 about 52 per cent.744

738 739 740 741 742 743 744

Bishop et al. (1995), p. 8. See Bishop at al. (1995), p. 347. See Bishop at al. (1995), p. 348. See ILO (2001), p. 310. ILO (1998), p. 73. See Bishop et al. (1995), p. 364. See ILO (2001), p. 173. 147

As general consequences, the variation in employment, increase in competition, and decreasing in wages became sources of internal uncertainty and instability affecting organizational behavior directly. According to Levy and Spiller (1994) who have studied the privatization and regulation of the new telecommunications industry in different countries, exclusive focus on regulatory governance is inadequate. The privatization process and regulation depends also on exogenous formal and informal institutions such as domestic commitment capability, stock markets with security regulations, law system and public confidence in the government, which may be lacking in some countries. Moreover, the role played by the regulatory agency itself is an object of concern. The privatization and regulation issues have opened an agenda for political and economic discussions.745 It has increased the discussions about the efficacy of the privatization processes, and the role, size and scope of the regulatory agencies in many countries. When rules are not completely defined and political variables might strongly influence company’s decisions, different sorts of ex post contractual problems arise within privatized companies. It constitutes an important source of uncertainty and risk, especially for companies acting under a new competitive environment, due to the many information asymmetries . In the cases of emerging markets, uncertainty occurs mainly because, very often, there is no historical process driving the regulatory agency and companies’ strategic decisions, and often they might change according to a country’s institutional singularities and interests. Failures in regulation also mean unregulated competition. Regulatory uncertainty might change the amount of investments, size of resources and management orientation constantly. Therefore, the combination of the privatization processes, the on-going development process of regulatory policies and the establishment of competitive models are sources of uncertainties, mainly in countries with weak institutions. It increases the reluctance of investors and creates irregular investment flows. Moreover, as markets become more competitive, they also become more variable and unpredictable.746 The more markets become unpredictable in the sense that they become more variable, the more variable also become the sales and profits of the firms that supply them.747 Sawyer and Shapiro (2002) comment: “Competition shifts sales and profits as well as reducing the amount that any particular firm can make on the product, and when the competition is technological, it alters the product as well as its price, changing the requirements of its production and those in the market.”748 High competition leads to high product/service diversification and constant change in market strategies and production systems. Within the firms, high competition is reflected in short-term perspective strategies for investments and expectations of return. Companies acting under these on-going definitions about high competition and investments will face serious problems to invest in long-term commitments with stakeholders. Because it is also an ongoing process in many countries, the privatization process with the establishment of competition provides low safe745 746 747 748

148

See, for instance, Baron (2003), pp. 331-332. See Sawyer/Shapiro (2002), p. 50. See Sawyer/Shapiro (2002), pp. 50-51. Sawyer/Shapiro (2002), p. 51.

guards for employees against losses and layoffs. Uncertainty and risk which comes from the privatization and on-going regulation processes often brings regulator and company into disagreement and provides new rules to the competitive model constantly. Taking the example of the privatization process in the UK, Bishop at al. (1995) concludes referring to government control : “Fundamental changes…are difficult to achieve after privatization and introduce considerable uncertainty into corporate activities. Uncertainty has also been created by the adversarial relation between regulator and firm. Regulators have considerable discretion in the way in which they affect corporate activities. Investment in particular is harmed by this ‘regulatory uncertainty’.”749 Fransman (2002) notes one of the key problems regarding to property rights protection in the market environment of the new telecommunications industries about the regulation of competition which came to be crucial for the survival of these organizations. He comments: “Only Microsoft can produce Windows, the de facto standard for PCs. But a large number of telecoms operators can provide long-distance and international bandwidth.”750 As a result of low entry barriers, the telecom operators face stronger competition, and under such conditions prices tend to push down, and especially under some downturn on demand, it creates a general cutting-costs culture in the whole industry.

3.7.5 The Stock Market Bubble Effects After ten years of ongoing growth in the American Economy, surfing on the wave of the IT driven New Economy, in 2001 it went through a period of difficulties. Growth almost vanished and unemployment rose by almost two percentage points in one year. In the US telecommunications industry, it was reported that 600.000 jobs disappeared between March 2001 and the same month of 2003. 751 Over the same period, shareholders have lost about 700 billion dollars. Many agree that a speculative bubble was at work, where excessive growth was fuelled by overconfident expectations about long-lasting high returns that the new technologies had to deliver. The subsequent collapse of the stock market could only have reflected a normal adjustment of share prices to their fundamental value. With the failure of several “dotcom” companies during the year 2000 and the slow-down of the US economy in 2001, a more realistic assessment of the changes induced though the New Economy became more widely spread. Events like these and other small turbulences have especially marked the new telecommunications industry introducing a significant level of uncertainty and instability into employment contracts. The source of these turbulent events is clearly linked with the chances of opportunistic short-term gains though speculations in the valuation of stock options. Many managers of the companies in the bubble took the opportunity of compensation schemes in stock options to push up the firm’s share prices as high as possible, cash the options, and

749 750 751

Bishop et al. (1995), p. 14. Fransman (2002), p. 23. See Vranceanu (2003), p. 2. 149

watch the company collapse.752 The problems involving specifically companies operating in the new telecommunications industry are highly related to the chances of short term opportunism created by stock options markets. Vranceanu (2003) comments that, this situation became more dramatic when a wave of corporate scandals involving CEOs and CFOs of leading US companies surged.753 Notorious examples were the companies of the new telecommunications industry, like WorldCom, Global Crossing, Tyco, Qwest, Adelphia, etc. According to Vranceanu, even the notable Enron scandal involved its risky dotcom branch, while its old economy background (gas distribution) was shrinking. All these events brought a wave of public distrust and criticism. He reports that, an opinion poll carried out in July 2002 by the Harvard Business School and the Pew Research Center showed that only 23% of Americans would trust bosses of large companies.754 Vranceanu notes that the logic of the business environment of the New Economy may explain why a majority of Old Economy firms were not affected by this type of opportunistic behavior. He notes: “If the manager knows that the firm is worth something and that after the burst of the bubble its value will come back in line with fundamentals, would he behave in the same way? Probably not. If he has to choose between an important one shot gain and the discounted value of a flow of future incomes, incentives to shirk are less powerful.”755

3.8 The Work Conditions in the New Economy Much has been observed in the sections before about the singular uncertainties which have influenced the companies operating in the New Economy, especially the new telecommunications industry. However, it is important to examine some particular evidence of uncertainty and instability affecting organizational behavior. Particularly we want to examine some plausible arguments that help to answer some questions, like: How are these uncertainties which have affected the new telecommunications industry since the privatization processes, likely to affect organizational behavior? What is the impact of these trends on workforce motivation? Do environmental uncertainties affect significantly the ways of governing relational contracts? Finally and most important for this work: How is it possible to develop trust within the hierarchies of the companies operating in the New Economy, like those of the new telecommunications industry, under such uncertainty and instability? According to Audretsch and Thurik (2001), “It is not just enterprises that are turbulent in the entrepreneurial economy, but also both jobs and the commitments between firms and workers.”756 The process which such companies go through is often marked by a great pressure on the workforce, such as the reduction of the post-privatization job offers in the wake of 752 753 754 755 756

150

See Vranceanu (2003), p. 14. See Vranceanu (2003), p. 14. See loc. cit. p. 13. Vranceanu (2003), p. 13. Audretsch/Thurik (2001), p. 15.

the restructuring of the traditional state monopolies, or by the constant layoffs and human resources re-dimensioning due to situations imposed by the new competitive model. It gave rise to high job instability facing frequent restructuring processes throughout the industry. As Guest (1997) comments: “The typical strategy of increasing competitiveness by cutting back on staff costs engenders a sense of insecurity and is unlikely to encourage a sense of trust and commitment in a company.”757 According to some of the ILO reports, we can identify some important features of the work environment in the New Economy, especially in the new telecommunications industry:758 ƒ

Problems rise from the convergence of hitherto discrete industries (convergence), often with discrete traditions of organization and industrial relations and the emergence of new businesses within traditional industries, such as the growth of wireless telecommunications.

ƒ

Liberalization and privatization has caused the loss of bargaining power of trade unions and the decline of unionized jobs;

ƒ

According to the institutional protection, the change has occurred differently in different countries. Countries like Germany and France have assured job protection and the maintenance of the employees rights through negotiations with private sectors and unions;759 The same does not occur in many other countries with low institutional job protection.

ƒ

A high proportion of young people with different profiles are entering these companies and they may not perceive the benefits of trade unions;

ƒ

Programs of earlier retirement have been used frequently as the chief mechanism to reduce staff size;

ƒ

Reports generally conclude observing a sense of high job insecurity, uncertainties and risk.

This figure is well illustrated by the ILO (2001) report. The report observes: “a sense of insecurity has increased among employees. At the same time, the empowerment of employees may have its downside for some, resulting from greater responsibility for outputs or in greater conflict in juggling competing demands or time and energy, arising from multiple commitments. Working time for many is blending with non-working leisure time . Part of the problem of long working hours (…) may be because job categories are also blurring.”760 The same document confirms the greater impact of the institutional changes on the new telecommunica757 758 759

760

Guest (1997), p. 21. See ILO (1998), ILO (2001), pp. 288-300, and ILO (2002). For example, the ILO (2001) reports that the German postal workers’ union, DPG, obtained a commitment from Deutsche Telekom in collective bargaining with the DPG. Deutsche Telekom also undertook to employ on full-time open-ended contracts all trainees who successfully completed their training program. The company also offered places for 2,600 new trainees. ILO (2001), pp. 283-284. 151

tions industry: “of the core ICT sector, it is only the telecommunications industry…the consequences for employees is the transition from a sheltered and stable environment to one that is now highly volatile and competitive.”761 The New Economy Index (1998) report illustrates the tendencies in the New Economy. Productivity and per capita GDP growth rates have slowed significantly since 1950 and income inequality has increased since 1970.762 In parallel, employment conditions have also deteriorated. Increased earnings are positively related specifically to educational level, mainly with college degree. General employee benefits have fallen. Contingent work has increased as well as job instability.763 The ILO (2002) discusses the theme ‘employment and employment ability’ focusing on the telecommunications industry, and reveals a general reduction of job supply in that industry, with some differences among countries.764 According to the report, though it is not a global tendency, some cases of global employment expansion can be verified in the sector for a certain period of time, as in the cases of Germany, United States, and Japan, in the 90’s, especially due to the entrance of competing companies in the market, the expansion of mobile telephony, and the Internet access and content companies. However, what one can notice is that, such perspective is not sustained during the first years that followed the 90’s. Chiefly after the year 2001, new dismissals occurred throughout the world due to deceleration of the economy, affecting especially the ICT industry, reflected in restructuring movements through mergers, acquisitions, and joint-venture formations. According to the same report, a critical problem is the quality of the new work posts.765 That points towards a tendency for precarious work conditions in segments of the sector, pointing out the cases in countries such as Spain, Italy, and Argentina. Employees have less benefits, more work hours and instability. Burton-Jones (1999) has shown that the work environment in such companies has been characterized by an increase in temporary, part-time, and autonomous jobs.766 Burton-Jones (1999) comments on the New Economy: “on current trends, employers and employees will be increasingly wary of entering into agreements which contain implicit guarantees or promises. This lack of mutual trust will continue to weaken the value of the employment contract as a form of work arrangement and move the employment relationship away from its relational context towards a more explicit transactional model.”767 According to Audretsch and Thurik (2001), the greater the uncertainty and turnover experienced by workers in the New economy mirrors the greater turbulence experienced by firms.768 They claim: “Replacing long-term fixed contracts with new flexible forms of work contracts provides the essential vehicle pro-

761 762 763 764 765 766 767 768

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ILO (2001), pp. 288-289. See The New Economy Index (1998), pp. 21 and 23. See The New Economy Index (1998), p. 27. See ILO (2002), p. 36. See ILO (2002), p. 145. See Burton-Jones (1999), p. 48. Burton-Jones (1999), p. 53. See Audretsch/Thurik (2001), p. 15.

pelling the transition from the managed economy to the entrepreneurial economy.”769 One can observe the transference of those uncertainties from the market dynamics to the work conditions. It can be a source of many problems and conflicts, among employees and managers, decreasing levels of trust. The increase of flexible contingent contracts and its impact on trust relationships is one of the main features observed by scholars in the New Economy.770 Gallagher (2002) observes that the growing introduction of contingent employment contracts into organizations which have primarily structured the employment relationship on the basis of permanent or more ongoing contractual arrangements also raises questions concerning the potential impact which the utilization of contingent workers has on managerial practices. He states: “One issue, which may be in need of greater understanding, is related to the possible impact which the introduction of contingent work arrangements has upon the “trust”.”771 Some empirical sources suggest that the use of contingent workers is associated with lower levels of trust and perceived organization fairness, and higher levels of perceived insecurity among permanent workers.772 Cunha (2002) notes: “Trust is likely not to develop with temporary workers, since they are allocated to short-term projects and there is no time to develop a trust relationship.”773 Moreover, Atchison (1996) observes that contingent workers should not be expected to express commitment to the organization because of the nonexistence of long-term prospects.774 Contingent contracts may cause even greater impact when they become current business practice but institutional regulations are not adapted to deal with these new labor demands. The lack of labor laws and regulatory institutions to enforce contingent contracts force businesses to negotiate contingent labor contracts on the basis of traditional long term employment contracts, and it might create many negative side effects, like high costs of contracting to the employer and false expectation of enduring relationship to employees. In this way, another problem observed by many scholars is the decreasing sense of loyalty to the organization.775 Short-term job perspectives, network-based activities and flexible organizational structures where employees work in different projects, and with different employees, will present problems in creating loyalty to one organization.776 Pfeffer (1994) observes: “the biggest disadvantage of contingent employment arrangements is the difficulty of obtaining loyal-

769 770 771 772

773 774 775 776

Audretsch/Thurik (2001), p. 15. See, for instance, Pfeffer (1994), p. 24, Burton-Jones (1999), pp. 46-48, ILO (2001), pp. 282-283, and Gallagher (2002), pp. 115-132. Gallagher (2002), p. 129. See Lautsch (1999), Morishima/Feuille (2000) and Pearce (1993) for contingent contracts associated with lower levels of trust, and Kochan et al. (1994) and Ugboro (2003) for contingent contracts associated with perceived insecurity among permanent workers. Cunha (2002), p. 40. See Atchison (1996), p. 373. See Argandona (2003), p. 15. See Argandona (2002), p. 18, and Pfeffer (1994), pp. 23-24. 153

ty, dedication, or willingness to expend extra effort on behalf of an organization.”777 According to Pfeffer, the costs of using subcontractors are more likely to show up over time and are more difficult to capture than the immediate benefits of cost-cutting and adaptation to product demand fluctuations. Due to such a scenario of constant adaptation to changes and reorganizations, the companies operating in the New Economy will usually present much greater employee turnover rates compared to those of the most traditional industries in the Old Economy. Burton-Jones (1999) comments that, at the end of the 80’s and throughout the 90’s, companies such as IBM and AT&T, for example, abandoned their non-dismissal policies, placing their implicit contracts under pressure, thus contributing to the rise in work insecurity among the survivors of consequent restructurings.778 The author comments that such measures have contributed to create a lack of trust in the company-employee relations, moving the old relational contract model towards a transactional contract model. What one can observe is that the use of contingent, short-term contractual relationships is strongly related to short-term perspectives of return over investment which is ultimately related to high competition, the kind of financial capital (venture capital), and the general uncertainties reported in this study. Among the many consequences of the changes occurred in the work environment, the personnel cut might be the cause of the feelings of uncertainty, anger, guilt, and lack of trust of the remaining employees, after staff reductions. The result of managing greater employee turnover rates is the difficulty in the development of a more adequate corporate culture to cope with a scenario of constant changes. Last but not least, it is also important to observe some internal changes on the corporate culture of these companies operating in the New Economy, mainly due to the increasing internal competition among peers. As pointed out by Bishop et al. (1995), it has also changed substantially the ‘culture’ of the privatized companies.779 According to Lewis and Dyer (2002), the impact on workplace culture in undermining formal family-friendly policies is particularly evident in relation to working time and the increasingly pervasive ‘long hours culture’.780 The authors note that in the organizations where the ‘long hours culture’ is the implicit norm, spending visibly at the workplace (i.e. face time) is valued because it is assumed that such behavior represents employee commitment and productivity. This practice clearly evidences the replacement of objective measures for subjective evaluation of performance. In this way, employees are often expected to demonstrate commitment by being willing to put work before their personal lives at all times.781 Presumably, these characteristics affect the system of reputations within the company, the way that people evaluate relationships and trust within these organizations, differently from the Old Economy.

777 778 779 780 781

154

Pfeffer (1994), p. 24. See Burton-Jones (1999), p. 53. See Bishop et al. (1995), p. 364. See Lewis/Dyer (2002), p. 305. See Lewis/Dyer (2002), p. 305, Lewis/Taylor (1996), and Bailyn et al. (1996).

3.9 The Brazilian Telecommunications Case Study

3.9.1 Privatization Process Following the general policies of liberalization and privatization worldwide, the privatization process of the telecommunications sector in Brazil occurred through the Telecommunications Law of 16.07.97, which created the Brazilian Regulatory Agency, ANATEL (Agencia Nacional de Telecomunicações).782 The privatization of the telecommunications sector in Brazil began in 1998 with the auction of the state monopoly companies. The purpose was to promote a general reform in the infrastructure of communications in the country through the establishment of a new competitive market model with the transference of ownership control from the state to private groups. In this way, new corporate actors acquired the rights to explore commercially defined telecommunications services into defined regions against the duties to develop in its commercial area the basic infra-structure of standard public services. The new Brazilian telecommunications model was based on the principles of competition, universality and quality.783 These principles were committed to diminish the state’s managerial role and to establish a new regulatory model. The objectives were to promote competition and diversification of services and to supply the basic public infra-structure by providing telecommunications services ‘universally’ for the Brazilian population. In order to establish the competitive model, the country was divided into commercial regions and the telecommunications services were basically categorized, for licensees’ purposes, in fixed telecom operators, mobile telecom operators and special services providers (such as Digital TV, Cable TV, special data services, etc.). Traditional state-owned companies (incumbents) sold to private groups faced competition in the market with new ‘entrants’. According to the model, at least two different companies could compete in the same market. Basically two phases were defined in the privatization process. In the first phase of the privatization process, the competitive model considered the entering of other ‘entrant’ companies to start up their activities within the defined regions and therefore competing in the market with the privatized ‘incumbents’. On the one hand, incumbents were responsible for reaching the universality goals stipulated by the government. Incumbent companies were, with their goals, to ‘universalize’ the basic public services by supplying the infrastructure in their licensed regions up to the end of 2003. On the other hand, new ‘entrants’ would invest in their startup infrastructure to compete. The second phase began with the accomplishment of these goals of universality, and thereafter incumbents would be allowed to compete in different regions and explore commercially different services (e.g. fixed telephony and mobile), also including the possibility for conditional fusions and acquisition. In 2003 approximately 41 mobile telecom operators and 11 fixed telecom operators were competing in the Brazilian market according to their regional 782 783

See ANATEL (2000), p. 23. See loc.cit. 155

licensees.784 The origin of the investments in the privatization process came from: Brazil 39%, Spain 18%, Portugal 15%, USA 13% and Italy 9% representing a total volume around US$ 70 billion.785 The increasing demand for basic products, like internet and cell phones, followed the world tendency. In the end of 1998 cell phone lines counted about 7,3 million. In the end of 2003 they counted about 46.3 million.786

3.9.2 The “Painful Modernization” The telecommunications industry in Brazil could be used to illustrate the impact of the New Economy upon human labor conditions. In one of its reports, the International Labor Organization (ILO, 2001) presents a lot of the effects of the New Economy upon human labor. In spite of the overall optimism in the report, it characterizes labor under the New Economy as a balance of potential opportunities amid high risks and uncertainties. The report points out the Brazilian case characterizing it as “painful modernization.”787 According to the report, effects of the New Economy occurred in Brazil accompanied by many controversies, revealing a great reduction of work posts in the ICT industries, the elimination of the traditional national industries, and a great dependence on foreign capital flows. Old state monopoly companies had to adapt quickly to this new model through constant reorganizations, and new companies faced a critical time to set up in this highly competitive market, often ruled by deficient regulations. Such institutional conditions produced significant changes in such companies’ internal environment.

3.9.3 Employment Conditions The employment condition in the new Brazilian telecommunications industry can be characterized by high job uncertainty and instability. It was also characterized by initial great expectations and high employment rates and subsequent layoffs and fluctuations of the work force. Because it was part of the requirements to get licensees to operate in the country, new entrant companies had to hire a certain number of employees according to the contractual statements with the Brazilian Regulatory Agency. Moreover, the incumbents undergoing strong restructuring and reorganization processes with high demand expectations started to hire employees to renew their work force. In 1999 gross revenues from telecom operators in the country increased 57.2 % with great expectations, for example in 2000, Brasil Telecom, a telecom operator controlled by Telecom Italia Group reported 244.7% of sales growth in one year.788 However, after the crisis started in the middle of 2000 and 2001, expectations about the Tele784 785 786 787 788

156

See Gazeta Mercantil (2003), p. 25. See DIESP (2001), p. 44. See ANATEL (2004), p. 9. ILO (2001), pp. 172-173. See Exame (2004), p. 27.

com boom in the country had weakened and telecom operators started to layoff any excess work force. This job fluctuation is well illustrated in the following Table 3-2. Garcia (2004) developed an empirical research in one Brazilian state in order to analyze the employment conditions in the telecommunications sector, after the privatization period. By analyzing eleven telecom operators in the southern region of the country, Garcia (2004) concluded that companies frequently used layoffs and used outsourcings on the restructuring processes. He concludes that the process was noteworthy for significant loss in job supply and high job turnover. However, he noted that, the crucial problem was the loss of job quality and employment conditions.789 Next, we present some data that help us characterize this environment of greater instability and insecurity for work relations in the New Economy. We analyze comparatively the general performance of the telecommunications industry, in relation to work posts variation, personnel rotation (turnover), and investments in training and development, against that of other industries herein characterized as Old Economy (Steelworks, Mining, Petrochemical). Relatively more frequent and greater positive and negative variations in jobs among the industries might be an indication of higher instability and uncertainty levels relative to future employability prospects. Table 3-2 reveals that there was a greater variation in the number of work posts in the telecommunications industry in comparison with the other Old Economy industries. Figure 3-14 (based on Table 3-2) presents a better illustration of the Percentual variation of the work posts.

Table 3-2: Percentual Variation of Work Posts per Industry Year Industry

1998 Posts

Telecom

1999 Posts

152.9

Steelworks Mining Petrochemical

242.3

Var.

2000 Posts

2001

Var.

Posts

2002

Var.

Var.

226.9 -10.56

Posts

Var.

292.7

17.21

70

80.4

12.93

80.2

-0.25

81

0.98

82.7

2.05

189.6

202.7

6.46

196.2

-3.31

205.6

4.57

245.5

16.25

44.9

45.1

0.44

44.7

-0.89

46.2

3.24

55.7

17.05

36.89

255.1 -14.73

Posts

2003

245.8

Source: ANATEL (2003), p. 126, and IBGE (2004). We can notice a general negative variation in all the industries during the period 20002001, characterizing a generalized recession all through the economy. However, in that same period a relatively low variation is noticed in the work posts in the Old Economy industries, when compared to the telecommunications industry. While the Old Economy industries show a relative stability in job supply and a positive tendency in the majority of the

789

See Garcia (2004), p. 796. 157

mentioned periods, except for the recession period – 2000-2001, the telecommunications industry presents significantly greater positive and negative variations.

Figure 3-14: Job Variation per Industry 40

Variation %

30 20 10 0 -10

1998

1999

2000

2001

2002

2003

-20 Year Telecommunications

Steelworks

Mining

Petroquemical

Source: ANATEL (2003) and IBGE (2004).

Immediately after the privatization process of the telecommunications companies in 1998, it was noticed that the industry initiated a process of new contracting, and presented a 36,9% growth in the period 1998-1999, and a 17,22% growth in the consecutive period 1999-2000. In the following period, characterized by recession, 2000-2001, the telecommunications industry presented a considerable loss of 14,73% of the work posts, against losses of only 0,25% in the steelworks industry, 3,31% in the mining industry or 0,89% in the Petrochemical industry. In the period 2001-2002, though the Old Economy industries recovered again showing positive rates, the telecommunications industry again presented a negative rate of 12,43%, only recovering in the following period, 2002-2003, presenting a positive variation of only 7,69%. Such greater labor flow suggests a greater frailty of the sector in face of the market changes, and, consequently greater instability for work conditions. Such variation can be seen in Table 6-2 below, which reveals the rates of employee turnover and investments on personnel training and development per industry. The employee turnover data per industry reveal that, although the telecommunications industry invested amounts similar to or even higher than the other industries in personnel training and development in 2001-2003, its manpower rotation percentual reached much higher levels.

158

Table 3-3: Employee Turnover Rates X Investment in Training and Development Industry Mining, Metallurgy and Steelworks

2002

2003

9.9

10.0

9.6

6.8

8.2

21.4

20.3

18.5

Mining, Metallurgy and Steelworks

1,036

1,250

1,597

Chemical and Petrochemical

1,280

1,377

1,933

Telecommunications

1,395

1,223

1,603

Employee TurnChemical and Petrochemical over (%) Telecommunications Investments in T&D (R$)

2001

7.7

Source: Sextante Brasil (2004).790

Looking at Table 3-3, it is clear that there has been a tendency of greater turnover rates in the telecommunications industry as compared to the other (Old Economy) industries. Nevertheless some other hidden information could be deduced from the table. The employee turnover rates in the telecommunication industry also come with high job turnover. High employee turnover and job turnover rates produce job instability which might have transmitted a perception of greater insecurity to the employees within the telecommunications industry, for the threat of their work contract termination. Such a perspective, therefore, makes it considerably difficult to build implicit contracts based on social mechanisms, like interpersonal trust, which require socialization through a long period of interaction between the individual members of such companies. Apparently, the first look at T&D costs in the telecommunications industry would suggest a possible loss of the investments made on human capital development due to the high costs associated with the high turnover rates. However, for an appropriate evaluation, the cost benefit analysis should be more carefully considered. It has to compare the benefits of investing in social mechanisms, like trust, and with this providing more safeguards to the employees against job termination, to the benefits of acquiring new workers in the market in order to cope with internal demand, maintaining high turnover rates.

790

Formulas: Employee Turnover = (admissions + termination /2 / total workforce)*100(%); Investments in T&D = (Investments in T&D (Headcount) / Total Employees) in R$ (Reais) - Brazilian Currency. 159

4. Empirical Analysis: Hypotheses and Methods

4.1 Condensing Literature into a Basis for Empirical Research In this work we have described how a set of institutional innovations have produced many sources of uncertainties and instability into the business environment of companies operating in the New Economy. We have focused our attention mainly on the companies of the New Telecommunications Industry, a subset of the ICT industries, which have been subject to many restructuring and reorganization processes due to institutional changes such as market liberalization, privatization, increased competition, technological development and diversification, all of these sources of uncertainty. The companies operating in the New Economy in an environment of greater market uncertainty, risk and hard competition include in their routines a constant re-dimensioning of their resources. It has been illustrated that constant reorganization and adaptation require constant redesign, reallocation and contracting of new resources. That also suggests more decentralized, flexible and self-managing organizational forms. Another characteristic that has been pointed out in this work is the critical time factor for the management of a continuous innovation process, and a reduced lifecycle of products and services. In addition, there are great expectations for the increase in demand, including uncertain and irregular demands. Ultimately these trends have affected organizational behavior directly, and, in consequence it has substantially increased behavioral uncertainty and job instability. The nature of the work, work profile and work conditions were characterized as very dissimilar in comparison to the traditional work in the Old Economy. Companies operating in the New Economy were characterized by knowledge-intensive work within network-based organization forms, which give rise to more complex and specialized tasks. It was argued that the traditional mechanisms of performance control, monitoring and measuring may be less appropriate when confronted with the new demands of work activities based on information and intensive knowledge application. We characterized the work profile in such companies as multifunctional, complex and marked by variable routines. A central feature of work in the New Economy is dealing with uncertainty.791 It means that, the uncertainty and the knowledge-intensive nature of the work as the main environmental characteristics, make the work in the New Economy relatively more dependent on implicit motivational incentives rather than on traditional control and regulation to gain the cooperation necessary for unique and more complex tasks. Such a set of characteristics suggests a greater need for implicit contracts as a way of facing a high degree of uncertainty, and consequently, a greater need for relationships based on trust, as a social mechanism of control and motivation in the formation of spontaneous cooperation. It was also acknowledged that trust counts as a decisive control and coordination mechanism as organizations move towards more flexible, decentralized and virtual 791

See Audretsch/Thurik (2001), p. 18. 161

forms (network-based forms). Moreover, changes towards a knowledge-based way of production suggest a greater necessity for trust and employee commitment.792 Delivery of ICT services differs from traditional goods. Products are intangible, customers are actively involved in the production of services and the consumption of services occurs simultaneously with their production. Because employees who deliver these services must engage in selfsupervision, high levels of employee commitment and involvement are needed.793 However, at the same time, our analysis suggests the existence of lower levels of trust in companies operating in the New Economy. As Burton-Jones (1999) well characterized, these institutional changes have created a new job environment in these companies, moving the traditional model of relational contracts to more short-term transactional contracts.794 They are usually companies formed by a younger workforce and marked by high employee turnover rates, due to the constant re-dimensioning of the workforce through layoffs. The prevalence of contingent contracts, flexible work and more frequent use of technology to connect teamwork members, suggests lower levels of trust in these companies.795 The measuring of individual performance is based on more subjective data and marked by ambiguities. This occurs in newly established companies or in companies undergoing a restructuring process, where the development of an effective corporate culture or of a more adequate culture to cope with the challenges of constant changes is not possible.796 It was noticed that aggressive market competition is incorporated into such companies and contributes towards the formation of a greater internal competitive environment. Due to the high number of contingent contracts and network forms of organization these companies experience serious difficulty in obtaining loyalty, dedication or willingness to expend extra effort on behalf of the organization.797 The work rhythm is characterized by long daily hours to the detriment of individual leisure time. Such situations characterize a rupture in the sense of ‘community’ within these companies.798 Even considering possible gains in flexibility, entrepreneurship, and individual empowerment in the work environment, the general conditions of human labor in the New Economy companies tend to present greater problems for the creation of implicit motivation and employee commitment. In this case, pressure for short term results imposes greater stress on the environment, and individual competition and constitutes barriers against the building up of trustbased cooperation relationships. Empirical evidence has already suggested these relation792 793 794 795

796

797 798

162

See Adler (2001), p. 215. See Jackson/Schuler (1996), p. 166. See Burton-Jones (1999), pp. 52-53. For discussions about low levels of trust related to contingent contracts see Pfeffer (1994), p. 24, Cunha (2002), p. 40, and Gallagher (2002), p. 129. See Lautsch (1999), Morishima/Feuille (2000) and Pearce (1993) for contingent contracts associated with lower levels of trust, and Kochan et al. (1994) and Ugboro (2003) for contingent contracts associated with perceived insecurity among permanent workers. See Coutu (1998) and Javenpaa et al. (1998) and Cascio (2002) for low levels of trust related to virtual teams. See Legge (1995), p. 183. According to Legge: “It is impossible to build a strong corporate culture without stability of membership and high turnover (or, perhaps more accurately, low labour stability) undermines the motivation to invest in training and multiskilling.” See Cunha (2002), p. 40, and Argandona (2002), p. 18. See Argandona (2003), pp. 13-15.

ships.799 In this sense, Hardin (2002) claims, “reasons for uncertainty and even doubt at the individual level have an institutional analog. Many institutional deliberations change the views of the participants and, therefore, the collective intention…the inherent problem of inconsistency over time, changing conditions that end or threaten to end an interaction or that radically changes its stakes, and reasonable concealment makes distrust potentially the correct prima facie judgment in many relationships.”800

4.2 Main Hypothesis Following the Rational Choice Theory approach, we take the observations of the New Economy institutional environment to structure our hypotheses. As most of the internal trade among members of organizations is realized by repeated transactions, the thesis takes the perspective of repeated-games to illustrate the changes in relational contracting. When people interact over a period of time, threats and promises concerning the future behavior may influence current behavior and repeated games capture this fact of life. By reducing the probability of future encounters between interactive partners, it also reduces the chances for people to develop trust relationships. The main argument of the present study is that different industry-specific institutional frameworks shift a set of specific parameters for corporate governance which may restrict and alter the ways of governing relational contracts, affecting the levels of trust within companies differently. We believe that companies acting under different industry-specific institutional framework constraints will end up with different capacities to develop trust levels in their hierarchies. More specifically, we argue that under the effects of relative higher uncertainty and instability from industry-specific institutional framework, the companies operating in the New Economy have significant limitations in creating the required elements to develop and sustain trust as an implicit control mechanism (as a managerial device of the corporate governance). We argue that it becomes impossible, or inefficient, to keep these elements necessary for trust development and sustainability, when companies face high institutional uncertainty and instability. In the case of these companies operating in the New Economy, even if trust is highly desirable, limiting factors from an industry-specific institutional framework, constrain the development of trust. Hence, the central hypothesis, which emerges from our investigation, is: Hypothesis 1 (H1): Due to the relatively higher institutional uncertainty and instability, New Economy companies will have a tendency to present lower levels of trust when compared with Old Economy companies.

