Managerial Conservatism: A Job Steps Model
At the end of this post is the abstract for an old article of mine on why managers are conservative. Here’s another possible reason. Suppose that a manager’s pay depends on his perceived skill as in the diagram above. If his skill is thought to be low, he isn’t hired and he earns $0 from the firm. If his skill is thought to be high enough, he is hired. If his skill is still higher, he is promoted to a higher salary step, all the way up to the CEO, who in the graph is given a maximum possible pay (a maximum not essential for the story I am going to tell).
I think a story can be told similar to the one in my JEMS article for why most managers in the firm will be nearer being fired to being promoted– that is, in the lower half of their step’s skill level, not the upper half. The reasoning would go something like this. Most people in the population are thought to have such low skill that they are not even hired– so they make no decisions for the firm. Some few people look good enough, so they are hired into the first step. But since most people are lower skill, most people hired are in the bottom half of the irst step, not the upper half. Similarly, most people don’t get promoted past the first step. So in the second step, more people are in the lower half than the upper half.
Here is why this creates managerial conservatism. If you are a manager in the lower half of your step, and are given a 50-50 gamble on whether to have your perceived skill rise or fall half a step, you will reject the gamble. If you rise, you still are not good enough to get a promotion. If you fall, you get fired or demoted. Most managers are in the lower half of their step, so most managers are conservative and avoid taking gambles.
“Managerial Conservatism and Rational Information Acquisition,” Journal of Economics and Management Strategy (Spring 1992), 1: 175-202. Conservative managerial behavior can be rational and profit- maximizing. If the valuation of innovations contains white noise and the status quo would be preferred to random innovation, then any innovation that does not appear to be substantially better than the status quo should be rejected. The more successful the firm, the higher the threshold for accepting innovation should be, and the greater the conservative bias. Other things equal, more successful firms will spend less on research, adopt fewer innovations, and be less likely to advance the industry ’s best practice. In Ascii txt-Latex (76K) or pdf (278K, http://Pacioli.bus.indiana.edu/erasmuse/published/Rasmusen_92JEMS.conservatism.pdf). /a>