799 800

Cannon et al. (2000) conclude that uncertainty creates information problems in exchange. Morgan/Hunt (1994) support a negative relationship between trust and uncertainty. Hardin (2002), p. 95. 163

4.3 Secondary Hypotheses Towards a better evaluation of such a scenario, we further propose the analysis of trust as an independent variable, including its relationship with other elements of the management and of organizational behavior. Using the reasoning of game theory, two secondary hypotheses related to the assumptions of the transition from the traditional model of relational contracts to more short-term transactional contracts are formulated.801 With such a perspective, we want to investigate the possible relationship between the levels of trust in such companies with employee commitment (H2) and employee turnover rates (H3). The secondary hypotheses are also considered as validation hypotheses, working to discriminate validity of the study. Both secondary hypotheses illustrate the tendency of a transition from a long-term relational contracting model to a more short-term transactional contracting model. These hypotheses are helpful in obtaining a better description of the possible consequences of institutional changes to relational contracting in the New Economy. By doing so, the primary objective of this work is not to drive our attention to discuss the potential benefits of these elements in the context of the New Economy, but rather to place them in a specific context and analyze their relationship with the trust levels. Beyond that, a better understanding of the relationship between levels of trust and company performance becomes equally important. It places the trust levels within their economic context. This therefore contributes towards a better understanding of the relative efficiency of such an implicit mechanism (see Figure 4.1).

Figure 4-1: The Analysis of the Hypotheses

Trust Levels (H1) Employee Commitment (H2)

Employee Turnover (H3) Market Performance Analysis

This work does not have the aim of creating a direct causal relation between levels of trust and organizational performance. Trust is assumed to be an element of the ‘social capital’ of the firm, as a complementary control mechanism, that might contribute substantially to form spontaneous cooperation, therefore reducing transaction costs. As observed in this work, other variables should be taken into account. However, in order to provide a better comparative analysis, market performance measures will be considered, in order to place the levels of trust within their specific business context. It addresses important issues for future research, for a 801

164

See Burton-Jones (1999), pp. 52-53.

better understanding of the possible influence of trust on organizational performance. According to most theorists and some previous empirical studies which have reported a positive relationship between trust levels and individual and teamwork performance,802 it is expected that trust levels significantly contribute to decrease transaction costs and increase organizational efficiency.

4.3.1 Employee Commitment Employee commitment is a multidimensional variable related to the level of employees’ attachment to the organization, and it assesses the retention of firm-specific human capital. Milgrom and Roberts (1992) observe that, employee commitment results from a set of incentives.803 It is understood that trust is a necessary condition, but on its own not enough to create employee commitment levels, which must be related to other additional incentives such as bonuses and rewards. We understand that interpersonal trust is an intrinsic motivation element that might have a strong positive relation with employee commitment. Employee commitment dimensions assess attachment of individuals to a specific organization, through personal calculative economic costs and benefits, affective-emotional attachments and normative values and norms like standards of reciprocity. Therefore, its dimensions are based not only on calculative self-interest, but also on those incentives which come from interaction within the organization. As it was observed in Section 2.7.2, employee commitment is important because, according to its multidimensional measures, it provides valuable information about different perspectives of employees’ attachment to the organization, like the level of employee willingness to assume organizational objectives, and it provides focus for possible actions. Organizational commitment is considered essential for organizational change and the development of the subject has been intimately connected to the management of cultural change.804 Legge (1995) comments that employee commitment measures are the best predictor of actual labor turnover (motivated by the employee) and it has a strong relationship with employee satisfaction and motivation, and a moderate relationship with performance. According to Audretsch and Thurik (2001), it is not only enterprises that are more turbulent in the New Economy, but also jobs and the commitments between firms and employees.805 Many scholars have related a general concept of loyalty to employee commitment.806 In the economic perspective, Furubotn and Richter (2001) argue that the concept of “loyalty” may

802 803 804 805 806

See Dirk/Ferrin (2001) for many empirical works relating trust to performance. See Milgrom/Roberts (1992), p. 30. See Legge (1995), p.174, and Tosi et al. (1994), p. 259. See Audretsch/Thurik (2001), p. 15. See, for instance, Legge (1995), pp. 180-182, Robbins/Coulter (1999), p. 420, Furubotn/Richter (2001), p. 161, Simon (1991), pp. 34-37. 165

be assessed from a more general perspective of employee commitment.807 As we have observed, the concept of loyalty tends to decrease considerably in the New Economy.808 We observed that the primary benefit of employee commitment is employee retention.809 Employee commitment assesses motives to continue the relationship from the employee’s point of view, the perceptions that he/she has of the probability that there will be a dissolution of the relationship in the near future. It is expected that when employees perceive that their relationship with the company will probably terminate in the short term, they will behave differently than those that anticipate a long-term relationship. Therefore, the propensity to leave, resulting from the level of employee commitment, is an outcome variable with performance implications.810 Employee commitment measures provide some relevant perspectives for incentive scheme design and evaluation of returns from investments in human capital, when comparing the Old Economy and the New Economy companies. Based on the evidence discussed in Section 2.7.2, trust affects employee commitment; and therefore we expect to find a positive relationship between employee commitment and trust levels. Therefore: Hypothesis 2 (H2): Levels of trust will be positively related to employee commitment levels. Thus, New Economy companies, when compared to the Old Economy companies, will present lower levels of employee commitment. In this work we use the employee commitment measures from Meyer and Allen (1997). They use the perspective of attitudinal commitment which assumes calculative motivations in exchange for valued organizational rewards, for staying with the organization.811 The basic assumption is that attitudes are prior to and influence behavior. Their scales access employee commitment in three dimensions: affective commitment – based on emotional attachments to the organization; it involves the idea of wanting to remain in the organization having experienced membership positively; continuance commitment – based on calculative reasoning as a decision to remain with the organization because of the costs of leaving; it involves personal investment in the relationship with the organization and lack of alternative employment opportunities; normative commitment - based on normative bases as the sense of obligation to continue with the organization for the sake of loyalty; it refers to the feeling that one ought to remain with the organization because of personal norms and values. McGee/Ford (1987), building on this work note that continuance commitment has two separate components, one concerned with sunk costs and the other with a lack of alternatives. According to Guest (1992), affective commitment is linked to effort while continuance commitment is linked to 807 808 809 810

811

166

Furubotn/Richter (2001), p.161, for the authors: “loyalty can be understood as the identification of an individual with corporate goals; and feelings and emotions are involved in such association.” See, for instance, Pfeffer (1994), p. 24, Cunha (2002), p. 40, and Argandona (2002), p. 18. See Meyer/Allen (1997), p. 15. See Legge (1995), p. 183. According to Legge, empirical evidence shows that there is a strong positive relationship between commitment and employee motivation and satisfaction, and a negative relationship between commitment and turnover. Commitment is an important predictor of intention to quit. Therefore, the author states that commitment is the best predictor of labor turnover. See Legge (1995), p. 181.

labor turnover (motivated by employees). Moreover, continuance commitment is a precondition to build any strong corporate culture.812 Ugboro (2003) found a strong relationship between trust and commitment, especially with affective commitment. He found that downsizing reduces affective commitment and increases job insecurity. Ashford et al. (1989) found a strong negative correlation between commitment and job insecurity.

4.3.2 Employee Turnover Rates According to Audretsch and Thurik (2001), the degree of uncertainty and turnover experienced by workers in the New Economy mirrors the great turbulence experienced by firms. Replacing long-term fixed contracts with new flexible forms of work contracts (contingent), provides the essential vehicle driving the transition from the Old Economy to the New Economy.813 Whereas in the Old Economy, company contracts tend to be for general tasks and for a long period of time, in the New Economy contracts have become targeted towards specific tasks and for a short period. It is observed by Robbins (2002) and Tosi et al. (1994) that business environments under high market and technological volatility, are more susceptible to downward swings, which are often accompanied by permanent reductions in the work force, temporary layoffs, reduced pay, shorter workweeks, and the like.814 Therefore, in this study employee turnover rate is used as a validation hypothesis to confirm environmental volatility. According to Abelson (1996), there is a strong indirect relationship between employee commitment and employee turnover, and uncertainty surrounding the job environment and employee turnover.815 He states: “the more uncertainty people experience, the more uncomfortable the situation….satisfaction, uncertainty and commitment are consistently related to movement through the turnover process.”816 Axelrod (1984) observes that turnover might be a problem in promoting cooperation within organizations.817 Turnover costs are associated with the compensation system and decisions about contracting new workers and maintaining old workers and include the costs of recruiting, training, and reduced productivity from employing inexperienced employees.818 Lazear (1998) argues that there is no unambiguous statement that can be made. However, some factors might influence the optimal ratio of younger and older workers. As in for example, an industry with rapid technological change because technology is often embodied in the new entrants, and also when the amount of skills learned on the job is low relative to the amount

812 813 814 815 816 817 818

See Legge (1995), p. 181. Audretsch/Thurik (2001), p. 15. See Robbins (2002), p. 613, and Tosi et al. (1994), p. 42. See Abelson (1996), p. 530, and Legge (1995), p. 183, who comments that longitudinal research studies show an indirect link between commitment and turnover. See Abelson (1996), p. 530. See Axelrod (1984), p. 183. See Brickley et al. (2001), p. 346, Milgrom/Roberts (1992), pp. 344-348, and Lazear (1998), pp. 169-172. 167

learned in formal programs before entering the labor force.819 On the other hand, if employees expect to work for the firm for only a short time, they are less likely to be concerned about how their actions affect the long-term cash flows of the firm.820 In other words, short-term perspectives to maintain the job might permit opportunistic behavior. When dissatisfaction spreads to the organization itself, individuals are more likely to consider resigning.821 Van den Steen (2003) observes that employee turnover weakens organizational culture since new employees do not possess the same information as the old ones.822 The issue that emerges from this is the acceptance that in some organizational contexts it can be more profitable to sustain short-term employment contracts and high turnover rates. The expected positive benefits for sustaining high turnover rates should overcome those positive benefits of long-term contracts in which social mechanisms like trust are more likely to be developed. Research evidence has demonstrated negative relationships between organizational commitment and both absenteeism and turnover,823 and also between trust and turnover intentions.824 As observed, due to a particular framework characteristic, companies operating in the New Economy have been working under constant uncertainty. Environmental uncertainty about outcome, performance and job retention might be not only the cause of high job stress and instability, but also, as we focus on this work, the cause of weaknesses in trust relationships. According to Hardin (2002) the chief enemy of keeping trust relationships is the collapse of ongoing interactions in face of anything that might disrupt it. He claims: “sudden escalations of the stakes that lets one or the other of us treat the next round of our interaction as though it were part of new, perhaps only one-shot, interaction.”825 This is well illustrated in game theory, according to the repeated-game approach, if you understand my long-term selfinterest; you might trust me not to yield to certain short-term temptations. However, cooperation is difficult to sustain when the game is not repeated or there is a great probability of an end game. Rather than discuss whether employee turnover is advantageous or disadvantageous to the companies acting in the New Economy, based on the perspective of contract termination, we argue that high employee turnover rates sustain perspectives of employment relationship termination (from the employees’ point of view) and it negatively influences the levels of trust within the firm. Therefore:

819 820 821 822 823 824 825

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See Lazear (1998), p. 172. See Brickley et al. (2001), p. 346. See Robbins (2002), p. 186. See Van den Steen (2003), pp. 15-16. See, for instance, Hom et al. (1979), Angle/Perry (1983), and Pierce/Dunham (1987). See, for instance, Albrecht/Travaglione (2003), and Aryee et al. (2002). Hardin (2002), p. 145.

Hypothesis 3 (H3): Employee turnover rates influence and will be negatively related to levels of trust. Thus, New Economy companies, when compared to the Old Economy companies, will present higher levels of employee turnover rates.

4.4 The Organizations Used for the Study As the research hypotheses are introduced, the following Sections will present the research methods of testing these hypotheses. This is a cross-industrial comparison study between classified and validated groups of companies. Trust and other considered organizational elements in this study were observed primarily as dependent variables. The research tools chosen for this study were: 1) A Questionnaire survey; 2) Public and private data from organizations; 3) Interviews with companies’ managers; 4) Interviews with experts. A group of seven Brazilian companies, drawn from five different industries participated in the empirical survey called “Trust Inventory Project - Brazil”, which took place in the four states of the Brazilian Southeast Region: Sao Paulo, Rio de Janeiro, Minas Gerais and Espírito Santo. The questionnaires distribution-collection process and the interviews with the top managers took place in the period from the 15 July to 12 October 2004. The period from the 16 July to 7 August 2004 was reserved mainly for discussions between the research team and all participant companies about specific details of the research project. At least three days from 9 August to 8 October were allocated by each participant company for the questionnaire distribution-collection process. One or two days between August 15th and October 8th of 2004 were allocated by participant companies for interviews with HR and Market Strategy and/or Planning Directors, or equivalent posts in each participant company. This chapter is divided into three sections. Section 4.4 briefly describes the study organizations and the research process. Section 4.5 refers to the validation of the company grouping proposed by this study. Section 4.6 refers to the validation of the questionnaire.

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4.4.1 Description of the Organizations Studied Brief descriptions as well as the research process within the studied organizations are presented in this section. The objective was to put them into representative groups of companies operating in the New Economy and companies operating in the Old Economy. The criteria used for selecting, prospecting and grouping the studied companies was based on a review of the literature, interviews with specialists in the market and companies’ public and private data analysis. 1) Telecom 1 – Telecom 1 is considered one of the largest Brazilian telecommunications companies by gross revenue and the number of landlines in service. It started its activities in April 1999, one year after the privatization of the telecommunications industry in Brazil in 1998. The company provides traditional local telephone services, videoconference, image, internet, and data transmitting (data services). Its network and geographic presence covers 20 states with approximately 8,300 direct employees and some 11,000 other non direct employees (outsourcing). The research took place in the city of Rio de Janeiro where the company’s headquarters are located. It was chosen to distribute questionnaires only in the central building of the company where most of its city- based employees are located and considered the main company’s main site. Interviews with the Strategic Planning and HR Directors took place on two different days scheduled according to their agendas. The research team spent 5 days completing the questionnaire distribution-collection process. In total 380 questionnaires were distributed in an eight-floor building and 241 were collected. The research team distributed the questionnaires to each location and floor of the site and went back to these same places to collect them some time later. At least one member of the research team was available during the entire day to provide information and to support the collecting process.826 2) Telecom 2 – Telecom 2 is one of the largest cellular telephone operators both in the Southern Hemisphere and in the world, with over 24 million customers in Brazil.827 The company provides voice and data transmission services. It is a joint venture and started its activities in April 2003. The company is present in many locations, in 19 different Brazilian states, which represent 86% of the Brazilian territory. It was formed by the merger of two companies during the privatization period (1998) acting in the two biggest regional markets for cellular telephony. The Company’s headquarters are located in the city of Sao Paulo. Two main sites one in Sao Paulo and the other in Rio de Janeiro were chosen as the object of the research. 380 questionnaires were distributed and 316 collected by the research team. The research team distributed the questionnaires to each location and floor of each building of the company from the two sites and went back to the same places to collect them some time later. The entire questionnaire distribution process took 6 days. At least one member of the research team was available at the company during the entire day to provide the necessary support. Inter826 827

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The standard procedures to distribute and collect questionnaires are described in the Section 5.2. Data provided by Telecom 2.

views with the HR Director and the Strategic Planning Director took place in Sao Paulo on one day. 3) Telecom 3 – Telecom 3 is a telecommunications company providing services for the long distance call market, and for data services for business and residential markets in Brazil. The company started its activities in Brazil in January 2000 two years after the privatization of the telecom sector in the country. The company’s activities cover 15 states of the country and its headquarters is located in Rio de Janeiro. The questionnaires were distributed and collected in two main sites of the company: the headquarters in Rio de Janeiro and the site located in Sao Paulo. In total, 340 questionnaires were distributed and 246 were collected from those sites. The research team distributed the questionnaires at each location and floor of each building of the company from the two sites and went back to these same places to collect them some time later. The questionnaire distribution process took 4 days. At least one member of the research team was available during the entire day to provide any necessary support. A special room was offered by the company for the research team to work in. Interviews with the Strategic Planning and HR Directors took place on two days. 4) Steelworks – A steelwork company located in Vitoria, Espirito Santo State. It has just one site where its Headquarters are located with all administrative and operational staff. The company produces two basic semi-finished products for re-rolling into flat products with various different applications such as the automobile industry, steel structures and oil pipelines, having as main raw materials iron ore and coal. For the distribution and collection of questionnaires it was necessary to work to a specific plan. Some specific procedures were adopted according to the company’s routine concerning the collection of questionnaires from the operational staff. The research team, HR people and a representative of each operational area from different shifts met in order to design the best plan to inform employees about research purposes and benefits, distribution and collection of questionnaires, assuring that employees would feel informed and comfortable enough to express their feelings and to cooperate with the research. Because the company’s activities are classified as ‘high risk level’, formal safety standards would not allow the research team to have free access to all different locations in the operational areas in order to collect the questionnaires. Therefore, employees were asked to return their questionnaires personally to the research team in the central location where the research team was allowed to stay on days scheduled with the company. The distribution process took 9 days. Altogether, 350 questionnaires were distributed and 302 were collected. Interviews with the HR director and the Strategic Planning Director took place during two days. 5) Mining – A mining company with its main industrial activities located in the Espirito Santo State. It has three basic sites, the headquarters in Belo Horizonte city, in Minas Gerais State with some industrial units in some municipalities, and in Anchieta city, in Espirito Santo State. The Company’s headquarters and main office are located in Belo Horizonte with most

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of the administrative staff and a part of the operational staff. A part of the administrative staff and most of the operational staff are located in Espirito Santo State (location of pelletizing and port facilities). The company also has an office in Vitoria for handling foreign trade and exchange operations, in addition to sales offices in Amsterdam and Hong Kong. The concentrated iron ore is sent from the industrial units in Minas Gerais State to the Anchieta Unit along a 396 km pipeline. The company produces two basic products: pellet feed and sinter feed. Because there is also a ‘high risk level’ of company safety, the research team was not allowed in all operational locations, the method described to distribute and collect questionnaires in the previous company was also applied to this Mining company. Two company sites were chosen to distribute and collect questionnaires, the headquarters in Belo Horizonte and the industrial site in the municipality of Anchieta. For the administrative staff located in the headquarters, in Belo Horizonte, the research team adopted the normal standard procedure to distribute and collect questionnaires. In this case the research team distributed the questionnaire to each location of the site and went back to the same places to collect them some time later. In the industrial area of Anchieta, the employees were asked to return their questionnaires personally to the research team in the central location where the research team was allowed to stay on the days scheduled with the company. The distribution process took 7 days. Altogether, 220 questionnaires were distributed and 158 were collected. Interviews with the HR director and the Strategic Planning Director took place on two days. 6) Petrochemical – The largest synthetic rubber manufacturer in Latin America828, the company has three industrial plants located in three different Brazilian Sates. The company’s headquarters are located in Duque de Caxias, Rio de Janeiro State along with one of its industrial plants. The company produces synthetic rubber as its basic product. The research team chose to distribute and collect questionnaires at the main site of Duque de Caxias, Rio de Janeiro State, therefore, administrative and operational staff were covered by the research team. In the main building the research team distributed the questionnaires to each location, floor, and building of the company and went back to the same places to collect them some time later. At least one member of the research team was available during the entire day to provide all the necessary support. The research team had access to the industrial area and was always accompanied by an HR member. It was possible to cover different employee teams shifts and the administrative staff for 6 days. Altogether, 240 questionnaires were distributed and 191 were collected. Interviews with the HR director and the Strategic Planning Director took place on one day. 7) Media – The main Media company of Espirito Santo State, operating media channels: TV, Radio and Newspapers. The company covers only Espirito Santo State. It has four sites in different municipalities of that State and it´s headquarters are located in the capital, Vitoria. One mini-auditorium inside the company (an easy access central location) with 50 seats was 828

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Data provided by Petrochemical.

reserved during three days and groups of employees were invited in advance by HR staff to go there at different times of the day in order to fill out the questionnaire. Additionally, the research team went to some locations of difficult access because the employee’s routine would not allow them to be in the auditorium (like the call center). In this case the research team distributed the questionnaire to each location and floor of the site and went back to the same places to collect them some time later. At least one member of the research team was available at the company during the entire day to provide all the necessary support. Altogether, 230 questionnaires were distributed and 189 were collected. Interviews with the HR director and the Strategic Planning Director took place on two days.

4.4.2 Criteria for Classification of the Study Organizations The criteria for choosing the companies studied here took into account four relevant features defined according to the literature review and empirical observation of the reality of those organizations as it concerned the research problem. The classification of the studied companies, was made according to features selected in line with the reasoning of the thesis, based on the previous definitions of the New Economy in this study. The first criterion refers solely to the industrial segment. The other criteria are aligned with some industry-specific characteristics. We classified companies by observing the impact of technological innovations on the industry through their effects on estimated demand (expectation of permanence of future demand for the products), the relevance of technological innovation and intensity of competition, and the relevance of diversification of production systems and products for the company’s survival in the market. It was possible to identify some of these relevant aspects from the data collected from the companies used for the validation of the companies grouping (See the following Section 4.5). Therefore, the proposed classification that served as a basis for the classification of the companies studied here was: 1) The industrial segment 2) The nature of the productive process 3) The dependence on technological innovation 4) The market volatility

1) By the Industrial Segment we understand: The New Economy companies were primarily classified as producers, providers or network operators of ICT services – namely the companies of the ICT industry. As observed in the literature review (Chapter 3) the New Economy companies have a historical role in the evolution of information and communication technologies. However, as we also pointed out, the New Economy and the traditional manufacturing industrial economy, namely the Old Econo173

my are not mutually exclusive. Therefore, the New Economy affects the economy as a whole in different degrees (See Section 3.6). Considering this feature, Old Economy companies are those companies which use ICT services as means of production, but not as an end.

2) By the nature of productive process we understand: We are looking at the productive process according to the impact of the estimated future demand on the stability of organizational design, division of functions, and the definition of professionals’ functions. This feature is related to the intensity of external changes and the need for reorganization and flexible organizational and labor structures. In industries we define as Old Economy, such as steelworks, mining and synthetic rubber, when the expectation that demand will persist for 20 years is considered very high. The transformation of the productive methods and production systems is relatively slow, and although the usage of new technologies in these industries might be intense, technology here is a means to production and not an end. The companies do not sell technology. The relatively slow changes to estimated demands in these industries allow for a continuous and incremental improvement process with education of the labor force to keep up with innovations. Technological development follows incremental trajectories and it happens mainly within the R&D laboratories of those companies. As productive processes are relatively stable and demands are relatively predictable it allows for long term planning. On the other hand, in industries we define as New Economy,such as the ICT companies, it is impossible to estimate for how long a product will remain on the market. Sudden technological breakthroughs may make an entire line of products obsolete, for which there will be no further demand. Therefore, productive processes tend to change rapidly, and the need for high flexibility prevents the development of more stable organizational structures. Professional roles and functions are not clearly definable, and professionals are expected to construct their role as they employ their knowledge in the development of new products, services or processes. Innovation and knowledge are fundamental for survival and competitiveness, and technology development is not a means to an end, but the end in itself. In this case, it might be necessary to completely change workers in the case of new technology acquisition. Knowledge is a form of asset, a specific investment made by the worker (for instance, on a change from analogical to digital technology, or more recently on a change from traditional telephony to IP telephony - the cost of retraining the labor force and the time it would demand to train workers is an incentive for the company to prefer substitution). Labor contracts tend to be more transactional, varying according to each project or the current technology. In the case of the Old Economy, this relation is inverted. Since technological development follows incremental trajectories the labor force tends to become the best specialist in the technology the company utilizes (this is the case of operators in chemical and petrochemical industries, for instance), and the company depends heavily on the ability to retain labor to function properly.

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It allows the existence of some HR policies like career planning and long term labor contracts (see Section 4.5.5).

3) By dependence on technological innovation we understand: This feature refers to the need for intensive and continuous processes of innovation through the application of knowledge as the key factor of production in the New Economy companies. In the Old Economy companies, although they might have a frequent application of knowledge in the production processes, it is not as susceptible to sudden loss of competitiveness, due to technological innovation as it is in the New Economy. Therefore, companies are evaluated by their dependence on this intensive and continuous technological innovation processes. Due to high competition and fast technological obsolescence, the prevalent work dynamics within New Economy companies where the survival of the organizations depends heavily on technological innovation is focused on the development and/or enhancement of information technologies. This dependence on technological innovation inbuilt with the ordinary tasks was illustrated in Section 3.5.3. Castells (1996/2000) describes the work dynamics that notably characterize and distinguish an economy based on information - informationalism, from industrialism as “the action of knowledge upon knowledge itself as the main source of productivity. Information processing is focused on improving the technology of information processing as a source of productivity, in a virtuous circle of interaction between the knowledge sources of technology and the application of technology to improve knowledge generation and information processing.”829 This dynamic happens more intensively in those ICT industries where technology is the product and not merely the means to produce something else. On the contrary, the Old Economy companies are here characterized by the relatively major role of those other productive factors of industrialism. Therefore, the Old Economy group of companies is strongly characterized as capital or labor-intensive industry. It means productive processes that require large sums of financial resources (capital), or large number of workers to produce particular goods. Old Economy companies are traditionally characterized by industrial plant and assembly lines, having their economic activities strongly related to economy of scale and/or mass production systems. Classical examples of capital intensive industries are the oil refining business, automobile industry, steelworks and metalmechanical industry. Classical examples of labor intensive industries are the textile industry, agriculture and restaurants. In these cases, the dependence of technological innovation is relatively low. Technology follows incremental developments as continuous trajectories over existent technological paths (see Section 3.3.2). In many cases, these companies have technological developments concentrated in R&D as supporting units, or they may even eventually outsource the acquisition of new technologies from external research centers, according to

829

Castells (1996/2000), p. 17. 175

their productive processes and market needs which eventually follow relatively slow breakthroughs.

4) By market volatility we understand: Market uncertainties caused by the threat of technological substitution, in combination with a high competitive model. In this case, uncertainty in relation to future demand and competition are heavily dependent on technological obsolescence. The market position of these companies is driven mainly by the possibilities of radical change to the equilibrium between the players, due to the capacity to innovate and/or stimulate new demands through the creation or enhancement of new technologies. In this sense, market volatility is highly dependent on technological volatility (see Section 3.5.1). The effects of market volatility are illustrated in the fast change of relative prices stimulated by intense competition and technological obsolescence (see Section 3.3.3). In the New Economy, products present shorter life-cycles and are the subjects of constant substitution or significant improvements. In addition to the threat of technological substitution, the industrial competitive model stimulates market volatility. For example, competitive models based on newly established companies (entrants) and privatized-reorganized companies (incumbents) have fostered high competition, as in the case of the new telecommunications industry. Therefore, New Economy companies struggling in a highly competitive market and looking for competitive advantages through technological innovation are subject to constant reorganization. On the contrary, Old Economy companies present relatively lower market volatility due to the combination of relatively slower technological change and stable demand, which allows relatively slower product change or improvement and less need for reorganization and internal adaptations due to environmental changes.

Table 4-1: Classification of the Organizations Studied Industry

Company Name in the Study

New Economy Telecommunications

Telecom 1

Telecommunications

Telecom 2

Telecommunications

Telecom 3

Old Economy Mining

Mining

Steelworks

Steelworks

Petrochemical

Petrochemical

Alternative Media

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Media

Therefore, according to the abovementioned features and based on empirical observation of the reality of those organizations, the above seven study companies were classified into three different groups: three New Economy representative companies were represented by the three telecommunications companies (Telecom 1, Telecom 2 and Telecom 3); three Old Economy representative companies were represented by Steelworks, Mining and Petrochemical. The Media company, bringing a different set of organizational features and profile, was classified alternatively. As it was not classified in these previous two groups we called this company “Alternative”. In several aspects, as presented in the following Section 4.5, the grouping comparison was confirmed through significant differences between the companies’ profile. Therefore, our classification is the following: As observed in Chapter 3 of the literature review, the New Economy group of companies was strongly characterized through ICT service producers, providers and/or network operators, namely, in this study, the new telecommunications companies. As observed in Section 3.6.3, the New Telecommunications Industry brings not only telecom services and equipment, but, due to the development, convergence and commercial concentration of distinct technologies, it also aggregates computers, software, semiconductors, the Internet, e-commerce and some of the media. Due to the highly unstable and uncertain demand, repeated technological spillovers and high competition, these companies have been characterized in this study mainly as intensive and continuous innovation driven companies. This condition is fully met by the ‘menu’ of products of these companies. ICT products are commonly built on different and/or convergent technologies. Even within a single telecom company, alternative technologies may compete, complement or substitute one another through the market selection mechanism. In this sense, it might be efficient to create the market mechanism within a single telecom company. For these companies, profitability is achieved mostly through value-added services (VAS). It calls for the condition of continuous innovative products and processes. On the contrary, the Old Economy group of companies is strongly characterized as capital or labor-intensive. It means a chief role for productive factors that require large sums of financial resources or workers to produce a particular product.830 These companies have their economic activities related mostly to economies of scale and mass production systems. They produce ‘commodities’ for the market. Although they might frequently use knowledge application in their production processes, it is solely an additional input among others. As observed in Chapter 3 (Section 3.3.2), in the Old Economy, technological innovations are developed through a cumulative process within the R&D laboratories of large-size incumbent firms, which tend to generate routines of incremental technological improvements over existent technologies. In contrast, the New Economy has fostered new technological innovations through the development of diversified and competing technologies, internally or externally to the boundaries of firms, that ultimately are submitted to the market selection mechanism. Old Economy compa830

See The New Economy Index (1998), p. 20. 177

nies have relatively stable demand and few changes in standardized products. Their production systems, core technologies and products traditionally exchanged in the market suffer relatively few technological changes; therefore technological innovation and R&D play a relatively small role. Technological innovations and improvements occur more linearly in a continuous technological development process within the company’s R&D units and these companies operate in the market for a relatively long time. As we defined in Chapter 3, the essential difference between the companies chosen to represent the New Economy and those of the Old Economy is the fragility facing technological changes and the ruptures it might create, jeopardizing the survival of such organizations (see Section 3.3.2.). For instance, steelworks, mining and petrochemical companies, though under increasing pressure for competition based on the application of knowledge, suffer slower and smoother breaks from the fact that their products can count on relatively stable demand. The same does not occur in the New Telecommunications Industry companies, where the appearance of technological innovations can definitely eliminate, by substitution, such companies from the market. These differences among industries are related to the intensity and dependency of the innovative activity. Alternatively, the Media company was used for discriminating validity analysis. It was chosen because it did not fit the established criteria for Old/New economy, and it was important to see how the results would behave in an alternative perspective. It was done by observing relevant aspects of this company that show a mixed set of features from the two previous proposed groups, the media industry therefore being considered a perfect hybrid type. The critical production factor here is not knowledge application to foster technological innovation, as in the case of the New Economy groups of companies, it is specifically labor (Human Capital). Concerning the first feature, the Media company is not a producer, provider or network operator, but a high consumer of ICT services. Although it could not be classified in the New Economy group of companies, at the same time, it is not an Old Economy company from a traditional industry because it has different means of production and products, combining an intense use of new mass ICT technologies, like the Internet and TV broadcasting with old mass technologies, like newspapers and radio transmissions. The Media company is therefore highly sensitive to technological breakthroughs (a noteworthy characteristic of the New Economy). The frequency of technological change, the intensity of technological innovation and the frequency of change in the production systems which notably characterize the New Economy companies, have considerable importance for the Media company’s survival, considerably more than they do for the companies classified into the Old Economy group. In this sense, the threat of technological substitution exists for the Media company as it represents a precondition for competitive advantage. This happens because the means of production (informational channel) is inbuilt in the product. Therefore, the threat of technological substitution does not lie in the technology itself as a product, but in the greater impact and relevance that its commercial usage has as an information channel for the company. We note that, although the Media company does not have ICT as a final product, in some cases, the introduction of a 178

new ICT technology might be as threatening for it as it is for the New Economy group of companies. Its assimilation and use by the Media company is a precondition for competition in the market, more than any other company of the Old Economy group. Additionally, another factor that demonstrates the dissimilarities (highlighted in the data collected from the Media company) is related to product and service diversification. It is not possible to define the exact number of products and services provided through all communications channels and their frequency of change, because there are too many with frequent changes not precisely quantifiable by the company. It would ultimately define a strong characteristic of the companies of the New Economy group as can be observed in Table 5-3 (product diversification). Its “product” – that is, information, can count on a reasonably stable or maybe continuously growing demand, a feature of the Old Economy, but the means through which it is provided may change according to the technological paradigm, a feature of the New Economy. That is to say, the alternative channels of distribution are heavily dependent on ICT services. The existence of relative demand uncertainty, concerns the adoption of new channels of communication based on ICT services as alternative media channels (for instance, new communication channels, like Interactive TV, Digital TV and Internet were not exploited or not fully exploited by the company as alternative means of communication – there is actual uncertainty regarding investments in the potential use of these channels as alternatives - the same uncertainty that ICT companies have in estimating future demands and investing in the development and maintenance of these new technologies commercially). Therefore, according to interviews with the company’s managers, uncertainty is also related to a certain dependence on technological innovations which might possibly create future demand for alternative means of information, which are noteworthy features of the New Economy. Uncertainties also surround another critical factor in competition, that is, the gains of scale through geographical coverage. Considering the limited geographical scope for its commercial activities, alternative means of communication for distributing information is a critical factor for a company’s survival that might have the potential to create new products and future demands as alternative means of profit making. Finally, its inclusion in the ‘Alternative’ group was remarkably confirmed by the expert ranking in the validation of companies grouping. Both experts left this company out of the classification of the previous two company groups (See Section 4.5.1). We considered, therefore, the media industry as a perfect hybrid type.

4.5 Validation of the Companies’ Grouping After classifying the seven organizations into three different groups, based on the features above mentioned, the classification was validated through interviews with experts and data analysis of the companies. In Section 3.9 we have already presented some validating empirical data that emphasizes differences between the industries considered in this study. Tables 32 and 3-3 show respectively the relatively greater job instability and uncertainty in the New

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Economy companies group through the analysis of the percentile variation of jobs per industry and the employee turnover rates and investment in HR training and development per industry (see Section 3.9.3). However, aligned with the literature review, the data collected from the interviews with experts and company managers, and public and private data from the study companies, also provided sufficient support to characterize the company group. Another additional factor used in the classification was also the companies’ demographic profile in the following Section 4.6.10 (Demographic Distribution of Respondents). Public data were provided by companies or obtained through public sources, like websites and the company’s annual balance sheet publications to evaluate a companies’ profile, and financial and market performance. Additionally, the interviews with the companies’ managers also show the intensity of some organizational elements distinguishing different profiles between the proposed groupings, like different production systems, organizational structures and management styles. These interviews were done with the managers responsible for market and planning activities (commercial, marketing or planning directors or vice-presidents) and HR activities (HR directors or HR vice-presidents). In some companies where these areas were too structurally divided, interviews were done with more than two managers. It provided us with a perspective of the market dynamics, planning activities and HR policies adopted by these companies to deal with their business environment. Some objective questions asked in those interviews are summarized in the following tables. Most of the questions were formulated for respondents to classify their answers within a Likert scale from 5 (representing high intensity, frequency or likelihood) to 1 (representing low intensity, frequency or likelihood). The following subsections present a summary of some aspects of these companies which show several distinctions between the companies operating in the New Economy group and the companies operating in the Old Economy group. As observed, the Media company was not classified in these main groups and was used to discriminate validity. In many observations, whilst New Economy and Old Economy companies have many organizational elements in common, the Media company has a mixed profile, presenting those organizational elements in a singular way, not clearly classifiable within those two previous groups. Therefore, the Media company was classified as a perfect hybrid system. Its singularities are described in the following sub sections.

4.5.1 Interviews with Experts In order to validate our classification, we conducted interviews with two experts in Brazil. These people had some previous knowledge about these organizations; they were a professor of the Federal University of Rio de Janeiro, School of Economics, researching the New Economy, and a business manager from ARX Capital, a Brazilian investment management firm, graduated in Economics with an MBA from the University of Chicago. After introducing the research subject and objectives we presented the list of the study companies asking them to 180

freely classify the companies into two different groups: New Economy and Old Economy. Both ranked those companies with the three telecommunications companies in the New Economy group, and Mining, Steelworks and Petrochemical as Old Economy company group. The Media company was not clearly classified by either interviewee. Another two-hour interview was conducted with Mr. Luis Guilherme Schymura, ex-CEO of ANATEL, the Brazilian Telecommunications Regulatory Agency. The objective was to understand and validate the market environment and its singularities around the new telecommunications industry. Mr. Schymura confirmed a high degree of regulation uncertainty due to the recent privatization process, not only in Brazil, but also around the world. According to Mr. Schymura, the telecom business environment is the subject of interest of many players: government, private sector and society. He thinks that the new telecommunications industry provides the physical means for the globalization process; through technological development it provides the basic infrastructure for many other economies, fostering local and international competition in other industries. Regulation is an ongoing process and it contributes to create a highly uncertain and challenging business environment for these companies. According to Mr. Schymura the new telecommunications industry is distinct in many aspects, and the HR aspect is probably one of the most changeable. He also confirmed the new telecommunications industry as the principal agents of the New Economy.

4.5.2 General Profile of Organizations The organizations’ general profile helps us characterize the nature of the economic activities of these groups of companies. The New Economy group of companies, as presented in Chapter 3, has a strong representation of ICT service producers, providers and network operators (new telecommunications companies). These companies were characterized in this study mainly as intensive and continuous innovation driven companies, not exclusively due to the relatively major role of the innovation activity, but mainly due to the degree of dependence they have on technological innovations. As ICT services providers, they produce and provide mass or corporate ICT services for millions of customers. Therefore the relationship with these customers varies between personal and impersonal; usually, in order to provide mass ICT services (like Cellular Telephony, traditional Telephony, or Internet access), and is often established from call centers, segmented by volume of consumption, customer’s size and nature (individual or corporate, government or private). However, with other customer segments like government and corporate customers, these relationships become more personal. High competition and technological innovation impose intensive marketing and commercial activities. Contrary to this, the Old Economy group of companies are strongly characterized as capital/labor-intensive companies based on economy of scale and mass production systems. These companies have few, but important, corporate customers. Most international corporate customers and their relation181

ships have been established over a long period of time. They usually have long term contracts with their customers and their corporate activities are focused on production and operation improvements. Products are ‘commodities’, traditionally commercialized in the market (like steel, synthetic rubber or iron ore) and product changes are sporadic. Alternatively, the Media company has diversified customer segmentation with millions of customers, but only a few customers are responsible for the company’s survival.831 Through the use of these ICT infrastructures the Media company provides information services by using mass means of communication (TV channel, Internet, Newspaper and Radio) within one Brazilian state. Table 4-2 shows a general view of the studied organizations. Confirming the bibliography, the media company reveals relevant differences in the classification of the nature of market activities, companies’ lifespan, geographical dispersion of physical sites and geographical scope of activities. The lifespan of the companies shows a difference between the new telecommunications companies that started up through the recent privatization process in Brazil, in 1998, and other Old Economy companies. Due to the typical nature of their economic activities, the New Economy companies (telecommunications) are characterized by many physical sites distributed all over the country and through many representations in different states (network operations) while the Old Economy companies are often concentrated in a few industrial sites. Moreover, average customer retention, noted as numbers of years in New Economy companies, is relatively low when compared to the companies operating in the Old Economy. It has already been observed in Chapter 3 that in the New Economy, product innovation and competition play both a short term and a more significant role, marketing and commercial activities therefore tending to be crucial for a company’s survival in the face of external market events. The Media company presents a mixed profile. It has a long lifetime (76 years old). Its activities are concentrated in just one physical site within one restricted geographical area. However, the number of customers is difficult to define as well as average customer retention. As a mass communication company (TV channel, Newspaper and Radio) it might vary from millions of people as consumers of Radio and TV channel provider to a few but important customers (advertising purposes) that are frequent users of those communications means. The government is considered the most important customer for the company’s survival.

831

182

Data provided by Media company.

Table 4-2: General Profile Main Market Activity

Geographical Scope of Activities

Years of Activities832

Number of Employees

Telecom 1

Basic and Value Added Telecom Services - local fixed network operator

20 Brazilian States

4.5

8318

21

15 million retail and 10,000 corporate

3y to 6y

Telecom 2

Basic and Value Added Telecom Services - mobile network operator

19 Brazilian States

2

6360

20

24 million retail and 4,000 corporate

3y6m

Telecom 3

Basic and Value Added Telecom Services - international fixed network operator

15 Brazilian States

4.5

780

15

3 million retail and 2,000 corporate

3y

Mining

Mining, beneficiation, pelletization and exportation of iron ore

2 Brazilian States

27

1256

3

30 corporate

15y

Steelworks

Production of Steel Plate and Hot Rolled Coils

1 Brazilian State

21

3864

1

80 corporate

10y

Petrochemical

Production of synthetic rubber

3 Brazilian States

30

630

3

280 corporate

10y

5 mass communication channels

1 Brazilian State

76

773

3

Over 5 million

NA

Company

Number Average of Phys- Number of Customer ical Customers Retention Sites

New Economy

Old Economy

Alternative Media

832

The period considered was since the start up of the company’s activities in the market. As Telecom 2 is a joint venture of two newly established telecommunications companies in the market after the privatization process in 1998, the period since formation of the joint venture was taken into consideration. However, we could also have considered 4.5 and 5 years respectively since the start up of the activities of the two original companies. 183

4.5.3 Product Innovation-Diversification Profile As presented in Chapter 3, the New Economy was strongly characterized by intensive and continuous product innovation process and diversification, and short product life cycles. Table 4-3 shows these aspects through the number of products, diversification and significant modifications in existing products per year. These data show that the New Economy company group is relatively more intensive in new products (and services as ‘solutions’) development and launching, product innovation and diversification.

Table 4-3: Innovation-Diversification Profile

Number of Products

Number of New Products per year

Number of significant modifications in products per year

Impact of innovation in your market

Intensity of innovation

Frequency of technological change

Frequency of production systems change

Relevance of Research and PD

Telecom 1

More than 100 solutions for data and voice communication

30

more than 50

4

3

4

5

5

Telecom 2

Approximately 100 solutions for data and voice communication

10

more than 70

4

3

4

5

4

Telecom 3

More than 40 long distance voice services

10

more than 20

5

4

4

5

5

Mining

2 basic products

0

3

2

3

2

2

2

Steelworks

2 basic products

0

2

2

2

2

2

1

Petrochemical

14 basic products

3

5

3

3

1

3

3

1 TV channel, 2 Radio channels and 2 Newspapers

NA

NA

4

3

4

2

3

5= High

5= High

5= Very Frequent

5= Very Frequent

5= High

1= Low

1= Low

Company

New Economy

Old Economy

Alternative

Media

184

1= Seldom 1= Seldom

1= Low

On the contrary, the Old Economy company group has few standardized tangible products and low significant product modifications per year. In the Old Economy company group, the frequency of change in technological and production systems is relatively low, and following this aspect, research and product development (PD) has similarly less importance to these companies. Although the innovation activity itself within these companies (or through networks) is relatively greater in the New Economy group of companies, the aspect that most notably characterizes them is the impact of innovation on their market activities, the relevance of product development and the frequency of production and technological change due to technological innovation. These data confirm the proposed classification and are in line with the previous literature review. Alternatively, the Media company has mass communication channels and, similar to the Old Economy company group, it attributes relatively less importance to research and product development. The frequency of production systems sometimes suffers some changes, such as the introduction of Internet and digital TV, new means of communication, which might have a decisive role in the company’s performance.

4.5.4 Planning Process Profile Planning activities are strongly related to the level of uncertainty. It illustrates the companies’ capacity to forecast future demands and resources. Confirming the proposed classification and in line with the previous literature review, Table 4-4 shows that in the New Economy group of companies, the volatility of the elements used for planning activities are relatively higher when compared to the answers provided by the managers from the Old Economy group of companies. Managers were asked to consider short term (1 to 3 years), medium term (4 to 6 years) and long term (7 to 10 years or more) scenarios related to dominant time orientation for investment and expected results. The interviews suggested that the dominant time orientation for investment and expected results might be a critical factor to distinguish the New Economy from Old Economy companies. Managers were asked to indicate, in their view, the most critical factors in the planning process considering three production factors: Human Capital (like wages, investment in training and development, employee turnover costs, etc.), Capital (like machines and general tangible assets), Market information (like marketing research and general customers info. etc.). ‘Human Capital’ was frequently indicated in the New Economy group of companies while in the Old Economy group ‘Capital’ was the most frequent answer. This analysis also confirms the proposed classification and the previous literature review. The factor Human capital, was frequently mentioned by managers from the New Economy group of companies. It might have happened because some hidden Human Capital factors, like

185

“knowledge” and “innovation capacity” might be implicitly acknowledged in this option.833 Confirming our expectations the Old Economy companies pointed to ‘Capital’ as the most important factor for planning purposes.

Table 4-4: Planning Process Profile

Company

Volatility of the elements used in the Planning Process

Frequency of change in Regulation

Possibilities of mergers, venturing and fusion

Dominant Time Refer- time orientaence to Fore- tion for incast Future vestments Demands and expected results

Main Input

New Economy Telecom 1

4

4

5

2-4 years

short term

Market Info.

Telecom 2

4

5

5

2-4 years

short to middle term

Human Capital

Telecom 3

4

5

5

2 years

short term

Human Capital

Mining

2

2

3

10 years

long term

Capital

Steelworks

2

2

4

5 to 10 years

long term

Capital and Market Info.

Petrochemical

3

3

3

5 to 7 years

long term

Capital

2

2

2

3 years

5= high volatility

5= very frequent

5= high

long term

1= low volatility

1= seldom

1= low

middle term

Old Economy

Alternative Media

middle to long Human Capiterm tal

short term

Furthermore, the frequency of change in the regulation of the market is relatively higher in the New Economy (regulation uncertainty), as well as the possibilities of mergers, venturing and fusion. Alternatively, the Media company has a different profile. Although the volatility of the elements used in the planning process to forecast future demands, frequency of change in regulation and possibilities for mangers and venturing or fusion is relatively low, according to the company, political and macro economic factors as well as competition play a signifi833

186

It was observed by Rothwell (1992) that the innovation activity is very much a people-centered process where ‘intangibles’ are more significant than ‘tangible’ assets.

cant role, reducing the time reference to forecast future demands. Moreover, human resources were considered by the company as the critical input.

4.5.5 Human Resource Policy Profile Another important element which supports our classification is the HR policies adopted by the organizations studied and their outcomes (see Table 4-5). As expected, New Economy’ companies had a low average of employee retention while the Old Economy’ companies had a higher figure. It is in line with the assumption of high turnover rates and short relationship between employer and employees (transactional contracts) in the companies operating in the New Economy. Another relevant element, which confirms the previous literature review, is the performance system basis. As we observed in Chapter 3, the intensive use of knowledge and flexible structures in the New Economy’s production systems has driven measures of performance for more subjective data. On the contrary, the Old Economy is strongly characterized by performance systems based on more objective data. Moreover, as presented in Chapter 3, these research results are in line with the ‘organic’ model originally proposed by Burns and Stalker (1961) and later by Rothwell (1992) and Tosi et al. (1994) for classification of the organizations. High market and technological volatility characterizes the ‘organic’ organizational model. Organic companies will present high dependence on individual skills and the measuring of individual performance based more on subjective data, and less on objective measures. Uncertainty generates a high need for flexible organizational design and nonpermanent job tasks. Moreover, as commented by Tosi et al. (1994), conflicts between the concern for employees and organizational results are more frequent in the ‘organic’ model. Table 4-5 confirms this assumption. The New Economy companies revealed a high frequency of conflicts between concerns for employees and concern for results. On the contrary, the Old Economy companies showed a very low incidence of conflict, or no conflict. Moreover, the managers were asked to determine the basis of the merit system. Which kinds of individual skills and abilities employees were expected to be judged on by the company affecting the chance of career growth within the company’s hierarchy? The New Economy companies’ managers considered the factors to be the capacity to achieve results and team work skills. The Old Economy companies’ managers answered, technical and team work skills. It shows a tendency for a technocratic merit system in the companies of the Old Economy, and a more entrepreneurial system in the companies of the New Economy. Following the tendency of the New Economy companies,the Media company also presents an evaluation system based on more subjective data, eight years average employee retention and occasional conflicts between concerns with employees and concerns with results. However, like the tendency in Old Economy companies, the merit system is based strongly on technical skills. The HR managers of the participating companies were asked the main HR driven policies. We can observe that in the New Economy group of companies the HR policies are focused on 187

reorganization processes. HR managers of all these companies commented that all of them were passing through ‘transition processes’. For instance, Telecom 1 was formed by many local telecom companies during the privatization period. Its consolidation process has been performed by concentrating some management policies in the headquarters in Rio de Janeiro. The HR manager of Telecom 2 commented that the company was consolidating the process of joint venture formation through a complete restructuring of its employee’s functions, HR policies and departments roles. The HR manager of Telecom 3 commented that the company was about to be sold to another private group. Telecom 3 was focused on the creation of managerial transparency and employee empowerment to deal with future uncertainties.

188

Table 4-5: Human Resource Policy Data

Main HR Driven Policy

Average of Employee Retaining

Existence of conflicts between concerns with employees and concerns with results834

Performance System basis

Merit system basis

Employee evaluation and promotion System

Telecom 1

Achieve objective results and support the transition process

3y6m

Frequently

objective data

Capacity to achieve results and team work

Evaluation by superior

Telecom 2

Promotion of Leadership, motivation and integration and support the transition process

4y

Frequently

more subjective data

Team work skills

Evaluation by superior

Telecom 3

Transparency, empowerment and employee participation

3y6m

Sometimes

more subjective data

Capacity to Evaluation by combine results superior and and adaptive colleagues and skills to the monitored by Corporate an internal Culture system

Mining

Improve organizational environment and motivate employees

13y5m

Not at all

objective data

technical skills and team work

Career Plan and internal job offer

Steelworks

Attract and retain employee according to the company's needs

13y

Not at all

objective data

technical skills and team work

Career Plan and internal job offer

Petrochemical

Create Knowledge management and support the strategic planning process

12y6m

Not at all

objective data

technical skills and creativity

Evaluation by superior. Implementing career plan

Improve existing Human Capital and support org. changing

8y

Sometimes

more subjective data

technical skills and individual competencies

Evaluation by superior

Company

New Economy

Old Economy

Alternative

Media

On the contrary, HR managers of the Old Economy companies said that they were focused on another set of HR driven policies.The Mining Company was concerned to motivate employees and improve the organizational environment. Sequential organizational climate sur834

Respondents were asked for the following classification: Frequently, Sometimes, Seldom and Not at all. 189

veys have been performed by the company to monitor this process. The HR manager of the Steelworks commented that the focus was on employee retention in order to supply human resources according to the company’s needs. The HR manager of the Petrochemical commented that his focus was on the creation of knowledge management system to support the strategic planning process. What one can observe is that, while the New Economy companies were more focused on managing transition processes through managing reorganization processes, the Old Economy companies were more focused on employee retention and motivation and the improvement of their human capital. Following the tendency of the New Economy group of companies, the Media company HR policies were focused on the organizational change. The company has been undergoing reorganization in order to improve its human resources and change its strategic focus to other products and services. One of the most illustrative factors for companies grouping regarding HR policies concerns the tendency of the Old Economy companies to implement a career plan. It can be acknowledged that a career plan is a kind of incentive to the employees regarding future perspectives related to their efforts and dedicated work time in the company. Therefore, a career plan can be acknowledged as a mechanism to promote an employee retention by reducing employees’ expectations about future uncertainties. In the companies of the New Economy the nonexistence of this feature in the HR policies was observed. The Career plan was a common HR policy for the telecommunications companies before the privatization processes. It was possible to note, through the comment sheets analysis, that the ‘Lack of Career plan’ was frequently commented on by the employees of Telecom 1 and Telecom 2 (see Appendix 02). This factor highlights the literature review and constitutes a strong element of difference between these two groups.

4.5.6 Market Performance Data Comparison The market performance analysis provides another perspective of differentiation between the New Economy and Old Economy company grouping. In this section we provide empirical data to better understand the relationship between trust and organizational performance. As observed before, there is no direct causal link between trust and a company’s market performance. Beyond the validation of the companies’ classification, the placement of the levels of trust within their specific business contexts provides relevant empirical data addressing these issues for more comprehensive future research. Therefore, some stock market performance data is analyzed in this section as follows.

190

Figure 4-2: Stock Market Performance Telecom Brazil, Nasdaq and Ibovespa Telecom Brasil, Nasdaq e Ibovespa 400

350

250

200

150

100

50

Proxy Telebrás

Ibovespa

1/21/2004

9/21/2003

11/21/2003

7/21/2003

5/21/2003

3/21/2003

1/21/2003

9/21/2002

11/21/2002

7/21/2002

5/21/2002

3/21/2002

1/21/2002

9/21/2001

11/21/2001

7/21/2001

5/21/2001

3/21/2001

1/21/2001

9/21/2000

11/21/2000

7/21/2000

5/21/2000

3/21/2000

1/21/2000

9/21/1999

11/21/1999

7/21/1999

5/21/1999

3/21/1999

1/21/1999

9/21/1998

0 11/21/1998

Base 100 = 21/Sep/98

300

Nasdaq

Source: ARX Capital

Figure 4-2 shows a comparative historical performance of the Nasdaq, the Brazilian Stock Exchange Index (Ibovespa) and Proxy Telecom Brazil (or Proxy Telebrás). The group of all telecommunication companies has been known as proxy Telecom Brazil in the Brazilian market since their privatization in 1998, which represented 4.16% of the Ibovespa index in March 2004. Aligned with the historical factors commented in Chapter 3, the stock market data also provides a visual illustration of the instable market environment throughout the period in the table from September 1998 to January 2004. It can be observed that, since the privatization period in 1998, for most of the time, Proxy Telebrás had a better performance than Ibovespa and Nasdaq. However, since 2001, although presenting better performance when compared with Nasdaq, the Proxy Telecom Brazil underperformed Ibovespa.

191

Figure 4-3 shows that, specifically in the research time period, from July to October of 2004, this tendency remained the same. Figure 4-3 shows Proxy Telecom underperforming Ibovespa for most of this time period.

Figure 4-3: Comparative Proxy Telecom Brazil and Ibovespa - June-October 2004

Proxy Telecom Brazil, Ibovespa

Base 100 = 30/Jun/04

120

110

100

6/ 30 /2 00 4 7/ 8/ 20 0 7/ 16 4 /2 00 7/ 24 4 /2 00 4 8/ 1/ 20 04 8/ 9/ 20 0 8/ 17 4 /2 00 8/ 25 4 /2 00 4 9/ 2/ 20 04 9/ 10 /2 00 9/ 18 4 /2 00 9/ 26 4 /2 00 10 4 /4 /2 00 10 4 /1 2/ 20 10 04 /2 0/ 20 10 04 /2 8/ 20 04

90

Proxy Telecom Brazil

Ibovespa

Source: ARX Capital

Moreover, it was possible to obtain the market performance data from three of the seven studied companies. The companies are Telecom1, Telecom2 and Steelworks. The stock market data of these companies was collected taking into consideration the research time period from July to October 2004. The stock data was provided by a senior manager of the ARX Capital.835 The comparative market parameter used is the S&P 500 Index, considering in addition a country’s risk discount. Due to its frequent usage in the Brazilian Stock Market we opted for the Global 40 risk index discount. With this it was possible to calculate the S&P 500 return for the Brazilian Stock Market. Similarly, we used the Global 40 risk index discount to calculate companies’ stocks returns. Considering the abundance of market measurement possibilities we selected four measures in order to examine in a statistically comprehensible manner companies’ market performance, they are: 835

192

ARX Capital is a Brazilian investment management company located in Rio de Janeiro city.

ƒ

The CAP-M’s Jensen’s Alpha (Jα) – this gives an indication of excess profitability of a company relative to a randomly selected market portfolio return, here namely S&P 500. When Jensen’s Alpha is positive the company outperformed the market portfolio S&P. When Jensen’s Alpha is negative the company was outperformed by the market portfolio S&P and when it is zero it performed the same as the market;

ƒ

The CAP-M’s Beta (β) - a measure of the relative co-variation of the company’s stock with the market to the variation of the returns in the market. Therefore, Beta (β) is the risk/return measure of a company relative to the market assuming that variation measures of return stand in for risk. When Beta (β) is greater than 1, it indicates that the company has more risk than the market– i.e. higher variation. When Beta (β) is less than 1, it indicates that the company has less risk than the market – i.e. lower variation; and when it is not different from 1 it had the same risk as the market;

ƒ

Sharpe Performance Index (SPI) and Treynor Performance Index (TPI). These indices give the excess return of the company as a percentage of the total risk and the systematic or beta indexed risk of the company. The Sharpe Index (SPI) is the excess return of the company relative to its total risk as measured by the standard deviation of the return of the company. Computationally it is the average return of the company less the average risk free rate, here the S&P 500 return (less Global 40 risk index), divided by the standard deviation of the company’s return for the time period in question. Therefore, it is a measure of profitability relative to risk – the excess return as a percent of total risk. The Treynor Index (TPI) uses the same numerator as does the Sharpe index but divides it by the company’s period Beta (β). In this sense the Treynor Index looks at the return as a ratio of nondiversifiable risk or systematic risk. Usually both the Sharpe and Treynor indices are compared to the Market Sharpe and Treynor indices. When the particular company index is bigger than the market index that suggests the company is doing better than the market. When the company index is smaller than the market index that suggests the company is doing not as well as the market.

Companies’ stock data of the time period from July to October 2004 were entered in the JMP IN® 4 statistical software. The Fisher’s Kappa test was performed to check the data (Pvalue). Results of the P-values were considered consistent. Table 5-6 presents companies’ performance analyses where the zones are also noted for Jensen’s alpha and ß.

193

Table 4-6: Companies’ Market Performance Classification

Jα (Zone)

β (Zone)

Telecom1

New Economy

-0.000039 (0)

1.015261 (1)

- 0.03936

- 0.000730

Telecom2

New Economy

-0.004167 (Neg)

1.355627 (1)

- 0.01928

- 0.003766

Steelworks

Old Economy

0.005079 (Pos)

1.047079 (1)

0.186697

0.0041582

MARKET

SPI

TPI

- 0.10123

- 0.000692

As it can be observed in Table 4-6, Steelworks (Old Economy) presents the best results with positive Jensen’s Alpha, SPI and TPI outperforming Telecom1 and Telecom2 (New Economy) and the market. This partial negative result of the telecommunications companies (New Economy) in the above Table 4-6 is also confirmed in Figure 4-4. Figure 4-4 confirms this comparison tendency. It shows that Proxy Telecom Return underperformed S&P 500 Return considering the same period of July to October 2004. The companies’ performance data provides empirical evidences of different results between the New Economy company group and the Old Economy company group. One can observe that the new telecommunications companies operating in the New Economy underperformed the market in the given time period, and also performed overall less well than did one company in the Old Economy. We are also offering this market information as a confirmatory information profile to the proposed classification.

Figure 4-4: Comparative Proxy Telecom Return and S&P 500 Return Telecom Brazil, and S&P Ex Return 0.1

0.02 0.015 0.01

0.05

Return

0.005 0 -0.005

-0.05

/2004 10 /2 8

/2004 10 /1 3

9/28/2 0 04

9/13/2 0 04

8/29/2 0 04

8/14/2 0 04

7/30/2 0 04

7/15/2 0 04

6/30/2 0 04

0

-0.01 -0.015 -0.02

Date

Proxy Telecom Return

S&P 500 Return

Source: ARX Capital

194

4.5.7 Presentations of Survey Results to Participant Companies As we observe further in Sections 4.6.4. and 4.6.6, a research agreement/guideline was signed by the research team and each participant company. According to the research agreement, the research team would provide a feedback report to each participant company with general survey results concerning each specific participant company, (see a copy of the research agreement/guideline in Appendix 04). The participant companies were offered the option of having just the delivery of their feedback report or its delivery with a presentation of these results within the company by the research team. The research team sent a letter to each CEO of the participant companies inviting him to choose the delivery modality and to schedule the delivery day and the presentation optionally (a copy of the letter is in Appendix 03). Six companies opted to have the delivery of the feedback report with a presentation of their results. They were Telecom 1, Telecom 2, Telecom 3, Steelworks, Petrochemical and Media. These presentations were relevant to confirm the results and to get some additional feedback from the companies. After each presentation, the CEO or his representatives were asked to record the discussions about the survey results. All companies allowed the recording of the discussions. The data provided by those discussions and comments about the survey results were relevant to confirm these results and to get some additional observations by the research team. We summarized these observations: ƒ

In all five presentations, company representatives positively confirmed the results. No particular doubt or inconsistency concerning the presented results was observed. Results were well accepted by the participant companies.

ƒ

In four of the presentations, survey results were closely connected with previous organizational climate and employee satisfaction surveys. Although it is not conclusive in this study, it was suggested that trust results have some parallel with organizational climate and employee satisfaction researches. For example, it was observed by the Steelworks that in 2003 a well-known consulting company in the market elected the company as the best organizational climate in a national ranking survey.

ƒ

Some peculiarities concerning particular situations were observed. It was observed by Telecom 3 that recent layoffs might have impacted on survey results. It was observed by Telecom 2 that the recent joint venture process might have brought high uncertainty and job insecurity for some departments and it might have impacted on survey results. It was also observed by Telecom 1 that the high turnover creates a sense of job insecurity and uncertainty as to the maintenance of a trusting atmosphere.

ƒ

It was observed by Telecom 1 and Telecom 2 that the management of human resources with high turnover rates, considering the short life time of the company, and involving people from different regions of Brazil, seems to be much harder than to manage people with a long time of socialization within long established companies and a better developed

195

corporate culture. It was commented by Telecom 2 that probably companies located within the limits of specific regions might have better conditions to integrate and socialize employees, even within a short time scale. ƒ

It was commented by the Steelworks representatives that their option for the maintenance of some HR policies, like career plan and implicit agreements of non-layoff policy, creates an atmosphere of high interpersonal trust, job security and higher employee commitment.

In general the presentation of the feedback reports provided us with relevant confirmation of the survey results. It was generally confirmed, even by the company that did not partake in the presentations (Mining) that the survey results were consistent with the CEO’s intuitions about their management style, organizational climate, employee satisfaction surveys, and adopted HR policies. The feedback reports also presented a perspective for consensus validity, of the classification of the origin as well as a strong test of the consensus and criterion validity of the various questions of the questionnaire.

4.6 The Questionnaire Survey In order to collect data to answer the hypotheses, beyond the interviews and public and private data collected from participant companies as presented above, the study had to identify and select available validated questionnaires as the main source of data. The questionnaire and working material construction process took five months. It was done from February until July of 2004. By using pre-tested questionnaire forms it had the advantage of overcoming the complex time-consuming process of pre-testing and validation. In order not to violate the validity of the questionnaire some demographic-type questions were placed after the original questions, on a separate sheet of paper. Questionnaires were chosen from among some available published studies and the authors were contacted by e-mail. The procedures for selecting questionnaires are summarized as follows.

4.6.1 Construction and Validation of the Questionnaire Two validated questionnaires were chosen from previous studies to compose our questionnaire, named the “Trust Inventory Project – Brazil”. The complete questionnaire used in our project is divided into four different parts (see Appendix 01). The first part (Part A) was chosen to assess interpersonal trust within a company. It assesses interpersonal trust according to three different dimensions: trust in the supervisor, in a peer and in the work team. The second part (Part B) was used to assess three different kinds of employee commitment: normative, affective, and continuance commitment. The third part (Part C) of the questionnaire refers to demographic questions like age, education and some other supporting questions to our study, like expectations about the future. The last part (Part D) of the questionnaire was a comment 196

sheet where respondents could express their feeling and critics freely. In the following sections, we explain in more detail each of the first three parts of our questionnaire: Part A - Assessing Dimensions of Interpersonal Trust – After a thorough survey in the bibliography, we identified two valid questionnaires to be used in our research. The final criterion to select the best construction was based on the closest economics approach to trust. Such construction was well designed by Nicole Gillespie from the Melbourne Business School, University of Melbourne, Australia.836 It is called “Behavioral Trust Inventory”, or BTI, originally presented in 2003, in the Academy of Management Conference, Seattle, USA. The trust scale was specifically designed to assess the willingness to be vulnerable in interpersonal work relationships. The instrument was designed to assess interpersonal trust in the work relationships between leaders and their followers, and among peers. The inventory has also been used to assess leaders’ and members’ trust towards their work team. According to the Ms. Nicole Gillespie, until April of 2005 this questionnaire had been used to measure interpersonal trust in eight different countries. There are 30 questions in a seven-item Likert scale divided into 3 versions of 10 questions each, representing three different dimensions of trust. The three versions assessing trust in the immediate superior, a team member, and the work team, can be found in Appendix 01. The inventory is publicly available for free use when collecting data for research purposes. Initially an e-mail was sent to Ms. Gillespie on the 15th of April asking for the complete inventory. After our bibliographical research and analysis, on the 13th of May of 2004 another e-mail was sent to Ms. Gillespie asking for her permission to apply her inventory in our research project. A positive answer from Ms. Gillespie was sent on the 18th of May of 2004. Moreover, considering the large scope of our survey we had one doubt about the BTI concerning the follower/peer version. The questions were about the choice of the team member. We would have problems in handling the research if we randomly indicated one team member for each respondent in our survey. We sent an e-mail on the 17th of June asking her whether respondents could choose a team member, and answer the questions in relation to that person. Ms. Nicole Gillespie answered positively on the 21st of June affirming that it would be possible without violation of the original construction. The BTI represented the first part of our questionnaire with 30 questions in total: 10 assessing interpersonal trust between the respondent and his superior, 10 assessing interpersonal trust between the respondent and one chosen peer, and 10 questions assessing interpersonal trust between the respondent and his/her work team. Moreover, the trust scales for each dimension are basically divided into two equal parts. The first five questions of the 10 questions of the trust scales (e.g. A1, A11 and A21; A2, A12 and A22) were designed to measure trust within specific situations related to dependence on work related tasks. The last five questions of the 10 questions of the trust

836

See Gillespie (2003). 197

scales (e.g. A06, A16 and A26; A7, A17 and A27) were designed to measure trust within specific situations related to disclosure of personal and sensitive information with others. As Gillespie (2003) observes, whilst the first five questions are based on ‘professional’ forms of trust, on a more calculative basis, related to professional relationships, the last five questions of the scale are based on ‘personal’ forms of trust. The last five questions have clearly stronger emotional and relational basis than the first five questions.837 Part B – Employee Commitment - The second part labeled as Part “B” had 18 questions from the five-item Likert scale. This is a construction designed and validated by Isaiah O. Ugboro from North Carolina A&T State University, North Carolina USA. It was originally published in the Journal of Behavioural and Applied Management, Winter 2003, Vol. 4(3) pp. 231-253. However, before opting for Ugboro’s questionnaire we tried to use the questionnaire created by Aryee et al. (2002). On the 17th of June of 2004 we sent an e-mail to Mr. Aryee asking him for the complete questionnaire. Mr. Aryee replied informing that their original questionnaire presented some problems and it was under revision. We decided, therefore, not to use it. Accordingly we sent an e-mail to Mr. Ugboro on the 21st of June of 2004 asking for his permission to use his original questionnaire in our research. We also found an error in his published questionnaire from the above-mentioned article. We found some repeated questions and typos.838 On the 28th of June of 2004 we reported to Mr. Ugboro asking him for permission to use the questionnaire and for the correct constructor. On that same day, Mr. Ugboro sent us affirmative answers giving permission to use it in our project and reporting that, in fact, these errors happened in the printed published article. He sent us the corrected original constructor as he originally designed it. In Ugboro’s work, commitment measures are referred to as “Organizational Commitment”. In our study we relabeled this name according to a more appropriate terminology. So, we changed “Organizational Commitment” to “Employee Commitment”. The original items in the statements for Employee Commitment are from Meyer and Allen (1997). Each type of commitment (affective, normative and continuance) is measured using a scale containing six statements. For affective commitment, the statements dealt with a sense of belonging to the organization, emotional attachment to the organization, willingness to spend the rest of one’s career with the organization, the feeling that the organization’s problems are those of the employees, the meaning the organization has for the employee, and a feeling of being a part of the organization. The continuance commitment statements included the feeling of having few alternative employment opportunities if one leaves the organization, the feeling that it is necessary to remain with the organization, the difficulty of leaving, and lifestyle disruption from leaving the organization, and too much investment in the organization to leave. Concerning normative commitment, some statements dealt with a 837 838

198

See Gillespie (2003), p. 35. In the original questionnaire published in Ugboro (2003) there are repeated questions in Table 1, questions 4, 5 and 6 are repeated in 7, 8 and 9. Moreover, the introduction to Table 3 there seems to have some typos.

feeling of obligation to remain with the organization, and a feeling that leaving the organization is not right. Others dealt with loyalty, guilty feeling if one left, a feeling that one owes a lot to the organization, and a sense of obligation to the organization. Part C - Demographic Questions - An additional third Part “C” was added with 13 questions. The survey also solicited information on such demographic characteristics as gender, level of education, years of employment with present organization, and age. Moreover, as part of our analysis of the organizations, other questions were introduced in order to better know the present environment and employee’s future perspectives.

4.6.2 Translation Process As our empirical survey took place in Brazil, our original questionnaire was originally fully designed in English, and later translated into Portuguese. The original questionnaires from Nicole Gillespie and Isaiah O. Ugboro were designed in English, as well as the covering instructions and explanations, and Parts C and D. Two native Portuguese language speakers, Mr. Marco Tulio Zanini and Ms. Graziella Capone de Palma, who were fluent in English, started the questionnaire translation process separately. The translation from the first native speaker was given to the second native speaker, who was asked to see if she agreed with the first translation. Both translators were asked to meet and reconcile any differences. The number of initial queries of the second translator was less than one percent of the total words of the original English questionnaire. After this first step of the translation process, the Portuguese version was given to two other native speakers, who are used to working with English to Portuguese translations for revision. One of them was a business professor. The procedure was done in order to check any changes in the meaning of the original English questionnaire due to the translation. In this second step of the translation process, the number of initial queries from the first step of the translation process was less than one percent of the total words of the original English questionnaire. No differences that were not-reconcilable were detected during the review. As a result of the precise translation process, it was believed that the validity of the questionnaire was not violated. The next step was to organize the pre-test with a sample from a future respondent group.

4.6.3 Pre-Test for Questionnaire Validation The Pre-test took place in Brazil immediately after the translation process, in order to detect any misunderstanding or difficulties for prospective respondents to answer the questions in Portuguese. The respondents were also asked to provide a feedback about the comprehensibility of the questionnaire. Seven selected respondents from two private business companies answered the questionnaire and no considerable difficulties were identified. This group pro-

199

vided some additional feedback about the format and ease of following the covering instructions and explanations about the questionnaire.

4.6.4 Working Material Target companies were identified 2 months in advance. The research team sent formal invitation letters from Germany to Brazil to approximately 10 selected companies. An additional institutional support was provided by FIRJAN – Rio de Janeiro’s Industry Federation. FIRJAN identified and mediate in the invitation of some target companies and it became an important institutional support to approach some companies with more credibility in Brazil. In addition to the invitation letter, the research team provided two other documents to present the project to the companies: a Power Point presentation of the project was used to approach companies at the first or second meetings, and the “Guideline for Empirical Research” containing survey agreement conditions and instructions, provided by the research team, to those companies, that demonstrated real interest in participating in the project. In general, two or three previous meetings were necessary to present the project in each company before they came to a final decision. After the companies reached a final decision, the five-page Guideline was distributed. It served as non-disclosure agreement bringing together signatures of all team members and the person in charge for the research on each participant company (See Appendix 04). The Guideline was provided in English and Portuguese versions, and the companies were asked to sign one copy of each version. Moreover, in order to proceed with the processes of distribution and collection of questionnaires, additional material was provided for the research team when inside the companies, like ID cards and surveyor’s table with the name of the project (“TIP”) and the person’s name. Additionally, according to the specific company, a letter of presentation was enclosed with the questionnaire, the companies together with the research team also created e-mail texts, and/or memoranda in order to best communicate internally the research purposes and procedures.

4.6.5 The Questionnaires Distribution and Collection Process The questionnaire survey was conducted between July and October 2004 in Brazil. The research process followed formal scientific standards of data-collection in order to assure reliable results. In the following sections, we describe the formal procedures taken during the research period in order to produce accurate and reliable results. Special attention was paid to the distribution and collection of the questionnaires and to reproducing exactly the way in which the surveys were conducted with all the participant companies. The research team was composed of one research team manager, namely Mr. Marco Tulio Zanini, located in Rio de Janeiro, one research team support located in Sao Paulo, namely Ms. 200

Graziella Capone de Palma, and two teams of two people each composed of college students. These teams were trained and prepared during the previous days in order to be able to cope with the research purposes and standards. Research material was provided to the research team ,like ID cards and a surveyor’s table with the name of the project and person to work inside the study companies.

4.6.6 General Procedures Adopted The focus of the questionnaire distribution process was to assure confidentiality concerning all information exchanged between all participant companies and the research team as well as all the information provided by respondents in the questionnaires. All employees from the target organizations were surveyed anonymously. No member of these organizations has ever had the opportunity to inspect the individual answer sheet in order to avoid revealing the identity of single respondents. All the employees of each surveyed organization were informed about the questionnaire prior to the survey. No codes or names or different colors were used, to avoid identification. Therefore, some general procedures were adopted in order to create formal scientific standards of data-collection process. Those were: 1. A formal written agreement in two versions, one in English and the other in Portuguese, was signed between the research team and each participant company in order to assure confidentiality of all information exchanged and the acceptance by the participant company of the general standard conditions for participation in the project. 2. In order to be considered ‘valid’, all questionnaires returned were only accepted under the strict condition of being inside sealed envelopes sent by anonymous respondents and no names or signatures should be written on the envelopes or on the questionnaires. This information was largely communicated in those companies and it was written in the questionnaire cover sheet. 3. Employees should feel free to express their feelings and perceptions about their relationship with the company and its members. In order to get reliable information, the research team previously negotiated with each participant company a communication and a questionnaire distribution-collection plan. As a general criterion, any contact with the questionnaires by third parties or other company members was avoided. The questionnaires should return from the respondents’ hands directly to a member of the research team. 4. Employees should be well informed by the company of the confidentiality standards signed into the agreement with the research team. No information would be disclosed or individual respondent identified by the company, as well as no one from the company would have any access to any information provided by individuals in the questionnaire. This information was also provided in the questionnaire cover sheet.

201

In all the participant companies, a questionnaire, an envelope which could be sealed and a formal letter from the CEO describing the purpose of the survey were distributed, assuring confidentiality and stating that the management of the organization supported the research project. The employees were always permitted to fill in the questionnaire during their regular work hours. The completion of the questionnaire took about 20 minutes. In all participant companies, the HR department was responsible for providing basic support and facilities in order to assure the right research process.

4.6.7 The Study Sample These efforts resulted in the distribution of 2140 questionnaires within the seven participant companies. 1643 questionnaires were collected. The total response return after the cleaning process of the data was 76.78%. After the data was cleaned (See Section 4.6.9), the total sample consisted of 1621 questionnaires considered valid.839 Individual return rates per company are shown in Table 5-7. In the New Economy group, Telecom 1 had a return rate of 63.42%, Telecom 2 had a return rate of 83.16%, Telecom 3 had a return rate of 72.35%. In the Old Economy group, the Steelworks had a return rate of 86.29%, Mining had a return rate of 71. 82% and Petrochemical had a return rate of 79.58%. Media had a return rate of 82.17%. The companies’ return rates were considered statistically satisfactory for the purposes of the study and it was possible to consider two main sub samples for comparison purposes: the New Economy sample with 803 observations and the Old Economy sample with 645 observations. Additionally, 188 questionnaires formed the Alternative sample. The 1621 formally correct questionnaire responses were distributed, collected and considered valid according to Table 4-7.

839

202

All questionnaires were considered in the cleaning process. Blank questionnaires and questions with typos were not considered. Moreover, checking procedures were performed through many tests in the database. See the following Section 4.6.8.

Table 4-7: Questionnaire Distribution-Collection per Company Company

Industrial Sector

Distributed Collected Blank Questionnaires Questionnaires

Return

Valid Questionnaires

New Economy Telecom 1

Telecommunications

380

241

8

63.42%

233

Telecom 2

Telecommunications

380

316

3

83.16%

313

Telecom 3

Telecommunications

340

246

4

72.35%

242

189

1

82.17%

188

350

302

0

86.29%

302

Alternative Media

Media

230 Old Economy

Steelworks

Steelworks

Mining

Mining

220

158

3

71.82%

155

Petrochemical

Petrochemical

240

191

3

79.58%

188

2140

1643

22

76.78%

1621

TOTAL

Additionally, the Part D of the TIP questionnaire was a comment sheet. Respondents were invited to freely express their feelings and comments about the company in general. In total 316 (19,49%) employees recorded comments. Table 4-8 presents the response rate per company. In order to protect the identity of the respondents, only summaries of the comment of each organization participating in the survey were written, excluding all direct quotes and possible indicators of identity.

203

Table 4-8: Frequency of Comment Sheet Records Number of Valid Questionnaires

Number of Comment Sheets

Percentage

Telecom 1

233

41

18.00%

Telecom 2

313

57

18.21%

Telecom 3

242

73

30.16%

Mining

155

24

15.48%

Steelworks

302

52

17.21%

Petrochemical

188

29

15.42%

Media

188

40

21.27%

Total

1621

316

19.49%

Company New Economy

Old Economy

Alternative

All comments on the comment sheet were coded into categories. The summaries of these categories can be found in Appendix 02. Each comment was coded negative, positive, or no comment related to these categories. Two native Portuguese speaking researchers coded these comments independently. If differences in codes were discovered, the two researchers discussed the differences and agreed upon a final coding. All the comments written on the comment sheet were translated into English in a similar manner as the questionnaire was translated into Portuguese by two bi-lingual individuals, who independently translated the comments, and after the translation discussed the differences and agreed upon a final translation. The codes were compared and differences discussed. In the event of disagreements, they decided on the final code. For the entire sample, the disagreement percentage was below 2 percent.

4.6.8 Comment Sheet Analysis The comment sheet analysis provides supporting information to validate the companies grouping and to characterize differently the New Economy sample and the Old Economy sample. As can be observed in Appendix 2, Telecom 1 presented the highest frequency of comments on negative aspects of general work conditions, lack of career plan, excessive work hours, internal communication problems, general reward problems and negative perception of general concerns as to employees’ welfare. In Telecom 2 the highest frequency of comments

204

on uncertainty and change were due to job insecurity and lack of investments in human capital, despite a high frequency of comments of positive feelings about the company in general. Telecom 3 presented the highest frequency of comments on the actual situation of the company840, uncertainty and change on due to job insecurity and negative feelings about the future, despite a high frequency of comments of positive feelings about the company in general. On the contrary, the Old Economy company group presented different comments. Steelworks presented the highest frequency of comments on positive feelings about the company in general and employees’ welfare conditions, followed by comments on job satisfaction, and the positive feedback about rewards and company social responsibility activities. Similarly, Mining presented the highest frequency of comments on positive feelings about the company in general and employees’ welfare conditions, followed a few comments on reward problems.Similarly, Petrochemical presented the highest frequency of comments on positive feelings about the company in general and employees’ welfare conditions, followed by comments on reward problems. In contrast, the Media company presented the highest frequency of comments on reward plan problems, but almost equally as high were comments on positive feelings about the company in general. The Comment Sheet analysis provided us valuable information in resonance with the literature, about the negative work conditions and the perception of unfair situations in the work environment, which strongly characterize the new telecommunications companies operating in the New Economy. For example, in Telecom 1 the highest frequency of the comments were regarding the negative general work conditions, in the Telecom 2 the highest frequency of comments refered to the uncertainties and change due to job insecurity, and in Telecom 3 the highest frequency of comments were about future uncertainties about the actual situation of the company. On the contrary, the feeling of familiarity, job satisfaction and the perception of the company’s concern about general employee welfare, strongly characterized the companies operating in the Old Economy. For example, in all three Old Economy companies the highest frequency of comments were regarding the positive feelings about the company in general. Following the tendency of the New Economy group, the Media company had the highest frequency of negative comments on reward plan problems (see Appendix 02).

840

Telecom 3 has been in the market for sale for over 2 years. 205

4.6.9 Data Entry and Cleaning Procedures Since all questionnaires were to be sent from Brazil to Germany, the research team transcribed each questionnaire, one-by-one, by hand to an answer sheet. The entire transcription process took about one month. It was done in order to reduce the chances of losing the collected data. Seven files containing all the information from the questionnaires from each participant company were produced. All questionnaires were mailed to Germany and were equally distributed in 15 different postboxes. The brochures were taken in the personal travel baggage of the research team. The data-entering process started on the 26th of October. All data from the questionnaires was entered in the statistical program JMP IN® 4 statistical software. The entire data-entering ended on the 20 January 2005 taking altogether three months. Two people were dedicated to this phase of the work. Several tests were performed to clean the data. The cleaning procedures started on the TIP database on the 23 January 2005. Firstly, using the JUMP IN software tools, in order to check the precision of the entry process, a random sample of ten percent of the questionnaires was selected and checked thoroughly for the correctness of the entry. It was checked by comparing the questionnaires and the database as to whether it had some typo errors from the dataentering process. No errors were detected in this checking procedure. During the entry process range entry checks, which did not allow data out of a certain given range to be entered, were used, in this way avoiding implausible entries. Additionally, subsequent checking was made against the final database. Some logical relationships were programmed. Ten questions from the questionnaire, in pairs, were chosen for the checking procedures. These five pairs of questions should express the same meaning from the respondents. We did a cross check with these questions in pairs trying to identify any incongruence between the answers from the same respondents. It was decided that questionnaires with more than one incongruent question should be considered invalid. For example, questionnaire observations on question B.39 (I would be very happy to spend the rest of my career with this organization) and question C.11 (Assuming that you have the choice, how long do you think you will continue working for this company?) were chosen for cross checking procedures. In the end of our checking procedures no questionnaire presented more than one incongruence, so nothing was eliminated. The final database with the date of 5th February of 2005 was considered checked and ready to provide the basic data for the thesis.

4.6.10 Demographic Distribution of Respondents As Table 4-9 shows, there seems to be some differences in the demographic distribution of the employees between sub samples. It shows sub samples in number of respondents and respective percentile per subgroup of demographic category. These data were collected from

206

demographic questions – Part C of the TIP questionnaire. The data was processed using the JMP IN® 4 statistical software. The comparative analyses of the statistical difference between categories were tested. The p-value - false positive error - used for statistical significance was p < 0.010. As demographic questions consist of categorical responses and categorical factors, a Chi² analysis is used as statistical method to identify important relationships between variables.841 In order to simplify our observations, some categories were reclassified into other condensed categories. This test estimates response probabilities for each subgroup and test that they are the same across subgroups. In this sense, Chi²-value represents the magnitude of differences between what is observed and what is expected. It was assumed that Chi² cell contributions in the range 2.5 to 3.0 are ‘suggestive’ of a difference, and Chi² cell contributions greater than 3.0 are indicative of ‘significant’ difference in actual relation to expected percentages. In this sense, significant and suggestive differences found are commented on.

841

See more about this statistical method in Sall et al. (2001). 207

Table 4-9: Demographic Distribution of Respondents Categories

New Economy Num

%

Old Economy Num

%

Alternative Num

%

Gender Female

327

41.60

89

13.82

92

49.20

Male

459

58.40

555

86.18

95

50.80

Under 30 (Young)

288

36.69

169

26.32

61

32.62

30 to 39 (Middle Age)

330

42.04

217

33.80

69

36.90

40 or over (Senior)

167

21.27

256

39.88

57

30.48

Under College Degree

77

9.83

109

17.08

47

25.41

College Degree

295

37.68

224

35.11

65

35.14

Some Professional Post-graduation Degree (e.g. MBA)

338

43.17

142

22.26

52

28.11

Some Academic Post-graduation Degree (Master, PhD)

73

9.32

163

25.55

21

11.35

Administration

281

37.02

147

22.86

50

27.62

Marketing and Sales

304

40.05

17

2.64

66

36.46

Production and Tech. Support

174

22.92

479

74.49

65

35.91

Top Manager (More than 20 subordinates)

48

6.12

39

6.09

15

8.02

Middle Manager (between 1 and 20 subordinates)

257

32.78

203

31.72

74

39.57

Subordinate

479

61.10

398

62.19

98

52.41

Very Short Time (Less than 2 years)

221

28.19

101

15.66

47

25.13

Short Time (2 to 3 years)

268

34.18

73

11.32

38

20.32

Middle Time (2 to 4 years)

231

29.46

83

12.87

31

16.58

Long Time (More than 4 years)

64

8.16

388

60.16

71

37.97

Less than 7

13

1.65

30

4.65

36

19.25

7 to 8 hours

89

11.32

154

23.88

33

17.65

8 to 10 hours

397

50.51

306

47.44

73

39.04

More than 10 hours

287

36.51

155

24.03

45

24.06

None or One

129

16.41

382

59.32

62

33.33

Two

252

32.06

97

15.06

40

21.51

More than Two

405

51.53

165

25.62

84

45.16

Age

Educational Level

Work Area

Hierarchical Level

Time of Employment at the Company

Work Hours per Day

Other Employers in the last 8 years

208

The demographic data analysis confirms many theoretical assumptions in this study and it was also used to validate the research instrument. The following findings confirm those theoretical assumptions: ƒ

The Gender category presents significant statistical differences between the New Economy sample and the Old Economy sample (p-value MD; S > Y

A4 Sup

Var.

Var.

p-value

Results

A11

p-value

Results

Dimension

A21

0.0061

S > MD; S > Y

A12

A22

0.0001

S > MD > Y

A13

A23

0.0001

S > MD; S > Y

A14

A24

0.0002

S > MD; S > Y

A15

A25

0.0002

S > MD; S > Y

A26

0.0001

S > MD > Y

A5

0.0531

S > MD

A6

0.0040

S > MD > Y

A7

0.0065

S > MD; S > Y

A17

A27

0.0001

S > MD > Y

A8

0.0001

S>Y

A18

A28

0.0001

S > MD > Y

A9

0.0002

S>Y

A19

A29

0.0001

S > MD > Y

A10

0.0002

S>Y

A20

A30

0.0001

S>Y

Peer

A16

Team

Therefore these checking results of the trust scales per trust dimensions and age categories lead us to believe that the variable relationships were in the expected direction thus contributing to consensual and criterion validity.

5.2 Hypotheses’ Analytical Framework The thesis hypotheses test and analysis follows the analytical framework of New Institutional Economics. As it was well illustrated in the three-level schema of Williamson (1996) in Chapter 2, Section 2.6, management decisions (Corporate Governance) are affected by two major factors: institutional frameworks and individual characteristics. These factors external to corporate governance are important because they shift to accommodate new parameters continuously provided, and change the comparative costs of governance, and individual behavioral assumptions.849 The formal and informal aspects of industry-specific institutional frameworks, influence differently the corporate governance structures across industries through different laws and regulations, cultural norms and values, which ultimately change the comparative costs of governance defining different management styles. Ultimately, we 849

216

See Williamson (1996), p. 223.

have observed that such constraints in the form of institutional uncertainties directly affect human behavior by changing the views of the participants and the stakes over time.850 It was observed in Section 2.6 that, due to environmental uncertainties, industry-specific institutional frameworks shift specific parameters of governance structures which might restrict the development of some governance mechanisms and favor some others. It was also observed that trust is a complementary implicit control mechanism to coordinate transactions which can be selected according to relevant environmental circumstances. The individual level in Williamson’s model is most characterized by being subject to bounded rationality as well as to opportunism. In this level, individual attributes such as age, gender, education may also influence the corporate governance level. In Section 2.6 we have shown the influence and effects of environmental uncertainty and instability on the levels of trust. The New Economy companies’ environment was well characterized in Chapter 3 as highly uncertain and unstable from many aspects. Based on that, we proposed the classification for the study organizations. We preceded with the study organizations grouping into three different groups: the New Economy group, the Old Economy group and the Alternative group. These environmental uncertainties were attributed to institutional factors (institutional innovations) which ultimately were confirmed in Chapter 4 through our previous empirical data analysis. Additionally, it was observed in Chapter 2 (Section 2.9.4) and confirmed through our demographic data analysis that different industry-specific institutional frameworks create cultural variations and influence individual characteristics by selecting an individuals’ category by gender, age and education, thus defining different management styles across industries. Although those individual characteristics change across industry-specific institutional frameworks, we have argued that they play a minor role in the different trust levels between the New Economy sample and the Old Economy sample. In other words, we argue that trust is a highly sensitive variable that might change slightly due to demographic differences, but it changes drastically due to environmental uncertainties caused by different industry-specific institutional framework constraints. In Chapter 4 we presented the study Hypotheses. Following the Rational Choice Theory approach, we took the observations on the New Economy institutional environment to structure our hypotheses. The study hypotheses are: Hypothesis 1 (H1): Due to the relative higher institutional uncertainty and instability, New Economy companies will have a tendency to present lower levels of trust when compared with Old Economy companies.

850

Hardin (2002), p. 95. 217

Hypothesis 2 (H2): Levels of trust will be positively related to employee commitment levels. Thus, New Economy companies, when compared to the Old Economy companies, will present lower levels of employee commitment. Hypothesis 3 (H3): Employee turnover rates influence and will be negatively related to levels of trust. Thus, New Economy companies, when compared to the Old Economy companies, will present higher levels of employee turnover rates.

5.2.1 Analysis of Main Hypothesis Regarding the Hypothesis H1, the main argument of the present study is that different industry-specific institutional frameworks, shift a set of specific parameters for corporate governance which may restrict and alter the ways of governing relational contracts, affecting the levels of trust within companies differently. It was argued in Chapter 2 that companies acting under different industry-specific institutional framework constraints will have different capacities to develop trust levels in their hierarchies. More specifically, we argued in Chapter 3 that under the effects of relatively higher uncertainty and instability from an industry-specific institutional framework, the companies operating in the New Economy have significant limitations in creating the elements required to develop and sustain trust as an implicit control mechanism (as a managerial device of the corporate governance). Therefore, we maintain that the effects of environmental uncertainties of industry-specific institutional frameworks are the main cause of differences in the levels of trust between the two study samples: the New Economy sample and the Old Economy sample. Moreover, through the literature review and subsequent empirical data analysis, we could observe that these two samples presented significant differences regarding the demographic profile. For example, it was observed in the literature and confirmed through our empirical data analysis (see Section 4.6.10) that New Economy companies present a relatively younger work force with a more symmetrical distribution of gender categories. In contrast, the Old Economy is predominantly masculine and it is characterized mainly by a larger number of ‘Senior’ employees (in the age range: over 40 years old). Based on the singularities pointed out in the literature review and subsequent data analysis of demographic questions, the New Economy companies used to have a younger labor force for relatively short-term labor contracts. On the other hand, the Old Economy companies were characterized by having more long-term labor contracts, high employee retention, and therefore a more ‘Senior’ work force profile. As people normally spend longer in these companies (see Table 5-5), the demographic profile is considerably different from the New Economy companies. It is important to note that the causes of such differences in demographic characteristics lie in institutional selection mechanisms, such as managerial practices, that ultimately are managerial characteristics of

218

industry-specific institutional frameworks. Empirical works have observed this aspect.851 For instance, Perry et al. (1994) and Slonim (2004) investigate gender-based selection in the work place and show that, the effects of organizational and industrial gender segregation is at least the result of many individual gender-based selection decisions. The authors argue that decision makers’ propensity to use gender as a basis for selection and promotion varies across different industrial and organizational contexts. Perry et al.’s (1994) work explains the persistence of gender segregation from either a contextual or cognitive perspective. They claim that some relatively stable contextual features of organizations can influence the cognitive processes of decision makers, so that decision makers are more likely to use gender in selection decisions. According to Slonim’s (2004) work, decision-makers might discriminate by taste and belief towards each gender’s trustworthiness according to different organizational contexts. Furthermore, as observed in Section 2.8.5, it is also important to acknowledge that some empirical results in the relationship of trust with socio-demographic characteristics have yielded inconsistent results. For example, some authors like Anderson and Derrick (1990) and Thom et al. (1999) found a weak or no relationship between trust and socio-demographic characteristics.852 Also Croson and Buchan (1999) and Cox and Deck (2002) presented empirical works with no indication of substantial differences in trust and reciprocity between gender categories. On the other hand, more recent empirical works, like Fehr et al. (2003), Bellemare and Kröger (2003) and Sutter and Kocher (2003), report that age is related to trust.853 Moreover, scholars and researchers have predicted that gender, education, and wealth as well as race-ethnicity might also affect trust.854 Despite the possible differences in the levels of trust among socio-demographic categories, the present study sustains the premise that environmental uncertainties of industry-specific institutional arrangements, rather than individual characteristics, are the major cause of the possible differences in the levels of trust between the New Economy sample and Old Economy sample. Although it is not the main concern of the present study to analyze demographic categories related to trust, the sample size allows us to make some observations on some demographic categories, the most noticeable being gender and age, which helps us to reinforce our premise of the major role of environmental uncertainties on trust levels. Therefore, the main hypothesis is tested using mean comparisons, namely the Analysis of Variance (ANOVA/ttest), in two stages: The first stage assesses the levels of trust for the three study samples: New Economy sample, Old Economy sample and Alternative sample. The second stage is the analysis of the levels of trust per gender and age categories for the two-study sample: New Econ851 852 853 854

See, for instance, in gender-base selection in the work place, Perry et al. (1994) and Slonim (2004). See Anderson/Derrick (1990), p. 1098, and Thom et al. (1999), pp. 195-196. See Fehr et al. (2003), Bellemare/Kröger (2003) and Sutter/Kocher (2003). See, for instance, scholars like Zucker (1986), p. 63 and Keefer/Knack (2005), p. 716. Some empirical works like LaViest et al. (2000) and Wholey/Sommers (2001) reported that trust is related to age, education, wealth and race-ethnicity. 219

omy sample and Old Economy sample. By testing the main hypothesis in these two stages, the objective is to provide reasonable evidence to strengthen our premise that environmental uncertainties, rather than individual characteristics - namely gender and age categories, constitute the main cause of possible differences in the levels of trust between these samples. Therefore, we want to observe, by comparing these samples, whether or not the same differences in the levels of trust might be equally present among different age and gender categories. As the research was not originally designed to assure statistically an adequate gender-age representation, the objective here is not to process a comprehensive gender-age analysis of these samples, but to provide reasonable evidence of the minor influence of demographic variables on trust levels. By confirming that the same differences in the levels of trust are reasonably present among all gender and age sub-categories, it provided us with empirical evidence about the major role of the institutional uncertainties. In this regard we will be using the TukeyKramer HSD multiple comparison test for an Į set at 0.10. Also we will report the p-values whenever there are only two variables being compared. In the unlikely event of problems arising with the parametric assumptions, it being the case here that outliers are unlikely in the scaled ranges that we are working with for the questions in the survey, we will use the Wilcoxon Rank Sum Test for the ANOVA comparisons and the Wilcoxon Signed Rank Test for binary Comparisons. In this case we will use the Hettmansperger (1991) MCT derived for the Kruskal-Wallis test which is the same as the Wilcoxon test. This is a simple sample size weighted Boneferroni-type adjustment.

5.2.2 Analyses of Secondary Hypotheses Towards a better evaluation of relational contracting in the New Economy, we further propose the analysis of trust as an independent variable, including its relationship with two other elements of management and organizational behavior. As observed in Chapter 4, two secondary hypotheses related to the assumptions of the transition from the traditional model of relational contracts to more short-term transactional contracts are formulated.855 In such a perspective, we want to investigate the possible relationship between the levels of trust in such companies with employee commitment (H2) and employee turnover rates (H3). Both secondary hypotheses illustrate the tendency of transition from long-term relational contracting to a more short-term transactional contracting model. These hypotheses are helpful to obtain a better description of the possible consequences of institutional changes on relational contracting in the New Economy. Therefore, the secondary hypothesis H2 (employee commitment) is tested considering two stages: The first stage is a consistency check of the relationship between trust and employee commitment variables. We test some trust and employee commitment variables to confirm the

855

220

See Burton-Jones (1999), pp. 52-53.

relationship between the levels of trust and employee commitment measures already present in the previous literature review. The relationship between trust and employee commitment has already been confirmed in many works, such as Pillai et al. (1999), Brockner et al. (1997), Ugboro (2003), Farrell (2003), Crossman and Lee-Kelley (2004), Lazzarini et al. (2004), and When and Kwon (2004). The second stage is the analysis of the levels of employee commitment by mean comparison, namely the Analysis of Variance, for the three samples: New Economy sample, Old Economy sample and Alternative sample. Finally, the secondary hypothesis H3 (employee turnover rates) is also tested by mean comparisons. The relationship between employee turnover rates and trust has already been pointed out by some empirical studies, like Albrecht and Travaglione (2003), and Aryee et al. (2002). Furthermore, the secondary hypotheses are also used for the study validation. The data from the questionnaires was processed using the JMP IN® 4 statistical software. The Analysis of Variance (ANOVA/t-test) was used for the three sample mean comparison. The p-value - false positive error - used for statistical significance was p < 0.01. We used the parametric t, because we have bounded variables and so the outlier effect will not be a problem. By using the Tukey-Kramer HSD Test it was possible to identify where exactly the statistical differences are.

5.3 Main Hypothesis Test In the following Section 5.3.1 we present the means comparison of the levels of trust. In Section 5.3.2 we confirm the statistical results through the analysis of the previous empirical data on industry-specific institutional framework effects. In Section 5.3.3 we perform the agegender test to support our argument.

5.3.1 Levels of Trust - Mean Comparison The main hypothesis is tested using mean comparison, namely the Analysis of Variance (ANOVA/t-test), in two stages: The first stage assesses the levels of trust for the three study samples: New Economy sample, Old Economy sample and Alternative sample. The p-value false positive error - used for statistical significance was p < 0, 01. Table 6-3, Table 6-4 and Table 6-5 show the results of the means comparison. Results confirm the thesis’ main hypothesis (H1). As one can observe, all variables of the trust scales for the three trust dimensions show a strong statistical significance between the New Economy sample and the Old Economy sample. Most of them preset p-values smaller than 0. 0001. Therefore, the mean comparison of the trust variables between the New Economy sample and the Old Economy sample present a strong statistical significance.

221

The Alternative sample (Media company) also presents a statistical significance when compared to Old Economy sample concerning all variables, excepting variable A20. Comparing the Alternative sample with the Old Economy sample, the Old Economy sample presents in most of the variables the highest levels of trust. The Alternative sample presents almost no statistical significance when compared to the New Economy sample, with exception of three variables, namely variables A6, A11, and A25, in which the New Economy sample presents a higher level of trust than the Alternative sample. Therefore it is reasonable to observe that the trust levels of the Alternative sample are closely related to the trust levels of the New Economy sample. The overall results of the main hypothesis test are highly consistent with our arguments from the previous literature review and the proposed classification of the companies grouping.

Table 5-3: Trust Measures – Trust in Superior Means Variable

Dimension

p-value

New Economy

Old Economy

Alternative

Observation

Statistical Difference

< 0.0001

5.70521

6.05116

5.61170

Statistical difference

OE > NE, OE > A

A2

< 0.0001

5.17154

5.62422

5.02660

Statistical difference

OE > NE, OE > A

A3

< 0.0001

5.43202

5.96279

5.30851

Statistical difference

OE > NE, OE > A

A4

< 0.0001

5.40585

5.86977

5.34759

Statistical difference

OE > NE, OE > A

< 0.0001

5.36480

5.81522

5.23404

Statistical difference

OE > NE, OE > A

0.0001

4.21883

4.50776

3.89362

Statistical difference

OE > NE > A

A5 A6 A7

Trust in Supervisor

A1

< 0.0001

4.90306

5.33953

4.63298

Statistical difference

OE > NE, OE > A

A8

< 0.0001

4.24459

4.76242

4.09043

Statistical difference

OE > NE, OE > A

A9

< 0.0001

4.80559

5.24961

4.64362

Statistical difference

OE > NE, OE > A

A10

0.0007

4.65522

4.92093

4.37766

Statistical difference

OE > NE, OE > A

222

Table 5-4: Trust Measures – Trust in a Peer Means Variable

Dimension

p-value

Observation

New Economy

Old Economy

Alternative

Statistical Difference

< 0.0001

5.72427

6.00620

5.45745

Statistical difference

OE > NE > A

A12

< 0.0001

5.33503

5.67752

5.17553

Statistical difference

OE > NE, OE > A

A13

< 0.0001

5.32234

5.65891

5.20745

Statistical difference

OE > NE, OE > A

A14

< 0.0001

5.42259

5.84317

5.51064

Statistical difference

OE > NE, OE > A

< 0.0001

5.38959

5.80465

5.34043

Statistical difference

OE > NE, OE > A

A15 A16

Trust in a Peer

A11

0.0049

4.85660

5.11975

4.78723

Statistical difference

OE > NE, OE > A

A17

< 0.0001

5.00762

5.46822

5.01064

Statistical difference

OE > NE, OE > A

A18

< 0.0001

4.73604

5.15349

4.76596

Statistical difference

OE > NE, OE > A

A19

< 0.0001

5.12944

5.56056

5.20213

Statistical difference

OE > NE, OE > A

A20

0.0082

5.16244

5.41860

5.18085

Statistical difference

OE > NE

Table 5-5: Trust Measures – Trust in Work Team Means Variable

Dimension

p-value

Observation

New Economy

Old Economy

Alternative

Statistical Difference

< 0.0001

5.71066

6.03727

5.57754

Statistical difference

OE > NE, OE > A

A22

< 0.0001

5.28680

5.71273

5.11230

Statistical difference

OE > NE, OE > A

A23

< 0.0001

5.32614

5.72671

5.14439

Statistical difference

OE > NE, OE > A

A24

< 0.0001

5.41244

5.83851

5.20321

Statistical difference

OE > NE, OE > A

< 0.0001

5.36929

5.76863

5.16043

Statistical difference

OE > NE > A

< 0.0001

4.16117

4.56056

4.10160

Statistical difference

OE > NE, OE > A

< 0.0001

4.55527

5.12112

4.45455

Statistical difference

OE > NE, OE > A

A28

< 0.0001

3.83355

4.52100

3.95187

Statistical difference

OE > NE, OE > A

A29

< 0.0001

4.33756

4.99845

4.51872

Statistical difference

OE > NE, OE > A

A30

< 0.0001

4.60610

4.98442

4.61497

Statistical difference

OE > NE, OE > A

A25 A26 A27

Trust in Work Team

A21

223

5.3.2 Confirming the Effects of Institutional Uncertainties on Trust Levels The results presented in Table 5-3, Table 5-4 and Table 5-5 on the levels of trust confirm the main thesis Hypothesis H1 and show many similarities with the literature review, which was also confirmed by our previous empirical data analysis in Chapter 4. According to the thesis’ classification of the companies, the data analysis of the New Economy companies group and Old Economy companies group present in many aspects, different characteristics which were already stressed in our previous literature review. Table 4 shows the analysis of the dimension, trust in the superior ,and suggests a different relationship between subordinates and superiors amongst the company grouping operating in the Old and New Economy. In the Old Economy, long run perspectives of socialization among corporate members within the company, are likely to produce stronger trust ties between subordinates and superiors, related to dependence on work related tasks and within specific situations related to disclosure of personal and sensitive information. Equally, Table 5 indicates that such strong trust ties are most likely to be found between hierarchical equals in the Old Economy. It suggests that in the Old Economy, peers are more likely to cooperate informally, facilitating, for instance, the tacit knowledge transfering process by sharing sensitive information. Results of Table 6 show that, in the Old Economy, people also trust more in their work team. It suggests that in the Old Economy companies work team related tasks are more likely to produce better informal cooperation and people’s willingness to expend extra efforts to solve problems and conflicts together.856 Such differences in the trust levels between the New and Old Economy suggest that the development of informal cooperation based on trust relationships is likely to produce better employee commitment and satisfaction in the Old Economy.857 On the contrary, the lower trust levels found in the New Economy companies suggest difficulties in developing informal cooperation in the New Economy, which suggests a different set of incentives to motivate employees. The analysis of the differences in the set of institutional features observed in our data set, in line with the previous literature review allows us many observations: The institutional environment of the companies operating in the New Economy was characterized in Chapter 3 as highly uncertain and unstable. Many features highlighted through the literature review and confirmed in the empirical data analysis, have supported these aspects. The New Economy companies were characterized as being relatively more dependent on technological innovations. Although continuous innovation activity might also be a strong characteristic of these companies, the dependence on technological change better highlights this feature. Most notably, the empirical data analysis shows that these companies are susceptible to suffering the impact of innovations in their markets, with a high frequency of change in technological and production systems (see Table 4-3). Compared to the Old Economy compa856 857

224

See Dirks/Ferrin (2001), p. 456. See Dirks/Ferrin (2001), p. 458.

nies, New Economy companies present in general a greater number of products, new products per year and significant modifications in existing products. Therefore, in line with the literature review, our data shows that research and product development activities are also relatively higher. It empirically confirms the assumption of relatively higher competitiveness associated with technological innovation and technological uncertainty in the New Economy environment. For instance, Walker and Weber (1987) accessed technological uncertainty and demand uncertainty using Likert-type scales from 1 to 5. Technological uncertainty was accessed though the frequency of change in product specifications and the probability of technological improvements. It was also observed that the planning processes of these companies are notably different from those of the Old Economy (see Table 4-4). The volatility of the elements used in the planning processes is relative higher, as well as the frequency of change in the market regulation (regulation uncertainty). The time reference used to forecast future demands was predominantly characterized as from 2 to 4 years, and the dominant time orientation for investments and expected results was characterized as ‘short-term’. The main input considered in the planning process was ‘human capital’ and market information (see Table 4-4). In contrast, Old Economy companies presented different figures. The time reference used to forecast future demands was predominantly characterized as from 5 to 10 years, and the dominant time orientation for investments and expected results was characterized as ‘long-term’. The main input considered in the planning process was ‘capital’ and market information. These observations highlight the level of demand stability and planning activities. For instance, in Walker and Weber (1987), demand uncertainty was accessed through demand fluctuations and uncertainty of volume estimates. Furthermore, as observed in Chapter 2, environmental uncertainty regards adaptation requirements, and it has a direct effect on human resources allocation and replacement. Under high levels of environmental uncertainty it might create an environment of high employment instability. In Chapter 3, Section 3.9, Tables 3-2 and 3-3 have already emphasized this feature in the New Economy, namely in the new telecommunications industry. In general, New Economy companies facing a high degree of uncertainty, demand more flexibility and decentralization in order to provide faster response to the market (see Chapter 3). Internally, it demands constant internal reorganization processes, like constant changes in the production processes and in the allocation of resources (informational, physical or human). Many of these aspects were highlighted in our empirical findings. As expected, New Economy companies facing high competition and environmental uncertainty, presented different HR policies profile (see Table 4-5). According to our analysis, the main HR driven policies in the companies operating in the New Economy, are focused on dealing with reorganization processes and in motivating their employees in order to cope with transition processes. The average employee retention is considerably lower, between 3.5 years and 4.5 years (see Table 4-5). It was also observed that there was a higher tendency to have frequent conflicts between concerns with 225

employees and concerns with results, and a frequent use of more subject data to measure employees’ performance was noted. Moreover, the employee evaluation system was notably based on their immediate superiors’ evaluation criteria, which suggests more idiosyncratic relationships. On the contrary, Old Economy companies presented performance systems based on more objective data and merit systems based on technical skills and team work evaluations. Career plans are appointed as the basic system for employees’ promotion (see Table 45). These features in regard to HR policies, highlight two different styles of managing human resources. They provide relevant evidence, on the assumption of this study, about the transition from the traditional model of relational contracts to more short-term transactional contracts.858 In this study, the characterizations of a company’s profile, through these features, are equally important to the validation of companies grouping. An important observation in this sense concerns the distribution of employees per working area. As observed in Section 4.6.10, the ‘Work Area’ category also presents significant statistical differences between the New Economy sample and the Old Economy sample (p-value NE) happen with relatively similar intensity and frequency per gender and age sub categories. These results are supportive and provide us with reasonable evidence that, when analyzing the statistical differences between the New Economy sample and Old Economy sample per age and gender sub categories, the significant statistical differences found in the trust levels (Table 5-3, Table 5-4 and Table 5-5) are not associated with the differences in gender and age categories. In other words, similar patterns of trust variables with statistical differences are similarly distributed in both gender and age sub categories. Once more, it leads us to reject the belief that demographic categories, namely gender and age, have a causal relationship with those significant statistical differences found in the levels of trust between the New Economy sample and the Old Economy sample. Therefore, the gender and age analyses reinforce the belief that institutional uncertainties, rather than individual characteristics, are the main cause for the differences found in the levels of trust between New Economy sample and Old Economy sample. To summarize, based on these results we conclude that the gender and age categories do not represent a relevant explanation for the statistical differences identified in the levels of trust between the New Economy sample and Old Economy sample. Although demographic profiles might change across industry-specific institutional frameworks, we confirm that they have a minor role in justifying the significant statistical differences found in the trust levels between

233

the New Economy sample and the Old Economy sample. In other words, we observe that trust is a highly sensitive variable that might change slightly due to demographic differences, but it changes drastically due to environmental uncertainties caused by different industry-specific institutional framework constraints.

5.4 Secondary Hypotheses Test The secondary hypotheses were designed to better illustrate the differences in relational contracting between the New Economy and the Old Economy. In this study the secondary hypotheses are also considered as validation hypotheses for the study. According to the literature review, it is to be expected that trust levels have a positive relationship with employee commitment levels. Therefore, the secondary hypothesis H2 is built upon the belief that the levels of trust will be positively related to employee commitment levels. Thus, New Economy companies, when compared to the Old Economy companies, will present lower levels of employee commitment. Moreover, it is also to be expected that relatively high employee turnover rates, create a perception of discontinuity of the employment contract affecting the perception of continuity of the employment relationship. Game theory shows that cooperation is difficult to sustain when the game is not repeated or there is a great probability for an end game. We believe that, by increasing employee turnover it considerably reduces the employees’ probability to trust in others, once his/her relationship with the company has a greater probability of not continuing to exist in the long–term. Therefore, we believe that employee turnover rates influence, and will be negatively related to, levels of trust. Thus, New Economy companies, when compared to the Old Economy companies, will present higher levels of employee turnover rates. These secondary hypotheses reinforce the belief that there are significant changes in relational contracting, between the companies operating in the New Economy and those operating in the Old Economy.

5.4.1 Test of the Relationship between Trust and Employee Commitment The first stage of the secondary hypothesis testing H2 (employee commitment) is the test of the relationship between the levels of trust and employee commitment measures. Firstly, the consistency checking was performed between some trust variables and some employee commitment variables (see Table 5-8). This test was previously performed to understand whether the relationship between the trust variables and employee commitment variables are aligned. The testing procedure was performed with different trust variables representing the three trust dimensions of the study. Equally, some employee commitment variables from the three different employee commitment dimensions were considered. The trust variables A2, A4, A7, A12, A14, A17, A22, A24 and A27 were chosen representing three different trust dimensions 234

of this study. For this stage, the employee commitment variables chosen were B39, B47, and B55, equally representing three different dimensions of employee commitment. The sevenitem Likert scale used in the questionnaire for respondents, was grouped into three categories: Agree, Disagree or Indifferent. The trust variables were checked for consistency with those response groups. As can be seen in Table 5-8, all groups presented low p-values in the consistency checking. The results demonstrate high consistency between trust variables and employee commitment variables. Secondly, after the consistency checking, it was possible to perform the test of correlation between some trust variables and the employee commitment variables (see Table 5-9). Correlation quantifies how well two variables (trust and employee commitment) vary together. In this stage all previous variables of the consistency checking were considered, and some additional employee commitment variables; they were B39, B40, B41, B46, B47, B49, B54, B55, and B56. The Spearman’s Rho test was performed using the JMP IN® 4 statistical software. P-values for this test present a strong statistical correlation between the trust variables and the employee commitment variables (Table 5-9). All Spearman’s Rho results were found in the positive zone.

Table 5-8: Consistency Checking between Trust and Employee Commitment Variables Group Means Test (Consistency Check B39)

TRUST VARIABLE

Group Means Test (Consistency Check B47)

Group Means Test (Consistency Check B55)

p-value

Agree

Disagree Indifferent p-value

Agree

Disagree Indifferent p-value Agree Disagree Indifferent

A 02

< 0.0001

5.6495

4.60779

5.04615

0.0005

5.4655

5.09786

5.28261

< 0.0001 5.8061 5.01138

5.41905

A 04

< 0.0001

5.8915

4.96096

5.21649

0.0012

5.7206

5.39755

5.48913

< 0.0001 6.0262 5.30243

5.65714

A 07

< 0.0001

5.3536

4.19162

4.80928

0.0141

5.1253

4.81288

5.03273

< 0.0001 5.4798 4.72000

5.07857

A 12

< 0.0001

5.5662

5.15224

5.34359

0.0006

5.5557

5.27134

5.2971

< 0.0001 5.8286 5.21591

5.40952

A 14

< 0.0001

5.7332

5.27761

5.43077

5.39939

5.40942

< 0.0001 5.8831 5.41110

5.59048

A 17

< 0.0001

5.3064

4.8597

5.14872

0.0030

5.07622

4.96014

< 0.0001 5.5293 5.00142

5.11905

A 22

< 0.0001

5.6412

4.85672

5.28205

0.0003

5.531

5.25000

5.30182

< 0.0001 5.754

5.18750

5.47733

A 24

< 0.0001

5.7654

4.96418

5.41538

0.0001

5.6631

5.36585

5.39273

< 0.0001 5.8972 5.30966

5.57279

A 27

< 0.0001

5.0258

4.06567

4.54872

0.0002

4.8896

4.53354

4.60727

< 0.0001 5.1919 4.44886

4.80668

< 0.0001 5.7209 5.2949

235

Table 5-9: Correlation Tests between Trust and Employee Commitment Variables Statistical Test

TRUST VARIABLE

COMMITMENT VARIABLE

p-value

Spearman Rho

A 02

B 39

< 0.0001

0.2829

A 04

B 40

< 0.0001

0.2694

A 07

B 41

< 0.0001

0.3060

A 12

B 46

0.0001

0.0950

A 14

B 47

< 0.0001

0.1208

A 17

B 49

0.0005

0.0860

A 22

B 54

< 0.0001

0.2454

A 24

B 55

< 0.0001

0.1935

A 27

B 56

< 0.0001

0.2353

These results confirm some previous studies that claim the positive correlation between trust and the employee commitment. The relationship between trust and employee commitment can be found in Pillai et al. (1999), Brockner et al. (1997), Ugboro (2003), Farrell (2003), Crossman/Lee-Kelley (2004), Lazzarini et al. (2004), and When/Kwon (2004). Some observations suggest a strong relationship between the building process of trust and employee commitment. Antecedents of both trust and employee commitment include perception of fairness, and mutual expectations.862 In Chapter 2, Section 2.7.2, we observed that both trust and employee commitment relies on long-term expectations and require long-term strategies to develop. Following on from this, the levels of employee commitment are analyzed.

5.4.2 Levels of Employee Commitment The second stage of the secondary hypothesis H2 testing is the analysis of the levels of employee commitment by mean comparison, namely the Analysis of Variance, for the two samples: the New Economy sample and the Old Economy sample. Alternatively the Alternative sample is also analyzed. The p-value, false positive error, used for statistical significance was p < 0.01. Confirming the relationship between trust levels and employee commitment, it is to be expected that New Economy companies will present low levels of employee commitment. Table 5-10 presents the comparative analysis of the employee commitment variables. Results confirm the secondary hypothesis H2. As can be seen, the p-values show a strong statis-

862

236

See, for instance, fairness as antecedent of trust in Ouchi (1980/1998), p. 250, Kreps (1990), p. 124, and Keefer/Knack (2005), p. 716, as antecedent of employee commitment in Guest (1997), pp. 21-22.

tical difference between the New Economy sample and the Old Economy sample. Almost all employee commitment variables preset p-values smaller than 0. 0001 indicating strong statistical difference between these samples. Alternatively, the Alternative sample analysis corroborates the relationship between trust levels and employee commitment levels. As the trust levels comparison among trust dimensions showed before (see Table 5-3, Table 5-4 and Table 5-5), in most of the trust variables, the Old Economy sample presents significant statistical differences when compared with the Alternative sample. In the majority of the trust variables, the Old Economy sample presents higher levels of trust than the Alternative sample. Following this tendency, Table 5-10 shows that the Old Economy sample, when compared with the Alternative sample, presents significant statistical differences related to the employee commitment variables. In all of the employee commitment variables, the Old Economy sample is significantly greater than the Alternative sample. Moreover, half of the employee commitment variables show a significant statistical difference between the Alternative sample and the New Economy sample. In most of the employee commitment variables, the New Economy sample is significantly greater than the Alternative sample. Considering the employee commitment variables, overall results show that the New Economy sample presents the lowest levels of employee commitment in comparison with the Old Economy sample. It allows us some observations on the differences between those two groups of companies.

237

Table 5-10: Employee Commitment Variables Comparative Analysis Means Variable

Dimension

p-value

Observation New Economy

Old Economy

Statistical Difference

Alternative

< 0.0001

3.33291

4.26087

3.38503

Statistical difference

OE > NE; OE > A

B 40

< 0.0001

3.46633

4.03876

3.74332

Statistical difference

OE > A > NE

< 0.0001

3.94790

4.38975

4.02139

Statistical difference

OE > NE; OE > A

B 41

< 0.0001

3.75508

4.22636

3.92473

Statistical difference

OE > A > NE

B 43

< 0.0001

3.37357

4.09457

3.53476

Statistical difference

OE > NE; OE > A

B 44

< 0.0001

3.76142

4.32558

3.94118

Statistical difference

OE > A > NE

B 45

0.0001

3.35787

3.61395

3.47594

Statistical difference

OE > NE; OE > A

B 46

< 0.0001

3.30584

3.72981

3.50802

Statistical difference

OE > A > NE

< 0.0001

3.31258

3.94264

3.52406

Statistical difference

OE > A > NE

< 0.0001

2.46252

3.03721

2.60963

Statistical difference

OE > NE; OE > A

B 47 B 48

Continuity

B 42

Affective

B 39

< 0.0001

2.40280

2.95483

2.66310

Statistical difference

OE > A > NE

B 50

0.0001

2.60483

2.85226

2.69355

Statistical difference

OE > NE; OE > A

B 51

< 0.0001

2.28299

2.80155

2.39037

Statistical difference

OE > NE; OE > A

B 52

< 0.0001

2.46193

3.14729

2.71123

Statistical difference

OE > A > NE

< 0.0001

2.32614

2.83981

2.43011

Statistical difference

OE > NE; OE > A

B 53 B 54

Normative

B 49

< 0.0001

3.55964

4.18295

3.80214

Statistical difference

OE > A > NE

B 55

< 0.0001

2.67513

3.12558

2.71658

Statistical difference

OE > NE; OE > A

B 56

< 0.0001

3.19670

3.97054

3.39572

Statistical difference

OE > A > NE

Confirming some previous empirical studies, our empirical data analyses lead us to accept a positive relationship between employee commitment and trust. We observed before, in the literature review, that this positive relationship exists in a way that individuals’ predisposition to trust, might significantly foster employee commitment. Employee commitment measures, regard the companies’ capacity to retain employees for long-term relationships. Employee commitment is also considered essential for organizational change and the development of this subject has been intimately connected to the management of cultural change.863 It ultimately measures employees’ attachment to the organization and, added to other measures like trust levels, it measures the effectiveness of implicit internal mechanisms to deal with organizational change. As observed before, Legge (1995) comments that employee commitment measures are the best predictor of actual labor turnover (motivated by the employee) and have a strong relationship with employee satisfaction and motivation, and a moderate relationship

863

238

See Legge (1995), p. 174, and Tosi et al. (1994), p. 259.

with performance. Legge (1995) observes that empirical evidence has shown a strong positive relationship between commitment and employee motivation and satisfaction, and a negative relationship between commitment and turnover. Employee commitment is an important predictor of intentions to leave. Therefore, the author states that commitment is the best predictor of labor turnover.864 These observations are aligned with Vroom (1995) who also claims there is a relationship between job satisfaction and employee turnover rates and only a partial relationship of job satisfaction and job performance.865 In this work we use the employee commitment measures from Meyer and Allen (1997). Their scales access employee commitment through three dimensions: affective commitment – based on emotional attachment to the organization; it involves the idea of wanting to remain in the organization, having experienced membership positively; continuance commitment – based on calculative reasoning as a decision to remain with the organization because of the costs of leaving; it involves personal investment in the relationship with the organization and lack of alternative employment opportunities; normative commitment - based on normative bases as the sense of obligation to continue with the organization for reasons of loyalty; it feels that one ought to remain with the organization because of personal norms and values. McGee/Ford (1987), building on Meyer and Allen’s work note that continuance commitment has two separate components, one concerned with sunk costs and the other with a lack of alternatives. According to Guest (1992), affective commitment is linked to effort while continuance commitment with labor turnover (motivated by employees). Moreover, continuance commitment is a precondition to build any strong corporate culture.866 Ugboro (2003) found a high relationship between trust and commitment, especially with affective commitment. He found that downsizing reduces affective commitment and increases job insecurity. Also Ashford et al. (1989) found a strong inverse correlation between commitment and job insecurity.867 These results are consistent with the literature review and characterize the companies operating in the New Economy differently than the companies operating in the Old Economy. It leads us to believe that New Economy companies have less concern or capacity to retain employees. It means significantly less concern or capacity to build social mechanisms based on employees’ affective-emotional attachments and on calculative reasoning. The observations on employee commitment levels support and also stress the tendency about the transition to more short-term transactional contracts.868 As observed, this has strong consequences for the New Economy companies’ capacity to create employee motivation and satisfaction. We observed that a decrease in employee commitment also means a proportionate decrease in an

864 865 866 867 868

See Legge (1995), p. 183. See Vroom (1995), p. 218. See Legge (1995), p. 181. See Ashford et al. (1989), p. 823. See Burton-Jones (1999), pp. 52-53. 239

employee’s sense of loyalty, the company’s capacity to manage organizational change and in employees’ extra effort, and an increase in job insecurity.

5.4.3 Employee Turnover Rates The secondary hypothesis H3 (employee turnover rates) is also tested by means comparison. It is expected that the employee turnover rates influence and will be negatively related to levels of trust. Thus, New Economy companies, when compared to the Old Economy companies, will present higher levels of employee turnover rates. Private data collected from the studied companies, confirms the secondary hypothesis H3. The overall employee turnover rates were considered, both motivated by employer and by employee (dismissal, resignation or retirement). As it can be observed in Table 5-11, the New Economy company group present significantly higher employee turnover rates when compared with the Old Economy companies group – 24.02% of the New Economy companies group against 4.23% of the Old Economy companies group. Results confirm the secondary hypothesis H3.

Table 5-11: Employee Turnover Rates Comparison Employee Turnover Rates Company \ Year

2004

2003

2002

Telecom 1

37.32

39.00

18.00

Telecom 2

19.50

16.42

Telecom 3

21.10

16.85

Steelworks

4.33

4.71

4.69

5.00

Mining

3.70

3.90

4.40

2.16

Petrochemical

3.40

3.02

3.59

7.94

P-value

2001

< 0.0001 Means

New Economy

24.0271

Old Economy

4.2367

It can be observed that the New Economy sample with low levels of trust also presents the highest employee turnover rates. Moreover, the Media company presented the following employee turnover rates: 20.94% in 2003; 19.07% in 2002; 18.36% in 2001; and 17.49 in 2000. The mean is 18.96%. By observing the levels of trust of the Alternative sample, it also confirms the tendency of the relationship between high employee turnover rates and low levels of 240

trust. This negative relationship provides empirical evidence that levels of trust are related to the prospects of employment contract termination. Empirical evidence has already shown a relationship between trust and turnover intentions. For instance, Albrecht/Travaglione (2003), and Aryee et al. (2002) have found a negative relationship between trust and employee turnover. Moreover, empirical works have demonstrated a consistent relationship between employee turnover rates and job satisfaction which ultimately are relatively related to job performance.869 This is consistent with some recent findings from the US Department of Labor that the number-one reason for people to leave their jobs has nothing to do with pay or promotion, but with satisfaction.870 Van den Steen (2003) observes that employee turnover weakens organizational culture since new employees do not possess the same information as the old ones.871 Research evidence has demonstrated negative relationships between organizational commitment and both absenteeism and turnover intentions.872 Cotton and Tuttle (1986) performed a meta-analysis through a literature review and observed that employee turnover has a strong negative relationship with overall job satisfaction, satisfaction with the work itself, pay satisfaction, satisfaction with supervision and organizational commitment (the p-value reported was p < 0.0005).873 They observed an industry variable, a manufacturing versus service classification. In line with our study, they found that in manufacturing organizations, there are more reliable effects due to the presence of a union on turnover, than there are in service organizations. According to the authors, the greater influence of unions on turnover may be because unions are concentrated in manufacturing industries with greater power and overall importance. In contrast, some authors like Dalton and Todor (1982) observed that turnover may not be inherently a negative phenomenon.874 They understand that there are a variety of positive consequences for turnover. They observe that, to the extent that turnover is not excessive, that is, its costs do not exceed its benefits, a large amount of money might be saved each year by a reasonable level of turnover. Turnover costs are associated with the compensation system and decisions about contracting new workers and maintaining old workers.875 In this sense, Lazear (1998) argues that there is no unambiguous statement that can be made, however, some factors might influence the optimal ratio of younger and older workers. As for example, an industry with rapid technological change, because technology is often embodied in the new entrants, and when the amount of skills learned on the job is low relative to the amount learned in formal programs before entering the labor force.876 869 870 871 872 873 874 875 876

See Vroom (1995), p. 218 and Legge (1995), p. 183. See Gallup Institute (2004). See Van den Steen (2003), pp. 15-16. See, for instance, Hom et al. (1979), Angle/Perry (1983), and Pierce/Dunham (1987). See Cotton/Tuttle (1986), p. 63. See Dalton/Todor (1982). See Brickley et al. (2001), p. 346, Milgrom/Roberts (1992), pp. 344-348, and Lazear (1998), pp. 169-172. See Lazear (1998), p. 172. 241

Dalton and Tudor (1982) note that the costs of turnover are highly visible to administrators, and very easy to be taken into account.877 However, the authors claim that it is important to consider a cost-benefit analysis to understand at what point the cost of preventing turnover exceeds the cost of the turnover itself. Whether or not employee turnover is advantageous or disadvantageous to companies is not our focus in this study. Particularly in this work, it is important to analyze the consequences of sustaining high employee turnover rates as a strategy. These practices lead to many sideeffects on the work force. Game theory shows that cooperation is difficult to sustain when the game is not repeated or there is a great probability of an end game. According to Hardin (2002) the chief enemy of maintaining trust relationships is the collapse of ongoing interactions in face of anything that might disrupt it. He claims: “sudden escalations of the stakes that lets one or the other of us treat the next round of our interaction as through it were part of new, perhaps only one-shot, interaction.”878 In this sense, Axelrod (1984) observed that turnover might be a problem to promote cooperation within organizations.879 As well illustrated in Game theory, according to repeated-game approach, if you understand my long-term self-interest, you might trust me not to yield to certain short-term temptations. In this sense, employee turnover rates strategies impact on trust levels and organizational performance. By increasing employee turnover it reduces considerably employees’ probability to trust in others, once his/her relationship with the company has a greater probability of not continuing to exist in the future. At the same time, employees may not make a best effort to achieve the company’s objectives in the short-run or the best effort might be achieved only by strong short-term monetary rewards. For example, high employee turnover may intimidate employees to trust others in order to share sensitive information, since they will try to keep their jobs avoiding risky relationships. We asked HR managers mainly from the telecommunications companies to explain the reasons of such employee turnover rates. Most of the reasons given by these managers were budgetary and concerned with expected results; therefore downsizing is mostly used as an organizational strategy. Since the level of uncertainty is relatively higher, companies use an organizational headcount reduction as a cost-cutting strategy, also to cope with reorganization processes in the event of redundancy. None of the study companies justified their employee turnover rates in terms of a knowledge management strategy which means, acquiring new skilled labor by replacing workers. Although it would make sense to think about such a strategy for the management of telecommunications companies (New Economy companies) to deal with high technological obsolescence, it was not the main concern of HR managers in the interviews.

877 878 879

242

See Dalton/Tudor (1982), p. 213. Hardin (2002), p. 145. See Axelrod (1984), p. 183.

Based on the perspective of contract termination, we focus on the fact that high employee turnover rates sustain high perceptions of employment relationship termination and it negatively influences the levels of trust within the companies. As we have observed, due to a particular framework characteristic, companies operating in the New Economy have been working under constant high uncertainty. We find that high environmental uncertainty about outcome, performance and job keeping is not the only cause of high job stress and instability, but also, as we focus on this work, the cause of trust relationships weaknesses. Therefore, our observations on the high employee turnover rates of companies operating in the New Economy complement the condition of low trust levels under the influence of high institutional uncertainties. As we observed it has ultimate consequences for job satisfaction and motivation.

5.5 Main Theoretical Implications Empirical research findings have confirmed and validated many theoretical beliefs and assumptions. In this Section we introduce those main implications and theoretical links.

5.5.1 The Major Influence of Industry-Specific Institutional Frameworks This work has provided new insights into the New Institutional Economics studies on the relationship between institutional environment and organizational behavior.880 Specifically, this work has provided new insights for a better understanding of the influence of environmental uncertainties from different industry-specific institutional frameworks on organizational trust development as an implicit governance mechanism. Aligned with this research, the New Institutional Economics has recently approached some particular issues related to institutional change and trust, and uncertainty related to product innovation, new product development and new market creation.881 This study acknowledged and confirmed the major influence of industry-specific institutional frameworks on organizational trust. As approached in this work, the study observes different ways of governing relational contracting, which suggests the application of different incentive structures to deal with environmental uncertainty. By confirming the main hypothesis of the thesis, this study provided empirical evidence that, companies acting under different industry-specific institutional framework constraints will result in having different capacities to develop trust levels within their hierarchies. More specifically, we verified that under the effects of relatively higher uncertainty and instability from industry-specific institutional framework, the companies operating in the New Economy have significant limitations in developing required structuring elements to create and sustain organizational trust. Also, by observing another company (Media) under an alternative industry-specific institutional ar880 881

See, for instance, North (1990 and 1993) and Williamson (1975, 1985 and 1996). See, for instance, Keefer/Knack (2005) and Anderson/Gatignon (2005). 243

rangement, this study confirmed this finding and highlighted the fact that alternative institutional arrangements might also combine other organizational elements from the previous groups allowing other observations on the ways that trust develops. This empirical evidence leads us to acknowledge the existence of different management styles which might be favored according to industry-specific institutional arrangements. In this sense, this study acknowledges that a trust-based management style might be efficiently developed according principally to those macro institutional uncertainties, as constraints. Additionally, this study also has close connections with, and its empirical results provide valuable information for, structural-contingent model theorists.882 The structural-contingency model has been used both by those who focus on environmental and those who focus on technological concepts. The structural-contingency model explores the association between measures of organizational structure and of environmental uncertainty and related measures of complexity, innovation, competition and instability. In particular, this research validates assumptions of some earlier works, on the influence of the institutional framework and environmental uncertainty on organizational characteristics, like Gordon’s (1991) work on the assumption of industrial determinants on organizational culture formation, and Hrebiniak and Snow’s (1980) work on the industrial differences in environmental uncertainty and organizational characteristics related to uncertainty.

5.5.2 New Economy and Old Economy: Singular Organizational Systems This work contributes to the validation of many claims of New Economy theorists.883 We found significant differences between the New Economy and the Old Economy. The New Economy and the Old Economy constitute two different organizational systems in many aspects coexisting at the same time in the contemporary economy, having different dynamics regarding managerial practices, organizational structures, market strategies, and HR policies. Due to notable institutional differences in the nature of their economic activities and historical processes, these two groups of companies have different organizational elements and management styles. By investigating the influence of specific institutional arrangements on the levels of trust within the companies operating in the New Economy, this study has provided empirical evidence of significant changes in the nature of employment contracts and work conditions, as a consequence of the New Economy.884 By approaching trust from a cross-industrial comparison perspective it was possible to identify distinct organizational environments coexisting in the present economy. In this sense, this study confirms notable differences in the institutional arrangements of the ICT industries, 882 883 884

244

See, for instance, Burns/Stalker (1961), Duncan (1973), Hrebiniak/Snow (1980), Gordon (1991), Rothwell (1992), and Tosi et al. (1994). See, for instance, Webster (1995), Castells (1996/2000), Burton-Jones (1999), Audretsch/Thurik (2001), and Argandona (2003). See ILO/OEDC (1997), and ILO (2001).

here specifically the new telecommunications companies, in line with the assumptions of some New Economy theorists. The proposed companies grouping was confirmed. The core difference identified by this study among the companies chosen to represent the New Economy and those of the Old Economy, lies in the intensity and impact of the rupture that technological changes might create for such organizations impacting on future demand estimates. In conceptualizing the New Economy, we observed that, although continuous innovation processes might be frequently found with relatively more intensity within the New Economy companies, what can better characterize these companies is their dependence on technological ruptures. Estimates of future demand are strongly compromised by technological change and competition, which are ultimately related to institutional change.885 Those theoretical assumptions were confirmed through our empirical data in Section 4.5, by observing companies’ capacity to predict demand estimates, intensity of technological and production systems change, and consequently the impact of such organizational variables on the work environment. As a consequence of its institutional framework, in the New Economy, the nature of the work, the work force profile and work conditions were characterized as very dissimilar in comparison to traditional work in the Old Economy. We could observe that different management styles use different criteria, for selecting mechanisms, under different industryspecific institutional frameworks. In this sense our empirical survey confirms some previous studies on selecting mechanisms used, by industry type.886 Consequently, the demographic profile analyses of these two groups of companies were significantly different. For example, it could be verified that management select by age, gender and education. The companies operating in the New Economy presented a better educated and younger work force, with more gender balance. It confirms the assumptions already claimed by some New Economy theorists, like Argandona (2003).887 Moreover, it could be seen through our data analysis that industryspecific institutional frameworks affect differently employees’ perceptions of mutual advantage, preferences and perspectives about the future (see Section 4.6.8 and 4.6.10). Aligned with the previous assumptions of some New Economy theorists, the New Economy companies were characterized by relatively more knowledge-intensive work within network-based organization forms, which admit more complex and specialized tasks. It was acknowledged that the traditional mechanisms of performance control, monitoring and measuring may be less adequate when faced with the new demands of work activities based on information and intensive knowledge application. We characterized the work profile in such companies as multifunctional, complex and marked by variable routines. We observed that a central feature of work in the New Economy is dealing with uncertainty. On the contrary, in the Old Economy companies the work profile is relatively more stable. Old Economy companies were characterized by operating under relatively lower uncertainty. As shown in Section 4.5.3, a relatively lower 885 886 887

See North (1993), pp. 249-250, North (1990), pp. 7 and 84, and North (2005), p. 22. See, for instance, Perry et al. (1994) and Slonim (2004). See Argandona (2003), pp. 15-16. 245

frequency of technological and production systems change, define more stable routines and higher predictability. Such a stable environment is reflected in employment contracts. For instance, we found that Old Economy employees spend on average 12.5 years in their jobs as opposed to a maximum of 4 years in the New Economy companies. Moreover, by asking employees to freely express their feelings about their work environment, we found that employees in the Old Economy companies expressed more positive feelings about their company, the management and their welfare conditions (see Section 4.6.8 and Appendix 2). In contrast, employees in the New Economy companies emphasized some negative aspects of their work environment, like general negative work conditions, no management concern about employees’ welfare, high uncertainty about their future, job insecurity and excessive work hours. We acknowledge these empirical findings aligned with the ILO (2002) report on the critical problem of the quality of new work posts in the New Economy.888 Finally, through confirmation of our hypotheses we observed that Old Economy companies present significantly lower employee turnover rates, higher employee commitment and higher trust levels, which suggests higher job satisfaction and motivation created by the social elements built around long term perspectives and interactions. We acknowledge that these observations partially confirm the theoretical model presented in Section 3.5, earlier proposed by Burns and Stalker (1961), and later improved by Rothwell (1992) and Tosi et al. (1994).889 Burns and Stalker’s (1961) original model of an ‘organic’ firm in a rapidly changing environment contrasts with a ‘mechanistic’ firm in a relatively stable commercial and technical environment. Tosi et al. (1994) characterize an ‘organic’ organization model, referring to the companies which operate under high technological and market volatility, which are the main characteristics of the companies operating in the New Economy.890 Such an ‘organic’ model is characterized by more flexible and decentralized organizational structures, operating under an environment of strong change and tending towards the creation of greater conflict among staff. Such companies are defined by the authors as job-shop-oriented, in which jobs are available according to the reorganization of the production elements. Such a claim was well illustrated in Hypothesis 3 by observing high employee turnover rates in the New Economy. On the other hand, the ‘mechanistic’ organization model closely illustrates the Old Economy companies operating under a more stable environment and considerably lower employee turnover rates. What is notable in this work, according to our empirical findings, is that HR driven policies in the companies operating in the New Economy are very different from those in the Old Economy (see Section 4.5.5). In the New Economy they are focused on dealing with reorganization processes by motivating employees to cope with constant adaptation. A higher tendency to have frequent conflicts between concerns with employees and concerns with results, was also observed. Also a frequent use of more subject data to measure employees’ performance 888 889 890

246

See ILO (2002), p. 145. See Burns/Stalker (1961), Rothwell (1992), pp. 228-229, and Tosi et al. (1994), p. 40. See Tosi et al. (1994), p. 40-42.

was noted. Moreover, the employee system evaluation was notably based on immediate superiors’ evaluation criteria, which suggests performance evaluation systems based on more idiosyncratic relationships. On the contrary, Old Economy companies presented performance systems based on more objective data and long term perspectives, merit systems based on technical skills and team work evaluations. For instance, a career plan was indicated as the basic system for employees’ promotion (see Table 4-5). These features regarding HR policies highlight two different styles of managing human resources.

5.5.3 New Economy: Moving towards Transactional Contracts This work empirically confirms the general tendencies already noted by some recent studies of the International Labour Organization (ILO) and the Organization for Economic Cooperation and Development (OEDC) that have provided evidence of significant changes in the nature of employment contracts and work conditions worldwide as consequences of the New Economy891. Also the affirmation of some New Economy theorists on the increase of flexible contingent contracts and its impact on human relationships, as one of the main features observed in the New Economy.892 Through our empirical results we confirmed notable differences in relational contracting between the Old Economy and the New Economy. Most notably, the major influence of specific institutional arrangements on the levels of trust within the companies operating in the New Economy, provided us with strong arguments about notable changes in relational contracting. By comparing these two institutional arrangements, we observe that, in the New Economy, labor contracts have moved from a relational contracting mode to a more transactional contracting mode.893 Accordingly, work conditions in the New Economy were also characterized as unstable and uncertain, under more short-term transactional perspectives.894 In order to provide a good picture of relational contracting in the New Economy, we chose the analysis of trust levels with employee turnover rates and employee commitment levels. Through the literature review it was observed that employee commitment was strongly associated with motivation, and employee turnover is negatively associated with job satisfaction and motivation (see Section 2.7.2). Therefore, we acknowledge these hypotheses support the obtaining of a better description of the possible consequences of institutional changes on relational contracting in the New Economy. Trust was acknowledged as central to the understanding of relational contracting and the analysis of its mediating role provided valuable information for companies to monitor and evaluate their policies relative to the creation and maintenance of such complementary social mechanisms. 891 892 893 894

See ILO/OEDC (1997), and ILO (2001). See, for instance, Pfeffer (1994), p. 24, Burton-Jones (1999), pp. 46-48, ILO (2001), pp. 282-283, and Gallagher (2002), pp. 115-132. See Burton-Jones (1999), pp. 52-53. See, for instance, Burton-Jones (1999), pp. 52, and ILO (2001), pp. 288-289. 247

By analyzing the relationship between trust, employee commitment and turnover rates, the secondary hypotheses could be confirmed. We observed that employee commitment measures are the best predictor of actual labor turnover (motivated by the employee) and that it has a strong relationship with employee satisfaction and motivation, and a moderate relationship with performance.895 Moreover, employee commitment has been intimately connected to the management of cultural change.896 Our tests confirmed some previous studies relating trust variables and employee commitment variables. A strong statistical correlation was found between some of the trust variables and the employee commitment variables (see Section 5.4.1). Confirming the secondary hypothesis H2, all employee commitment variables presented strong statistical differences between these two samples. As a result, we observed that New Economy companies presented less concern in retaining employees or creating their attachment to the organization, to generate long term employee motivation and satisfaction, and to take into account social mechanisms, like trust, to promote organizational change. Additionally, employee turnover rates from the two company groups were analyzed in order to test the secondary hypothesis H3. As we observed, employee turnover is related to organizational culture management and has a strong negative relationship with overall job satisfaction, satisfaction with the work itself, pay satisfaction, satisfaction with supervision and organizational commitment.897 Confirming the secondary hypothesis H3, it confirmed the belief that the New Economy group of companies presenting low levels of trust, would present high employee turnover rates. On the contrary, in the Old Economy group of companies, high levels of trust were associated with low employee turnover rates. Aligned with game theory postulations, Hypothesis H3 provided us with evidence about the relationship between trust and perspectives of contract termination. These hypotheses capture the tendency of a transition from long-term relational contracting modes to more short-term transactional contracting modes.898 Finally, the above observations lead us to conclude the existence of two different management styles, in order to deal with different environmental variables under conditions of relatively high and low uncertainty. Such styles show different employees’ behaviors and preferences (see Section 4.6.10). In the New Economy, employees are more focused on the short term perspectives; they are more competitive, show preferences to remain working for the company from two to five years at the most and have lower expectations of mutual benefits. On the contrary, in the Old Economy, employees are more focused on the long term perspectives, they are more cooperative, show preferences to remain working for the company for more than five years or until retirement and believe or expect that their relationship with the company will produce mutual benefits in the long-term. 895 896 897 898

248

See Legge (1995), p. 183. See Legge (1995), p. 174, and Tosi et al. (1994), p. 259. See, for instance, Cotton/Tuttle (1986), p. 63, and Van den Steen (2003), pp. 15-16. Burton-Jones (1999), pp. 52-53.

5.5.4 Validation of Game Theory Application This empirical study has confirmed and validated the application of Game Theory as an influential tool in the study of human relationships in social groups from an economic perspective.899 Observing the New Economy’s institutional environment, we took the insights of Rational Choice Theory approach, to structure our hypotheses (see Chapter 4). We noted that most of the internal trade among members of organizations is realized by repeated transactions. The thesis took the perspective of repeated-games to illustrate the changes to relational contracting. We observed that when people interact over a period of time, threats and promises concerning future behavior may influence current behavior and repeated games captures this fact of life. Following the game theory logic, it was observed that reducing the probability of future encounters, between interactive partners, also reduces the chances for people to develop trust relationships. By confirming our hypotheses, this study confirmed and validated the useful application of game theory insights in order to illustrate social interactions between members of a given social group.

5.5.5 The Paradox Based on the literature, this study also suggests some specific situations in which the development of trust would be more appropriate than the application of explicit monitoring and control mechanisms (see Section 2.7). However, our empirical study suggests a paradox. Even when organizational tasks require the development of trust as a more efficient mechanism, industry-specific institutional constraints significantly limit the development of trust within those organizations. The New Economy environment suggests that trust could be highly desirable as an implicit control mechanism to coordinate specific tasks linked with the nature of information and knowledge-intensive production systems.900 However, limiting institutional factors, namely environmental uncertainties, present problems for the adequate development of trust. In other words, even if trust is highly desirable, this study provided strong evidence that New Economy companies have considerable constraints in developing trust as an efficient mechanism due to high uncertainty and instability.

899 900

See, for instance, Hardin (1971), Axelrod (1984), Kreps (1990), Wolff (1995), Casson (1997), Gibbons (2000), Binmore (2000, 2002), and Ricketts (2002). See, for instance, Adler (2001), p. 215-217. 249

5.5.6 Trust Properties and Dimensions Through the analyses of our empirical results, beyond the observations on the major role of environmental uncertainties from industry-specific institutional frameworks, it was also possible to observe that trust is a very sensitive variable that can be affected by other related variables. Confirming some empirical works on trust development of some organizational theorists, we also observed that trust develops differently among different trust dimensions, demographic variables and social context.901 In this study three different trust dimensions were measured: trust in the supervisor, trust in a peer and trust in the work team. We could observe that trust levels differ significantly among them. Considering the overall results of the total sample, trust in a peer was identified as greater than trust in a superior, which ultimately is greater than trust in the work team (see Section 5.1). Moreover, many cross checking tests with the trust variables were performed in order to understand how individual characteristics, like gender and age categories, could be influential variables in our results. We observed that, although the sample size was not primarily designed to access trust per gender or age category, it was possible to perform some tests in order to support our main hypothesis and to perform the validity checking of the database. As a result, similar statistical differences between the New Economy sample and the Old Economy sample were fairly equally present among gender and age sub categories confirming the major role of institutional uncertainties. Although it was not a major justification for the significant changes found between the trust levels of different groups of companies, this study could also confirm the previous literature review on the relationship between trust, age and gender. We could observe the tendency, predicted by some theorists, for trust to change almost linearly with age and slightly with gender.902 Supporting our belief, we observed that our empirical results provided us with consistent evidence that the differences found in the levels of trust between the New Economy and the Old Economy do not lie in individual characteristics, but mainly in environmental uncertainties as industry-specific institutional constraints. In other words, we observed that trust is a highly sensitive variable that might change slightly due to demographic differences, but changes drastically due to environmental uncertainties caused by different industry-specific institutional framework constrains.

5.5.7 Trust and Performance This study provided valuable information about a company’s market performance (see Section 4.5.6). The market performance analysis provided another perspective that differentiates the New Economy and Old Economy company grouping, and from which to understand better

901 902

250

See, for instance, Zand (1972), Cook (2000), and Gillespie (2003). See, for instance, Fehr et al. (2003), Bellemare/Kröger (2003) and Sutter/Kocher (2003).

the relationship between trust and organizational performance. In this sense, we observed that there is no direct causal link between trust and a company’s market performance. This study has emphasized that trust is one element of organizational performance; however trust is not a determinant of organizational performance. A better performance evaluation of these scenarios is, however, more complex and more dependent on other contextual variables. Trust is one organizational performance variable that should be evaluated according to specific contexts and organizational demands. We observed that the costs of having trust mediating transactions among company members compared with the costs of having explicit contractual agreements must be analyzed from the perspective of the costs imposed by industry-specific institutional constraints, which are most affected by environmental uncertainties. In this study additional performance data was analyzed showing that a high trust context in one Old Economy company was positively related to better market performance (see Section 4.5.6). In contrast, bad market performance contexts found in two companies operating in the New Economy were negatively related with trust. We acknowledge these results as not conclusive, because they cannot establish a causal relation, but valuable to the understanding of trust and performance, addressing these issues for future research. Therefore, beyond the validation of the companies’ classification, the placement of the levels of trust within their specific business contexts provides relevant empirical data addressing these issues for more comprehensive future researches. We acknowledge that our performance results are in line with some theoretical assumptions largely claimed by scholars such as Kreps (1990), Chiles and McMackin (1996) and Butter and Mosch (2003), on the positive aspects of trust decreasing transaction costs and improving performance. As observed in Section 2.6.2, previous empirical works on the relationship between trust and performance have already confirmed the positive aspects of a trust-based management style. For instance, Dirks and Ferrin’s (2001) meta analysis on trust studies, provides a list of empirical works on the positive relationship between trust and individual performance, group performance and unit performance.903

903

See Dirks/Ferrin (2001), pp. 453-454. 251

6. Conclusions and Outlook Trust was approached in this study from the economic perspective as an implicit complementary control mechanism within hierarchies. We choose the theoretical background from Transaction Costs Theory (TCE), Economic Contract Theory and Agency Theory to explore how trust works within business organizations. We observed that the central idea of trust studies applied to management, lies in the fact that it might become a competitive advantage to create and sustain a trust-based managerial style. Trust is fundamentally important, as an implicit motivational element, to allow economic exchange built on a consensual basis through the lens of the perception of mutual benefits and advantages. To a certain degree, it plays a central role within all human relationships and becomes relevant to intraorganizational exchange. In times of high competition with companies presenting similar products and prices, the quality of the relationships within the companies might be a considerable cost-cutting advantage. Scholars on trust studies have claimed that a high trust social context avoids opportunistic behavior and fosters high risk investments, reducing transaction costs and increasing organizational efficiency. However, this study stressed that such an advantage might be achieved according to specific contexts considering a cost-benefit analysis.904 We observed that trust might be highly important to motivate employees; however it is not a determinant variable for employee motivation. Explicit motivational elements such as monetary rewards, play a crucial role and they have been largely used by management. Therefore, this study suggested that management should identify its needs and its capacity to create and sustain a trust atmosphere within the organization observing some institutional and organizational variables. It is important to consider at what point the cost of sustaining a trust-based management style exceeds its benefits. In this sense, this study also identified some specific situations in which the development of trust, would be more appropriate than the application of explicit monitoring and control mechanisms. We observed that, mainly in modern enterprises where the knowledge transferring and information sharing processes are crucial for the company’s value-added creation, trust plays a very significant role, because it allows interactive partners to exchange freely without being afraid of a partners’ opportunistic behavior, also building a common sense of fairness and mutual benefits, and solving possible problems of ambiguity in performance measures. Together with the insights of game theory, some fundamental elements for coping with the trust-building process were also identified in this study, like environmental stability, time of interaction and information about partners, and maintenance of the reputation system. However, it has been also identified that in the main institutional frameworks affect those elements, and therefore trust, in many ways. By observing this, this work has focused on the effects of environmental uncertainty created by industry-specific institutional arrangements, on 904

See Wolff (2000), p. 2. 253

the levels of trust within business organizations. The objective was to understand whether trust changes under different industry-specific institutional frameworks. More specifically, this study argues that the combination of some sources of institutional uncertainties (specifically technological uncertainty, demand uncertainty, and regulatory uncertainty) impose significant constraints on the development of trust within business organizations. The main argument of this study is that different industry-specific institutional frameworks shift a set of specific parameters for corporate governance which might restrict and alter the ways of governing relational contracts. Consequently we argue that different industry-specific institutional framework constraints impose a different capacity for trust development within business organizations resulting in different levels of trust. Following the Rational Choice Theory approach, we took the observations of the New Economy institutional environment to structure our hypotheses. In this sense, this study has made an effort to validate the differences found between two different institutional environments, New Economy and Old Economy, through literature review and collection of empirical quantitative and qualitative information, using the comparative case study method. It was observed that high levels of uncertainty and instability can better characterize the business environment where the companies of information and communication technologies (ICT) industry operate under the paradigm of the New Economy. The New Economy companies were characterized, in comparison to the Old Economy companies, by network-based organizations which involve more complex and specialized tasks based on the application of information and intensive knowledge, in which the traditional mechanisms of performance control, monitoring and measuring, might be less effective. Such companies operate in an environment of greater market uncertainty and competition, incorporating in organizational routines constant reorganization and re-dimensioning of their resources. This suggests more decentralized, flexible and self-manageable organizational forms. Another characteristic that is pointed out in this work is the critical factor time for the management of a continuous innovation process, and a reduced lifecycle of products and services. In addition, the great expectations for an increase in demand, and uncertain and irregular demands. Due to the intrinsic nature of knowledge we characterized the work profile in such companies as multifunctional, marked by variable routines. Such a set of characteristics suggests a greater need for implicit contracts as a way to deal with a high degree of uncertainty, and consequently, a greater need for relationships based on trust as an implicit mechanism of control and motivation towards the formation of spontaneous cooperation. However, our analysis also suggests the existence of lower levels of trust in the New Economy companies. Such companies are usually formed by a younger workforce and marked by a high employee turnover, due to the constant re-dimensioning of the workforce through layoffs.905 The measuring of individual performance is based on more subjective data and 905

254

See Argandona (2003), p. 15.

marked by ambiguities. This occurs in newly-established companies or in companies undergoing a restructuring process, where the development of an effective corporate culture, or of a more adequate culture to cope with the challenges of constant changes are not possible. It was noticed that aggressive market competition dynamics are transferred into such companies contributing towards the formation of a more internal competitive environment (among members). The work rhythm was characterized by long daily hours to the detriment of individual leisure time. Argandona (2003) observes that such situations damage interactions among corporate members and characterize a rupture of the sense of ‘community’ within the company.906 What emerged from our analysis was that, those companies operating in the New Economy, in an environment of greater instability and uncertainty, would present a lower capacity to develop interpersonal trust, when compared to other companies operating in other more traditional industries (Old Economy). Even considering possible gains in work flexibility, entrepreneurship, and individual empowerment in the work environment, the general conditions of labor in the New Economy companies tend to present greater problems for the creation of employee motivation, employee satisfaction and employee commitment based on long term investments. In these cases, pressures for short term results impose greater stress and individual competition on the environment and constitute barriers against the building up of trust-based cooperation relationships. Therefore, the study argues that institutional uncertainties significantly decrease the levels of trust within companies operating in the New Economy (H1). In order to analyze the effects of institutional uncertainty on the levels of trust, the study observed a group of companies operating in the New Economy, namely new telecommunications companies, in comparison to another group of companies from more traditional industries, here labeled Old Economy. For a better evaluation of such a scenario, in order to better understand the scope of the changes to relational contracting, two secondary hypotheses related to the assumption of the transition from the traditional model of relational contracts to more short-term transactional contracts were formulated.907 In such a perspective, we investigated the relationship between the levels of trust in such companies with employee commitment (H2) and employee turnover rates (H3). Additionally, this study also presents a comparative market performance analysis of some study companies.

906 907

See Argandona (2003), p. 17. See Burton-Jones (1999), pp. 52-53. 255

6.1 Contributions to Management Studies The database used in this study was a result of a large scale empirical survey with seven Brazilian companies accessing the levels of trust and other organizational elements, namely employee commitment and turnover rates. The database showed high consistency and reliability through many validation tests performed with it. To the best of our knowledge, this is one of the largest sample sizes about trust in the world, and perhaps the largest one investigating trust by cross-industrial comparison. Observing the effects of industry-specific institutional arrangement on individuals’ propensity to trust within business organizations, the study had the purpose of collecting information that helps us build a more comprehensive understanding about the adoption of trust as a complementary governance mechanism, specifying some questions that contribute to build a more consistent theory of trust. Our empirical findings validate and confirm many theoretical beliefs and assumptions. Firstly, the proposed company grouping was confirmed. The New Economy and the Old Economy constitute two different organizational systems in many aspects coexisting at the same time in the contemporary economy, having different dynamics regarding managerial practices, organizational structures and organizational behaviors. Due to notable differences in the nature of their economic activities and historical processes, these two groups of companies present different organizational elements and management styles. Following this perspective, the three proposed hypotheses that were tested could be confirmed. Confirming the main thesis hypothesis, the levels of trust are outstandingly different between the New Economy group of companies and the Old Economy group of companies (H1). It could be verified that the New Economy companies group presented lower levels of trust when compared to those of the Old Economy company group (H1). It could also be verified that the New Economy companies group presented lower levels of employee commitment when compared to those of the Old Economy company group (H2). Finally, it could be verified that the New Economy company group presented significantly higher levels of employee turnover rates when compared to those of the Old Economy company group (H3). As observed, the secondary hypothesis H3 works as a validation hypothesis to confirm the volatile environment of the New Economy. Confirmation of the hypotheses could provide some relevant empirical evidence to the trust studies of management and organizational economics. We summarily analyze these contributions in four interrelated aspects: 1) The study data base confirms the major role of industryspecific institutional frameworks on the development of trust levels within business organizations. This study provides empirical evidence that companies, acting under different industryspecific institutional framework constraints, will differ in their capacity to develop trust levels in their hierarchies. More specifically, we verified that under the effects of relative higher

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uncertainty and instability from industry-specific institutional framework, the companies operating in the New Economy have significant limitations to develop the required structuring elements to create and sustain organizational trust. This empirical evidence leads us to acknowledge the existence of different management styles which might be favored according to industry-specific institutional arrangements. A trust-based management style can therefore be efficiently developed principally according to those macro institutional uncertainties, such as constraints. 2) We confirmed notable differences between the New Economy and the Old Economy – The present study brought forward new issues, not yet investigated, about the influence of specific institutional arrangements on the levels of trust within the companies operating in the New Economy. It provided empirical evidence in line with the general tendencies already demonstrated by some recent studies of the International Labour Organization (ILO) and the Organization for Economic Cooperation and Development (OEDC) that have provided evidence of significant changes in the nature of employment contracts and work conditions worldwide, as a consequence of the New Economy.908 By approaching trust from a cross-industrial comparison perspective, it was possible to identify distinct organizational environments, coexisting in the present economy. The core difference identified by this study among the companies chosen to represent the New Economy and those of the Old Economy, lies in the intensity of the rupture that technological changes might create for such organizations, impacting on future demand estimates. In conceptualizing the New Economy, we observed that, although continuous innovation processes might be frequently found with relatively more intensity within the New Economy companies, what better characterizes these companies is their dependence on technological ruptures. We observed that a central feature of work in the New Economy is dealing with uncertainty. Therefore, work conditions in the New Economy were also characterized as unstable and uncertain, under more short-term transactional perspectives. In this sense, this study has confirmed a paradox: even when organizational tasks require the development of trust as a more efficient mechanism, industryspecific institutional constraints significantly limit the development of trust within those organizations. The New Economy environment suggests that trust could be highly desirable as a control mechanism to coordinate specific tasks linked with the nature of information and knowledge-intensive production systems. However, limiting factors of industry-specific institutional framework presents problems for the adequate development of trust. In other words, even if trust is highly desirable, this study confirmed empirically that New Economy companies have considerable constraints to developing trust as an efficient mechanism due to high uncertainty and instability. Therefore, we conclude that Old Economy companies have better environmental conditions to build trust as a complementary mechanism of control. Old Economy companies operate under a more stable environment and the nature of their industrial processes allows the development of trust based on long term interactions among their corporate members. 3) Although research results provided us with consistent evidence that the dif908

See ILO/OEDC (1997), and ILO (2001). 257

ferences found in the levels of trust between the New Economy and the Old Economy do not lie in individual characteristics, but mainly in environmental uncertainties such as industryspecific institutional constraints, the TIP database allowed us to verify some trust properties and dimensions. In this sense, through the analyses of our empirical results it was demonstrated that trust is a very sensitive variable that can be affected by other related variables. We could observe that trust develops differently among different trust dimensions, demographic variables and social context. In other words, we observed that trust is a highly sensitive variable that might change slightly due to demographic differences, but it changes drastically due to environmental uncertainties caused by different industry-specific institutional framework constraints. 4) This study confirmed the trust mediating role. By confirming the hypotheses and analyzing the relationships between trust, employee commitment and turnover rates, we observed that trust is sensitively related to those other organizational variables in a virtuous circle. The New Economy companies presented lower trust levels, as well as low employee commitment, and showed less concern or capacity to retain employees or create employees identification with the organizational culture, to generate long term employee motivation and satisfaction, and to take into account social mechanisms, like trust, to promote organizational change. Additionally, we confirmed the belief that the New Economy group of companies presenting low levels of trust would present high employee turnover rates, contrary to the Old Economy group of companies, where high levels of trust were associated with low employee turnover rates. Aligned with game theory postulations, Hypothesis H3 provided us with evidence about the relationship between trust and perspectives of contract termination. We acknowledged the hypotheses analyses as supportive in obtaining a better description of the possible consequences of institutional changes in relational contracting in the New Economy.

6.2 Managerial Usage The present study contributes to a better understanding of the management of intangible assets of the firm. Management has been increasingly focused on identifying the drivers of performance metrics in critical relationships. Cannon et al. (2000) showed that the transactions that comprise organizational interactions are also comprised of critical intangibles which are rarely specified. It is also observed by Baker et al. (1993) that objective measures of performance are seldom perfect and the effectiveness of incentive contracting in organizations depends on a large set of social, psychological and economic factors.909 This study provided new information in this area. Recently, increasing interest of organizational economists and managers in trust issues has been associated with the development of performance measures of intangible assets, like organizational reputation, social responsibility and ethical environment.910 Particularly, trust is 909 910

See Baker et al. (1993). See, for instance, Baker et al. (1993). See also the Reputation Institute.

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connected with all these concepts and it is essential to the study of relational contracting modes and all those recent subjects emerging from managerial studies, like leadership-building, corporate learning process, team work efficiency and corporate culture change.911 This is because the analysis of trust has necessarily to pass through the acquiescence of employees, reflecting perceptions of fairness, advantages and benefits in the corporate contract, and thus, it becomes an efficient measure of the intangible asset management of the firm. This study provided many insights for management to better understand organizational trust and, based on our observations of its mediating role, to drive their managerial actions to improve specific production activities. Therefore the empirical data on trust levels allows companies to better comprehend the management of the ‘social capital’ and to create sustainable organizational policies in context. In this sense, a trust-based organizational culture can be acknowledged as a management style to generate superior performance. This study is also relevant to a better understanding of the new ways of governing relational contracts in the New Economy addressing some important issues for future research. Our empirical analysis provides empirical evidence of recent changes to relational contracting in the companies operating in the New Economy, addressing recommendations for management policies, primarily as to the design of incentive schemes and the evaluation of returns over investment in human capital. This study confirmed the mediating role of trust with employee commitment and employee turnover rates. These relationships were proven to be consistent with previous empirical evidence, and together they better illustrate singular relational contracting modes under different industry-specific institutional frameworks. In fact, it was observed that all these variables concern the use of managerial policies committed to employee retention and long-term employment perspectives and to the privilege of implicit mechanisms rather than to explicit ones. In the end it has strong consequences for managerial decisions concerning human resources and we observed that implicit and explicit mechanisms should be considered. The overall picture of the study shows a tendency towards a transactional model in the employment relations. In the New Economy, companies have driven their managerial decisions by short-term perspectives. As environmental uncertainties and risks, as well as the costs of doing business, are higher, and following the earlier observations of Cyert and March (1992), it seems that short-term strategies are preferable.912 However, this study observed that, an increase in environmental uncertainties followed by a decrease in the levels of trust has several consequences. Very commonly, short term strategies are adopted in a changing environment which often requires a constant redimensioning and reallocation of a company’s resources. We observed that it also has a direct effect on human resource allocation and replacement, and it tends to create an environment of high job instability. Related to these pre911 912

See Legge (1995), p. 183, and Robbins (2002), p. 325-329. See Cyert/March (1992), p. 121. 259

vious observations, this scenario has a tendency to have high employee turnover rates that ultimately mean high costs to human resources management. A better performance evaluation of these scenarios is, however, more complex and more dependent on other contextual variables. We observed that the costs of having trust mediating transactions among companies’ members and the costs of having explicit contractual agreements must be analyzed under constraints imposed by industry-specific institutional frameworks. In this study additional performance data was analyzed showing that a high trust context in one Old Economy company was positively related to better market performance. In contrast, bad market performance contexts found in two companies operating in the New Economy were negatively related to trust. We acknowledge these results as not conclusive, because they cannot establish a causal relation, but nonetheless valuable, addressing these issues for future research. Empirical and interdisciplinary studies must be developed in order to offer a better understanding of the social phenomenon within the companies, thus creating a better understanding of the management of intangible assets. To this end, we proposed the analysis of the levels of trust in the New Economy. This is because one of the lessons learnt by companies in the last decades is that the expectation of gains by productivity improvement and innovations due to investment in new information and communications technology must consider future investment in human resources and reorganization processes. That implies that performance depends not only on initial capacity for creating tangible and intangible assets, but also on the capacity for adaptation to conditions of environmental changes through the continuous renewal, reconfiguration, and re-disposition of such assets.

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APPENDIX Appendix 1: The Questionnaire OTTO-VON-GUERICKE-UNIVERSITY MAGDEBURG Faculty of Economics & Management

DEPARTMENT OF INTERNATIONAL MANAGEMENT PROF. DR. BIRGITTA WOLFF PROF. EDWARD LUSK, PHD MARCO TULIO ZANINI, RESEARCHER

Questionnaire

Trust Inventory Project (TIP)

Instructions: 1. Your answers to the questions in this questionnaire are completely confidential. Do no sign or write your name. 2. The evaluation and processing of the questionnaires will be done by researchers from the Otto-von-Guericke University of Magdeburg, Germany. No one in the company will ever see your answers. We will never identify any individual responses; results will always be combined into groups for reporting purposes. 3. On average, completing the answers will take approximately 20 minutes of your time. 4. It is important that your answers reflect exactly the way you feel, so be comfortable to express your initial reaction to the questions. Do not spend a lot of time thinking over each question. We would rather have your first impression, your first idea. This is not a test. Your opinion is the only right answer. 5. Please mark just one answer per question. 6. Please answer the questions in order. Do not skip around. 7. When you have finished, please put the questionnaire into the envelope, seal it, and return it to the designated area. Remember: do not sign the questionnaire.

THANK YOU FOR YOUR COOPERATION!

287

This is the first part of the questionnaire. These questions deal with your professional relationships with people in your company. SECTION 1 – YOUR MANAGER Please indicate how willing you are to engage in each of the following behaviours with your MANAGER, by marking a number from 1 to 7. How willing you are to do the following with your MANAGER?

Not at all willing

Completely willing

A.01

Rely on your manager’s task related skills and abilities.

1

2

3

4

5

6

7

A.02

Depend on your manager to handle an important issue on your behalf.

1

2

3

4

5

6

7

A.03

Rely on your manager to represent your work accurately to others.

1

2

3

4

5

6

7

A.04

Depend on your manager to back you up in difficult situations.

1

2

3

4

5

6

7

A.05

Rely on your manager’s work-related judgements.

1

2

3

4

5

6

7

A.06

Share your personal feelings with your manager.

1

2

3

4

5

6

7

A.07

Discuss work-related problems or difficulties with your manager that could potentially be used to disadvantage you.

1

2

3

4

5

6

7

A.08

Confide in your manager about personal issues that are affecting your work.

1

2

3

4

5

6

7

A.09

Discuss with your manager how you honestly feel about your work, even negative feelings and frustration.

1

2

3

4

5

6

7

A.10

Share your personal beliefs with your manager.

1

2

3

4

5

6

7

288

SECTION 2 – A TEAM MEMBER In answering the following questions, we ask you to keep in mind ONE particular team member who is not your manager. Indicate how willing you are to engage in each of the following behaviours with THIS TEAM MEMBER—here called Team Member X, by marking a number from 1 to 7.

How willing you are to do the following with Team Member X?

Not at all willing

Completely willing

A.11

Rely on Team Member X’s task related skills and abilities.

1

2

3

4

5

6

7

A.12

Depend on Team Member X to handle an important issue on your behalf.

1

2

3

4

5

6

7

A.13

Rely on Team Member X to represent your work accurately to others.

1

2

3

4

5

6

7

A.14

Depend on Team Member X to back you up in difficult situations.

1

2

3

4

5

6

7

A.15

Rely on Team Member X’s work-related judgements.

1

2

3

4

5

6

7

A.16

Share your personal feelings with Team Member X.

1

2

3

4

5

6

7

A.17

Discuss work-related problems or difficulties with Team Member X that could potentially be used to disadvantage you.

1

2

3

4

5

6

7

A.18

Confide in Team Member X about personal issues that are affecting your work.

1

2

3

4

5

6

7

A.19

Discuss with Team Member X how you honestly feel about your work, even negative feelings and frustration.

1

2

3

4

5

6

7

A.20

Share your personal beliefs with Team Member X.

1

2

3

4

5

6

7

289

SECTION 3 – YOUR TEAM Please indicate how willing you are to engage in each of the following behaviours with YOUR TEAM, by marking a number from 1 to 7.

How willing you are to do the following with your Team?

Not at all willing

Completely willing

A.21

Rely on your team’s collective task related skills and abilities.

1

2

3

4

5

6

7

A.22

Depend on your team to handle an important issue on your behalf.

1

2

3

4

5

6

7

A.23

Rely on your team to represent your work accurately to others.

1

2

3

4

5

6

7

A.24

Depend on your team to back you up in difficult situations.

1

2

3

4

5

6

7

A.25

Rely on your team’s collective work-related judgements.

1

2

3

4

5

6

7

A.26

Share your personal feelings with your team.

1

2

3

4

5

6

7

A.27

Discuss work-related problems or difficulties with your team that could potentially be used to disadvantage you.

1

2

3

4

5

6

7

A.28

Confide in your team about personal issues that are affecting your work.

1

2

3

4

5

6

7

A.29

Discuss with your team how you honestly feel about your work, even negative feelings and frustration.

1

2

3

4

5

6

7

A.30

Share your personal beliefs with your team.

1

2

3

4

5

6

7

290

This is the second part of the questionnaire. Following are statements about your organization. SECTION 4 – YOUR ORGANIZATION Please mark the response that best indicates the extent to which the statement describes the current reality for your organization—i.e., the way that it is now.

STATEMENTS

Neither Strongly Disagree agree nor disagree disagree

Agree

Strongly agree

B.01

Based upon the past decisions of management of this organization, I am able to predict what management will do in the future.

1

2

3

4

5

B.02

Since my employment in this organization, management’s behavior and decisions have been consistent.

1

2

3

4

5

B.03

I can always rely on every word of the management of this organization.

1

2

3

4

5

B.04

The management of this organization tells the truth to employees in all situations.

1

2

3

4

5

B.05

The management of this organization always keeps its promise to employees.

1

2

3

4

5

B.06

I have never been disappointed whenever I rely on what management says in all situations.

1

2

3

4

5

B.07

In this organization, management seeks the inputs of employees when making decisions that affect employees.

1

2

3

4

5

B.08

In this organization, management makes a great deal of effort to involve employees in all aspects of the decisionmaking process.

1

2

3

4

5

291

STATEMENTS

Neither Strongly Disagree agree nor disagree disagree

Agree

Strongly agree

B.09

Whenever possible, management delegates decision-making authority to employees.

1

2

3

4

5

B.10

The management of this organization is always sensitive to the interests of employees when making critical decisions.

1

2

3

4

5

B.11

In this organization, management gives employees’ welfare high priority.

1

2

3

4

5

B.12

In all situations, management takes the extra step to protect the interests of employees.

1

2

3

4

5

B.13

The management of this organization provides employees with accurate information about the affairs of the organization.

1

2

3

4

5

B.14

The management makes an effort always to explain major organizational decisions to the employees.

1

2

3

4

5

B.15

The management of this organization freely shares ideas with the employees.

1

2

3

4

5

292

SECTION 5 – STABILITY OF JOB FEATURES Following are statements about your JOB FEATURES. Looking into the future, what is the likelihood that changes that you oppose could occur and negatively affect each of the following aspects or features of your current job?

STATEMENTS

Very unlikely

Unlikely

Neither likely nor unlikely

Likely

Very likely

1

2

3

4

5

1

2

3

4

5

1

2

3

4

5

1

2

3

4

5

B.16

Your potential to get ahead in your organization.

B.17

Your potential to maintain your current pay.

B.18

Your potential to attain pay increases.

B.19

The status that comes with your position in the organization.

B.20

Your current freedom to schedule your own work.

1

2

3

4

5

B.21

Your current freedom to perform your work in a manner you see fit.

1

2

3

4

5

B.22

Your current access to resources (people, materials, information) in the organization.

1

2

3

4

5

B.23

Your sense of community in working with coworkers.

1

2

3

4

5

B.24

The variety of tasks you perform.

1

2

3

4

5

B.25

The opportunity to do an entire piece of work from start to finish.

1

2

3

4

5

B.26

The significance of your job.

1

2

3

4

5

B.27

The extent to which you can tell how well you are doing your job as you do it.

1

2

3

4

5

293

SECTION 6 – POTENTIAL CHANGES Looking into the future, what is the likelihood that changes that you oppose could occur and cause the following to occur?

STATEMENTS

Very unlikely

Unlikely

Neither likely nor unlikely

Likely

Very likely

1

2

3

4

5

1

2

3

4

5

1

2

3

4

5

B.28

Lose your job and be moved to a lower level within the organization.

B.29

Lose your job and be moved to another job at the same level.

B.30

Find that the number of hours the company can offer you to work fluctuates from day to day.

B.31

Lose your job and be laid off for a while.

1

2

3

4

5

B.32

Lose your job and be laid off permanently.

1

2

3

4

5

B.33

Find your department and division’s future uncertain.

1

2

3

4

5

B.34

Lose your job by being fired.

1

2

3

4

5

B.35

Lose your job by being pressured to accept early retirement.

1

2

3

4

5

294

Please indicate your degree of agreement or disagreement with each of the following statements about your ability to change events that may affect you and your job in your organization.

STATEMENTS B.36

I have enough power in this organization to control events that affect my job.

B.37

In this organization, I can prevent negative things from affecting my work situation.

B.38

I understand this organization well enough to be able to control things that affect me.

Strongly disagree

Disagree

Neither agree nor disagree

Agree

Strongly agree

1

2

3

4

5

1

2

3

4

5

1

2

3

4

5

295

SECTION 7 – RELATIONSHIP TO YOUR ORGANIZATION Following are statements about personal feelings regarding your organization. Please mark the response that best indicates the extent to which the statement describes the current reality of your feelings with your organization—i.e., this is the way it is now.

STATEMENTS

Strongly disagree

Disagree

Neither agree nor disagree

Agree

Strongly agree

1

2

3

4

5

B.39

I would be very happy to spend the rest of my career with this organization.

B.40

I really feel as if this organization’s problems are my own.

1

2

3

4

5

B.41

I feel a sense of belonging to this organization.

1

2

3

4

5

B.42

I feel emotionally attached to this organization.

1

2

3

4

5

B.43

I feel like I am a part of the family at this organization.

1

2

3

4

5

B.44

This organization has a great deal of personal meaning to me.

1

2

3

4

5

B.45

Right now staying in this organization is a matter of necessity.

1

2

3

4

5

B.46

It would be very hard for me to leave this organization right now, even if I wanted to.

1

2

3

4

5

296

STATEMENTS

Strongly disagree

Disagree

Neither agree nor disagree

Agree

Strongly agree

1

2

3

4

5

1

2

3

4

5

B.47

Too much of my life would be disrupted if I decided I wanted to leave this organization at this time.

B.48

I feel that I have too few options to consider leaving this organization.

B.49

If I had not put so much of myself into this organization, I might consider working elsewhere.

1

2

3

4

5

B.50

One of the few negative aspects of leaving this organization would be the scarcity of available alternatives.

1

2

3

4

5

B.51

I feel an obligation to remain with my current employer.

1

2

3

4

5

B.52

Even if it were to my advantage, I do not feel it would be right to leave this organization now.

1

2

3

4

5

B.53

I would feel guilty if I left this organization now.

1

2

3

4

5

B.54

This organization deserves my loyalty.

1

2

3

4

5

B.55

I would not leave this organization right now because I have a sense of obligation to the people in it.

1

2

3

4

5

B.56

I owe a great deal to this organization.

1

2

3

4

5

297

Please answer the following questions about your personal data and perspectives: C.01 Are you: 01

Male

02

Female

C.02 Please, indicate your current work area: 01 02 03 04 05 06 07

Marketing/Sales Finance Administration/Management Human Resources Engineering/Production Technical Support/Systems Other, please describe:______________________________________________

C.03 The number of people reporting to you? 01 02 03 04

None 1 to 5 people 6 to 20 people More than 20 people

C.04 What is your educational level? 01 02 03 04 05 06 07

Completed High School Technical School Diploma College Diploma Some post-graduate education MBA Master Degree Doctor Degree

C.05 What is your age range? 01 02 03 04 05 06

298

Under 25 25-29 30-34 35-39 40-49 50 or over

C.06 How long have you been employed by this company? 01 02 03 04 05 06

Less than 1 year 1-2 years 2-3 years 3-4 years 4-7 years More than 7 years

C.07 How many hours per day on average do you work? 01 02 03 04 05 06

Under 7 7-8 8-10 10-11 11-12 More than 12 hours per day

C.08 How many other employers have you had in the last 8 years (since 1996)? (Do not consider this current one) 01 02 03 04 05 06

None One Two Three Four More than Four

C.09 Which of these objectives would you consider the most important in so far as it would improve your work situation? (please check only one) 01 02 03 04 05 06

More job stability Better salary More free time More responsibility Perform different tasks Chances to enhance my skills

299

C.10 Which of these attitudes do you most agree with? 01

It is important for me to compete, even considering that it might not benefit directly others—e.g. team or company

02

It is important to cooperate, even considering that it might reduce my immediate chances to advance in the company

C.11 Assuming that you have the choice, how long do you think you will continue working for this company? 01 02 03 04 05

Only a few more months Two years at the most From two to five years More than five years (but I probably will leave before I retire) Until I retire

C.12 What is the likelihood that your trust in the organisation and its people will be mutually beneficial? 01 02 03 04 05

Very unlikely Unlikely Neither likely nor unlikely Likely Very likely

C.13 I perceive that my future in this company: 01 02 03 04 05 06

300

will be better in approximately one year will be better in approximately three years will continue basically as it is now will deteriorate to the extent that I will leave the company will worsen but I will stay with the company I cannot evaluate it

COMMENTS SHEET Questionnaires cannot, of course, cover all issues on which you might like to express your opinion. We have therefore provided space for you here to make whatever additional comments you would like. ___________________________________________________________________________________ ___________________________________________________________________________________ ___________________________________________________________________________________ ___________________________________________________________________________________ ___________________________________________________________________________________ ___________________________________________________________________________________ ___________________________________________________________________________________ ___________________________________________________________________________________ ___________________________________________________________________________________ ___________________________________________________________________________________ ___________________________________________________________________________________ ___________________________________________________________________________________ ___________________________________________________________________________________ ___________________________________________________________________________________ ___________________________________________________________________________________ ___________________________________________________________________________________ ___________________________________________________________________________________ ___________________________________________________________________________________ ___________________________________________________________________________________ ___________________________________________________________________________________ ___________________________________________________________________________________ ___________________________________________________________________________________ ___________________________________________________________________________________

301

Appendix 2 - Comment Sheet Analysis 1) Telecom 1 Number of Collected Questionnaires

Number of Comment Sheets

Percentage

233

41

18%

Number of Comment Sheets

Percentage

01. Marketing/Sales

8

19, 51%

02. Finance

12

29,26%

03. Administration/Management

14

31,14%

04. Human Resources

2

4,87%

05. Engineering/Production

4

9,75%

06. Technical Support/Systems

1

2,43%

41

100%

Work Area

Total Commented Subjects: SUBJECT 1. Positive Feelings About the Company in General

Frequency of Comments 2

2. Positive Work Team Experience

2

3. Comments about Negative Behaviors at Work

4

4. Lack of Investments in Human Capital

2

5. Excessive Work Hours

6

6. Internal Communication Problems

6

7. Paternalism Manager X Employee Relationship

2

8. Lack of Values at Work

3

9. Reward Plan Problems (salary, bonus)

8

10. Negative Criticism to Management

3

11.General Concern to Employees Welfare

6

12. General Work Conditions (negative aspects)

9

13. Lack of Career Plan

7

14. Uncertainty and Change due to Job Insecurity

5

15. Problems with Physical Work Conditions

3

303

Some Transcriptions: “Motivate the collaborators to provide better quality of life. Integration Programs” “There is lack of strategic, consistent lead, excessive value to the short term, excessive variable, individual remuneration, too many directors/managers” “We are managing to attend external clients with excellence, but it is necessary that it also occurs with the internal clients” “Some points are important to develop a strong and dedicated team, as to be clearer in its their objectives with clear and transparent policies....... make the employees feel some stability, thus avoiding the high level of stress” “The company makes you work over 12 hours a day, without paying overtime and without having hour bank and still makes you work smiling as if it were the only and best company in the world” “Relationship with the company: High Bonus X Limited resources (demotivates). The Benefit Policy also demotivates” “What does the company lack? Applicability of the Values preached mainly the meritocracy” “I consider this job a professional school. My learning has been and still is of such magnitude every day that certainly would not be the same were I not here.” “Lacks transparence in the information related to the future of the company as well as it lacks divulging of the results achieved”

304

2) Telecom 2 Number of Collected Questionnaires

Number of Comment Sheets

Percentage

313

57

18.21%

Work Area 01. Marketing/Sales 02. Finance 03. Administration/Management 04. Human Resources 05. Engineering/Production 06. Technical Support/Systems Unspecified Total

Number of Comment Sheets 36 3 6 5 5 1 1 57

Percentage 63.15% 5.26% 10.52% 8.77% 8.77% 1.75% 1.75% 100%

Commented Subjects:

SUBJECT 1. Positive Feelings About the Company in General 2. Positive Feelings about Management 3. Positive Feelings about Employees Welfare Conditions 4. Positive Feeling about future opportunities 5. Positive Work Team Experience 6. Comments about Negative Behaviors at Work 7. Lack of Investments in Human Capital 8. Excessive Work Hours 9. Internal Communication Problems 10. Paternalism Manager X Employee Relationship 11. Lack of Career Plan 12. Lack of Values at Work 13. Negative Internal Competition 14. Reward Plan Problems (salary, bonus) 15. Negative Criticism to Management 16.General Concern to Employees Welfare 17. General Work Conditions (negative aspects) 18. Lack of Autonomy 19. Uncertainty and Change due to Job Insecurity 20. Negative feelings about the future

Frequency of Comments 11 4 4 4 6 2 8 7 3 2 4 3 4 4 1 4 7 1 13 5 305

Some Transcriptions: “This company has been going through several changes since the joint-venture and the fact that the process structure and the people have not been previously aligned has brought up several conflicts” “I believe this company within a possible range has been transparent and concerned about its employees” “I am very happy to be part of this time and I think that I still have a lot to contribute, and I sincerely hope to go on growing and mainly be recognized for the dedication paid to the company” “The problem with the company is the constant structure change that has been occurring for 2 years. This situation has turned the company into a disorganized body since the changes happen all the time. Nowadays we cannot have a promotion perspective, or even reach a managerial level because the company does not offer a reliable career plan.” “The company has become too big and at the moment I see little effective processes, everything occurs very slowly what wears out the companies” “There is too much uneasiness among people here!” “I feel very well working for this company, I am respected as an individual and as a professional, I am financially compensated in a fair way and the work environment is excellent” “The company could help sponsoring courses since there are several people willing to take a University degree and cannot afford it.” “I am very happy to cooperate with the company, the greatest conflict is that we known our sector will be operated by third parties and in face of this possibility I am sad. Anyway this company has contributed a great deal for my personal and professional growth.” “My dissatisfaction has to do with the uneasiness generated by the third parties contracts with the company” “I would like that a transparent career plan for the employee were implemented.” “The work is very stressing even causing health problems. We are overcharged from all sides and we must perform urgent tasks all at once. The work does not seem productive because it is a nonstop ‘putting out fires’.”

306

3) Telecom 3 Number of Collected Questionnaires

Number of Comment Sheets

Percentage

242

73

30.16%

Number of Comment Sheets

Percentage

01. Marketing/Sales

19

26.02%

02. Finance

14

19.17%

03. Administration/Management

6

8.21%

04. Human Resources

7

9.58%

05. Engineering/Production

18

24.65%

06. Technical Support/Systems

9

12.32%

Work Area

Unspecified

0.00% Total

73

100%

Commented Subjects:

SUBJECT

Frequency of Comments

1. Positive Feelings About the Company in General

14

2. Positive Feelings about Management

5

3. Positive Feelings about Employees Welfare Conditions

8

4. Positive Feeling about future opportunities

1

5. Positive Work Team Experience

5

6. Positive Feelings about the Corporate Culture

9

7. Reward Plan Problems (salary, bonus, benefits)

3

8. Criticism to Strategies and Market approach

1

9. Negative Criticism to Management

7

10. Uncertainty and Change due to Job Insecurity

24

11. Concerns about the actual situation of the Company

46

12. Negative feelings about the future

19

307

Some Transcriptions: “We have just gone through a downsizing and the morale is not very good. Telecom3 is an excellent company to work for however at the moment all employees are experiencing in their own flesh the risk of seeing the great dream end.” “The buy-off issue certainly harms the job link of the employees in relation to the company. It would be better if the Telecom3 solved this issue as soon as possible. “The transition phase the company is going through directly influences the answers. These are external factors that many times we have no influence over.” “We have been living uncertainty moments for over 2 years since the company is under a buy-off process.” “The Telecom3 is a marvelous, modern, dynamic and participating professional experience with state-of-art, sophisticated technology and with highly qualified personnel.” “I cannot understand why the buy-out process takes so long (over 2 years!) In this period the capital value of the company decreased and the lack of motivation of the employees increased.” “I helped build this company; I will do my best to make it successful. The acknowledgment of this company as successful endeavor will be a personal accomplishment.” “I have high hopes in the Telecom3, but even saying that I would stay 5 years longer. I am not sure whether it will stand or whether it will be that good for me that way.” “This entire insecure picture causes many employees to look for other jobs to leave Telecom3 simply because they are afraid of being in the next lit of dismissals.” “The work environment is excellent, the inter-departmental crews are united, and everybody gets along well, and helps one another. Consequently the production is higher and our joy of producing better, bringing better results is huge.” “This environment of insecurity and uncertainty of the buy-out of the company has been generating a great discomfort among the employees.” “This company is great. The people who work here are marvelous and true friends. It is a pity that the stockholders cannot come to an agreement and do not want to keep the business. I would love to stay much longer in this dear company!” “The worst is to be sure that this dream is ending....” “The management made an option for the easiest solution, the dismissal of employees, what has been occurring since 2001, in the mid-year of each year.” “My quality of life has improved approximately after I came to Telecom3.”

308

4) Steelworks Number of Collected Questionnaires

Number of Comment Sheets

Percentage

302

52

17.21%

Number of Comment Sheets

Work Area

Percentage

01. Marketing/Sales

0.00%

02. Finance

1

1.92%

03. Administration/Management

2

3.84%

04. Human Resources

4

7.69%

05. Engineering/Production

36

69.23%

06. Technical Support/Systems

9

17.30%

Unspecified

0.00% Total

52

100%

Commented Subjects: SUBJECT 1. Positive Feelings About the Company in General

Frequency of Comments 22

2. Positive Feelings about Management

4

3. Positive Feelings about Employees Welfare Conditions

8

4. Positive Feeling about future opportunities

3

5. Positive Work Team Experience

4

6. Job Satisfaction

6

7. Positive Feedback about Rewards

6

8. Positive Feedback about Social Responsibility

5

9. Comments about Negative Behaviors at Work

3

10. Lack of Investments in Human Capital

3

11. Internal Communication Problems

2

12. Paternalism Manager X Employee Relationship

1

13. Reward Plan Problems (salary, bonus)

4

14. Negative Criticism to Management

5

15. General Work Conditions (negative aspects)

3 309

Some Transcriptions: “It is extremely gratifying to work for Steelworks” “I would like to stress my enormous satisfaction in being a member of the personnel of the Steelworks for over 20 years. I have already been recognized for my work and professionalism, having been promoted.” “I am proud of working for this company because I have been part of it since its implementation until now.... the relationship among the people has improved a great deal and the behavioral level is high as showed in the organizational morale poll.” “The HR management has been fundamental in the support to operational areas.” “I am very proud of belonging to this organization.” “Working for Steelworks is as if I had won the lottery because in this company I have freedom of speech, and I work with the assurance that I will not be laid off.” “I trust the company management totally, and after my retirement I would like to go on rendering services to the company.” “Have been working for this company for 20 years and I am very proud because I deem it one of the best in the country.” “Among the missions of the company, the noticeable mission is the welfare of the employees.” “The company I work for is undoubtedly the best in the whole country.” “The opportunities at Steelworks are many and appear all the time; you just have to be prepared.” “This company is an entity extremely coherent with what it preaches in its mission and values. There is a concern with all the parties that need to be involved in the processes or suffer the consequences of its stages.” “I state that during my preparation proud of working for this company.”

in the period of studies I had in mind finding and be

“There is discrimination with the personnel that work in the shift of the time to leave; the bus of the shift is stopped to be inspected while the personnel of other shifts are not checked.” “I have an excellent relationship with my superior, nowadays he is more a friend than a boss.”

310

5) Mining Number of Collected Questionnaires

Number of Comment Sheets

Percentage

155

24

15.48%

Number of Comment Sheets

Percentage

02. Finance

5

20.83%

03. Administration/Management

1

4.16%

04. Human Resources

6

25.00%

05. Engineering/Production

10

41.66%

06. Technical Support/Systems

2

8.33%

Work Area 01. Marketing/Sales

0.00%

Unspecified

0.00% Total

24

100%

Commented Subjects:

SUBJECT

Frequency of Comments

1. Positive Feelings About the Company in General

10

2. Positive Feelings about Employees Welfare Conditions

5

3. Positive Feeling about future opportunities

2

4. Positive Feelings about the Corporate Culture

1

5. Comments about Negative Behaviors at Work

2

6. Lack of Investments in Human Capital

1

7. Reward Plan Problems (salary, bonus)

5

8.General Concern to Employees Welfare (negative)

3

9. Negative Criticism to Management

3

10. Negative feelings about the future

4

11. Problems with Work Schedule

1

311

Some Transcriptions: “I have been working for this company since 1977, therefore for 27 years and I have had several positions including managerial position in different areas.” “Mining is an enterprise that believes in the future and therefore, plans do researches and take decisions based on fundaments, it supports its technological and human potential. Mining has a solid position in the market and develops a sustainable work.” “Lacks acknowledgment of high potentials within the company, there is no coherence in the professional growth processes, change of positions and re-qualifications. There are different and unfair remuneration policies/personnel appraisals.” “There is a difference between the quality of training for the technical-operational and the managerial.” “The present changes need to be dealt with more criterions otherwise we lose the acquired culture. In the case of Mining, the differential has always been the commitment of its personnel who has always had corporate loyalty, and as a result the exceptional achievements reached.” “Mining is one of the best companies to work for; I have only thanks to give.” “I think the work I do for the company is not well divulged due to the indifference of the boss in relation to the crew. The management pays little importance to our work for the company for the little technical knowledge they have.... the management should show more interest in our work.” “I am under a temporary contract; this explains the lack of fondness for the company and the low capacity of control over my work in this company.” “This company is very good to work for, however it has let its employees down lately” “I love working here” “I am very fond of this company, the people, the work and the work environment. However, as the chances for promotions are few (there are no opportunities for all), and this is a negative point for me, consequently this affects the chances for a salary raise.”

312

6) Petrochemical Number of Collected Questionnaires

Number of Comment Sheets

Percentage

188

29

15.42%

Number of Comment Sheets

Work Area

Percentage

01. Marketing/Sales

2

6.89%

02. Finance

3

10.34%

03. Administration/Management

2

6.89%

04. Human Resources

1

3.44%

05. Engineering/Production

13

44.82%

06. Technical Support/Systems

8

27.58%

Unspecified

0.00% Total

29

100%

Commented Subjects:

SUBJECT

Frequency of Comments

1. Positive Feelings About the Company in General

10

2. Positive Feelings about Management

3

3. Positive Feelings about Employees Welfare Conditions

6

4. Positive Feeling about future opportunities

1

5. Lack of Investments in Human Capital

2

6. Internal Communication Problems

1

7. Paternalism Manager X Employee Relationship

2

8. Lack of Career Plan

1

9. Reward Plan Problems (salary, bonus, opportunities)

9

10. Negative Criticism to Management

1

11. Negative feelings about the future

1

313

Some Transcriptions: “After 16 years in this company, I have witnessed continuous changes and improvements within each sector. I am positive that this company will be outstanding for the management and that will provide a marvelous future for the employees as it has been demonstrated each year.” “The enterprise is very good to work for; there is nothing to complain about.” “I feel privileged for working for this great enterprise, because with the technical level we have achieved we also have acquired a fair compensation and a work environment that would be difficult to find somewhere else.” “I am happy with the company, I only would like more support in personnel investments for courses of professional enhancement.” “I have historical links with the company and gratitude for what I could provide me and my family with on the salary I earn in this work contract.” “In the activities developed (in the same position) there should never be salary differences among the employees.” “The organizational environment is good and the confidence in the professional capacity characterizes the relationship.” “The company is one of the best to work for and to learn. There are still people who are not motivated as in any place and they make the necessary changes difficult to take place but they do not impede them from occurring. There is lack of opportunities for some people while others have more opportunities.” “It is a productive enterprise with high potential resources but that is not using its full force energy, yet. I hope to be able to contribute more so that in a near future I may feel the results of a totally integrated work.” “The management of this company has been investing in the quality of life of its employees....I hope it does not change.” “The problem is the lack of growth opportunities.” “What impressed me most positively was the way the company faced its social and technical responsibilities. The employees are treated seriously and tenderly by all the superiors... the benefits added to the salaries are highly motivating.” “Our salaries should be equivalent to those in the market.”

314

7) Media Number of Collected Questionnaires

Number of Comment Sheets

Percentage

188

40

21.27%

Number of Comment Sheets

Percentage

01. Marketing/Sales

17

42.50%

02. Finance

3

7.50%

03. Administration/Management

5

12.50%

04. Human Resources

4

10.00%

05. Engineering/Production

10

25.00%

Work Area

06. Technical Support/Systems

0.00%

Unspecified Total

1

2.50%

40

100%

Commented Subjects:

SUBJECT 1. Positive Feelings About the Company in General

Frequency of Comments 10

2. Positive Feelings about Employees Welfare Conditions

2

3. Positive Feeling about future opportunities

3

4. Negative Behaviors at Work

2

5. Lack of Investments in Human Capital

6

6. Lack of Leadership

2

7. Excessive Work Hours

1

8. Internal Communication Problems

5

9. Paternalism Manager X Employee Relationship

4

10. Lack of Career Plan

5

11. Reward Plan Problems (salary, bonus)

17

12. Negative Criticism to Management

3

13.General Concern to Employees Welfare

2

14. Lack of Autonomy

1

315

Some Transcriptions: “I have been working for this company for 12 years, and have grown personally and professionally a lot. I respect and admire my superiors.” “I miss a career plan within the company, better salaries even if the responsibility level increases as well. The company does not offer meal tickets what is another drawback.” “The company is great and the people too, the work environment is good but I think there should be more integration among the different sectors.” “For a more efficient future in the management o the company I work for, there should be implemented a salary and career plan suggested some years ago but not performed so far.” “Some salaries paid by the company could be reviewed mainly by the top management. Not that they do not deserve them by there is a high discrepancy in relation to the others.” “I work for an ethical enterprise that deals with transparence and honesty in relation to its employees. I think we still have some problems in respect to career management and in the salary evolution in some sectors.” “I think the company does not give the right value to the professionals that work for it. We have many peers with low salaries, others with personal problems or health problems who do not receive the support they should.” “Media has everything to work out but there are basic things lacking such as: delegate more, clear communications, and commitment of all units (synergy) etc.” “Working for Media is like being in the Ferrari of F1 crew. You may not win all the races but is part of the best and most traditional team in the world.” “The company needs to invest more in the human resources that have been working for the company for a long time. They should have better salaries, profit share; better benefits... implement a career and salary plan eliminating the injustices of different salaries for the same positions.” “What lacks in the company is that more opportunities are given to its employees, some sponsoring for those seeking higher levels of education and other benefits...” “Media does not have clear policies, there are constant changes in the management and it is common to replace the whole team bringing "friends" without experience. We must evolve a lot in this field.”

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Appendix 3 – E-Mail model to the CEO DELIVERING THE FEEDBACK REPORT TO COMPANY NAME – THE TRUST INVENTORY PROJECT (TIP)

Dear Mr. /Ms. CEO,

Recently, we carried out the “Trust Inventory Project” (TIP) project in Brazil and we were happy to have had COMPANY NAME as one of the participant companies in this project that is the first cross-industry project assessing trust for Brazilian organizations. We would especially wish to thank Mr. H who provided invaluable assistance in the management of logistics for the distribution and collection of the questionnaire information. As part of our agreement, we now would like to provide you with the Feedback Report. We would like to propose the following options for the timely delivery of the report: 1. By special-delivery post directly to you; 2. Delivery of the report by a member of the research team who will be in Brazil from the 18th of April until the 4th of May; Also please let us know if you would like to have a PowerPoint presentation of the report made to a group of your choosing. If you could let us know the above information by the end of February this will greatly facilitate our planning. We greatly appreciate your participation and collaboration in this pioneering project.

Yours Sincerely,

Prof. Dr. Birgitta Wolff, Edward Lusk, PhD, and Marco Tulio Zanini, M.sc. (Research Team Members) University of Magdeburg – Germany

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Appendix 4 – Company’ s Guideline / Research Agreement

OTTO-VON-GUERICKE-UNIVERSITY MAGDEBURG Faculty of Economics & Management DEPARTMENT OF INTERNATIONAL MANAGEMENT PROF. DR. BIRGITTA WOLFF PROF. EDWARD LUSK, PHD MARCO TULIO ZANINI, RESEARCHER

June 29th, 2004 Trust Inventory Project (TIP) Company’s Guideline for the Participation in the Research Project

1. Objectives Thank you for participating in this research project. We believe that the research will provide NAME many benefits regarding the important role that human resources (HR) management plays in the organization. The information that one may develop from the questionnaire addressees the core management issues about shaping the corporate culture and insuring the highest level of employee commitment to the organization’s performance goals. The objective of the research is to better understand possible changes in the implicit control mechanisms between companies in the New and Old Economy. Implicit mechanisms, such as trust, have considerable impact on internal costs and represent assets of companies. In the 90’s the Brazilian market place changed dramatically with the privatization initiative. Emerging markets provided “first mover advantages”, and the opportunities to profit seemed to be guaranteed. Now, after some years, companies face more mature and competitive markets and management issues become key factors in the competitive environment that one associates with mature markets. Trust is at the core of these management issues. Recent research shows that trust is one of the main features for successful management related to many issues as efficiency and performance. The study will seek to measure the complex relationships among organizational commitment, job features and trust. Many scholars are studying these mechanisms. In order to better understand the changes in the internal situation of firms, the proposed research project addresses selected companies who are major players in the Brazilian business scene. Following you will find important information about the research project.

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2. Research Period The data collection extends from 15th August to 20th September, 2004. Your company is welcome to choose the most convenient dates within this period. We believe that three (3) to five (5) days are needed to distribute the questionnaires and conduct the interviews. We request you to choose dates convenient to your organization.

3. Research Instruments The research project includes three instruments for data collection: a) Interviews with the Director of the Human Resources Division and the Director of Strategy & Planning Division, b) HR and organization Information, c) Distribution and collection of questionnaires for employees.

a) Interviews The interviews with HR and Strategy & Planning Directors will take approximately 40 minutes. These interviews can be scheduled according to the director’s convenience within the research period (from 15th August to 20th September, 2004).

b) Human Resources Information The information about the human resources management that we would like to collect is: 1) General information about the firm’s incentive system (benefits packages and advantages for employees). 2) Relative expenses in training and human resources development; 3) Employee turnover rates for the last eight years. We kindly ask you to provide this information during the research period.

c) Distribution of Questionnaires The research method has been designed to accrue a certain number of valid questionnaires from your company. For reasons of statistical significance, a certain number must be reached. In order to attend this requirement we ask you to consider the distribution of 300 questionnaires. Moreover, we ask you to consider the formal procedures for questionnaire distribution detailed in item No. 5.

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4. Questionaire Respondents Profile Employees should be invited to cooperate by the board of directors at least one week or so in advance. The sample of employees should cover all departments of the company (sales, marketing, HR, products, engineering, legal, etc.). It is very important to assure a considerable degree of participation of respondents from the development, management and sales departments of different products and/or services. For this reason we would also like to attach a cover letter signed by the CEO or managing director of the board. We find this to be essential in insuring the enthusiastic participation of all people concerned.

5. Formal procedures for questionnaire distribution The research process follows formal scientific standards of data-collection in order to assure that results provide reliable information. We want to produce accurate and reliable results for the benefit of your company as well as the research project. Thus, we kindly ask for your attention and cooperation regarding the following procedures: a) As mentioned above, from our experience it is essential to obtain formal support from the board of directors before and during the research period. We ask the Board of directors to inform and invite all managers and employees participating in the survey at least one week before. Please request the special support of local managers. This could take the form of a memo or an e-mail. Moreover, enclosed with our questionnaire we would like to distribute also a cover letter from the CEO or board of directors supporting the survey. We provide you a sample of this letter in the Appendix No. 1 enclosed. b) Questionnaires should be distributed within the research period (from 15th August to 20th September, 2004). c) It is fundamental in order to get reliable information that the questionnaires be distributed and collected only by the members of the research team. Contact with third parties or other company members should be avoided. In this way, employees will feel free to express their feelings and perceptions about their relationship with company’s members and with the company. The research team will be available to distribute and collect all questionnaires during all questionnaire distribution phases. For that, a research team member will be available for the days scheduled by the company. The research team will go to each site to assure that questionnaires will be distributed and collected so as to maintain the confidentiality critical for this project. d) The questionnaire distribution process should be established in advance with the research team and according to the company’s routine. We kindly ask the HR department to support the coordination of the employees during the questionnaire distribution process. For the days scheduled by the company, there should be easy access to the research team

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member(s) inside the company. Respondents should fill out the questionnaire during the same day. It will proceed as follows: once employees were informed and invited in advance by HR department, generally two possible ways can take place according to company’s resources and routine: 1) one special room or auditorium inside the company (an easy access central location) will be reserved in those days and groups of employees will be invited in advance by HR to go there in different times of the day in order to fill out the questionnaire; 2) The research team will distribute the questionnaire in each location, floor, and building of the company and will go back in these same places to collect it some time later. A member of the research team will be there during the entire day to assure that no one has access to the questionnaires. e) The questionnaire includes approximately 70 short questions and is designed to be filled out in approximately 25 minutes.

6. Mutual nondisclosure agreement and data publishing For the essential data protection vis à vis third parties, the following indicates the formal relationship between the company and the research team. The deliverable to the company will be a comprehensive consulting report presented by the research team to the CEO and Board of directors and their invited designates. This will take the form of a detailed report of the state of the organization and inter-company comparisons. Hard copies will be delivered to the individuals participating in the presentation of the report and also an electronic copy will be available to the CEO. The research team has the intention to publish, in academic journals, some results of the study. In this regard, no information which would disclose the name of the participating companies or any private information will be contained in such publications. Also, all information of the comment sheets will be summarized so that individual direct comments or quotes will never be available to the company. We will keep confidentiality regarding to all individual information collected by the research team. We (the research team) will exclusively own the data and we will have the right to publish the results. Finally, the questionnaires will be maintained by the research team and the data base of response will be exclusive property of the research team.

7. Contact Person With the objective to create efficiency between our team representative and your company, we kindly ask you to indicate a contact person in your company responsible for all communication and contact with the research team. It would be important for this individual to have decision-making authority so as to facilitate the many detailed decisions that need to be made on an ongoing basis to execute this research project.

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8. Project Schedule to be fixed by your company -

One day between 19th July to 10th August to discuss with the research team the company specific details of the project.

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At least three days between 15th August to 20th September for the questionnaire distribution.

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One or two days between 15th August to 20th September for Interviews with HR and Strategy and Planning Directors.

We ask you to fix these dates as soon as possible We greatly appreciate your participation and collaboration in this project and will be happy to share these valuable results with you. From 19th July to 10th August the research team will be available in Brazil looking forward to discussing further details also in person. However, feel free to contact our research team anytime for any further question about the research:

Yours sincerely, Prof. Dr. Birgitta Wolff

Prof. Dr. Edward J. Lusk

Marco Tulio Zanini

Chair of International Management, Vice Dean of the Faculty of Economics and Management

Chair of Business Administration

Researcher

Our contacts: Prof. Dr. Birgitta Wolff, Office:  00-49-391/ 67-18789,  [email protected] Prof. Dr. Edward J. Lusk, Office:  00-49-391/ 67-18729,  [email protected] Marco Tulio Zanini, Office:  00-49-391/ 67-18630,  [email protected]

We ask you to sign the present document as a nondisclosure agreement and return it signed to the research team.

Place, Date

Company’s Representative Name and Signature

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APPENDIX No. 1

Memorandum (Draft) COMPANY’S LABEL To: All COMPANY’S NAME employees DATE: FROM: CEO Cc: SUBJECT: COMPANY’S NAME Participation in the Trust Inventory Project

Our company has agreed to participate in the research project “Trust Inventory Project” with the University of Magdeburg, Germany. Researchers from the University of Magdeburg, Germany have found out in their research that important “hidden factors” related to trust have critical importance for the success of companies. These factors have considerable importance regarding to the core issues on the quality of management and performance. The survey will be conduced simultaneously at various locations in our company. The research project team from the University will conduct the survey at our locations but the company will not have access to the complete questionnaires or view any of the information; it is completely confidential. The analysis of the questionnaires will be done by a scientist team from the University of Magdeburg in Germany. Please give your full support and participation to the survey. This is an important opportunity for the company to learn from our employees. Your feedback is extremely important and valuable tool to keep us on the right track. One final comment: the survey is a document which cannot be changed. There are several questions in the survey which under normal circumstances as your employer we would not ask our employees. But due to the nature of the project, we must keep the survey as it is presented. We need your participation in the survey to be meaningful but do not answer any question that you are not comfortable with.

Thanks for your cooperation,

Name of the CEO/President or Representative

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