Irina Levina Decentralization and Hiring Strategies at Russian Firms



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Irina Levina

Decentralization and Hiring Strategies at Russian Firms




  1. Introduction

During the last decades significant changes in the internal organization of firms were observed. In particular, organization of decision-making becomes more and more decentralized, with the increasing share of questions moving from sphere of responsibility of the CEOs and top managers to the responsibility of middle and local management. Following these changes, literature on decentralization of decision-making at the firms quickly develops.

Decentralization is important for growth and development of the firms. Delegation of certain share of responsibilities from the CEOs and top managers down along the managerial hierarchy allows implementing more projects, quicker taking competent decisions and reacting to the challenges of market economy. Furthermore, decentralization may improve motivation and incentives of employees. A number of recent papers demonstrate that decentralization is associated with better economic performance of the firms. Decentralized firms are on average more productive, more innovative, less vulnerable to economic shocks (see e.g. Acemoglu et al., 2007, Kastl et al., 2013, Aghion et al., 2015).

Decentralization of decision-making is accompanied by loss of complete control over firm and agency risks, because incentives of managers can diverge from incentives of owners or CEOs. To reduce agency risks of decentralization, firm CEOs may use strategy of delegation decision-making power to people they trust (based on personal contacts or trustworthy recommendations). However, this strategy would also have important drawbacks. Selection of candidates for the key positions on the basis of connections significantly limits the pool of eligible candidates and, hence, the “pool of qualification and talent” to choose from, which can strongly depreciate potential benefits of decentralization.

Current literature on decentralization, analyzing the relation between decentralization and economic results of the firm, does not consider potential role of hiring for key managerial positions policy. Yet, this policy can be important for the efficiency of decentralization.

Anecdotal evidence suggests that in Russia strategy of hiring people for key positions on the basis of connections is quite popular among both, centralized and decentralized firms. Is this strategy efficient in terms of firms’ performance? What factors, firm-level and institutional, shape firms’ decentralization and hiring policy choices? In this paper I use data of the “Russian Firms in a Global Economy” survey to answer these questions.

The paper demonstrates that decentralization accompanied with hiring for key positions on competitive market is associated with much better firms’ performance in terms of investment. However, share of firms that are decentralized and hire of the key positions on competitive basis is very low, only 7% of Russian manufacturing firms. What limits decentralization of decision-making to competitively hired professionals in Russia? Analysis presented in the paper points to the important role of institutional environment in limiting decentralization to competitively hired professionals. Firms situated in more corrupt regions are less likely to be decentralized and hire key people on a competitive basis, while being much more likely to be centralized and select people for key positions by connection. Analysis also reveals influence of the CEOs’ relation to owners, as well as age and gender on firm decentralization and hiring decisions.

Hereafter the paper is organized as follows. Section 2 presents literature review. Section 3 describes the data. Section 4 demonstrates relation between firm decentralization and hiring choices and investment. Section 5 presents results of regression analysis that investigates factors that shape decentralization and hiring decisions in Russia. Section 6 concludes.



  1. Literature Review

Importance of decentralization for growth and development of the firms was pointed since early works of Penrose (1959) and Chandler (1962). Delegation of authority is essential for creating large and efficient firms, because time the CEO possesses and number of problems she can solve simultaneously is limited.

Decentralization of decision-making is associated with agency risks. The agency risks of decentralization are discussed in many papers, including Radner (1992) and Aghion et al. (2014). At the same time, decentralization of decision-making can improve incentives and motivation of firm managers and employees, see theoretical papers by Aghion and Tirole (1997) and Baker et al. (1999), and survey of empirical research in behavioral economics by Weibel et al. (2014).

A number of papers demonstrate correlation between decentralization and economic effectiveness of the firms. Acemoglu et al. (2007) demonstrate that decentralized firms in France and UK are on average more productive and closer to the production possibility frontier. Kastl et al. (2013) show that decentralized firms in Italy invest more in R&D. Levina (2014) uses data on 7 European countries (Austria, France, Germany, Hungary, Italy, Spain, UK) to point that decentralized firms are more likely to export, to innovate and to bring new products to the market. Aghion et al. (2014) discuss that, while empirical research demonstrates correlation between decentralization and firm outcomes, establishing empirically the causal relation between decentralization and firm economic results is complicated because of the endogeneity problem.

A recent paper by Aghion et al. (2015) makes an important step towards deeper understanding of the relation between decentralization and economic efficiency of the firms. Paper analyses performance of centralized and decentralized firms from 10 OECD countries during the crisis of 2008-2009, and demonstrates that firms that were decentralized before the crisis turned out to be more efficient during the crisis – they demonstrated better dynamics of sales, TFP, profits.

Literature that studies factors influencing the choice of decision-making model at the firm demonstrates that institutional environment is important for decentralization choices. Firms situated in the regions with higher trust and stronger rule of law are more likely to be decentralized (Bloom et al., 2012), while higher corruption in the region reduces probability of decentralization (Athanasouli, Goujard, 2015). Higher competition in the environment firm operates makes decentralization of decision-making more likely (Bloom et al., 2010a). Larger firms are more likely to be decentralized (Bloom et al., 2012 and other), firms that face more difficult problems to solve, in particular, younger firms are also more likely to be decentralized (Acemoglu et al., 2007). For firms managed by owners or members of their families chances to have decentralized decision-making are lower (Levina, 2014).

Caroli and Van Reenen (2001) use data on French and English firms to analyze the relation between quality of human capital and organizational changes, in particular, decentralization of decision-making at the firms. In the theoretical part of the paper authors demonstrate that higher quality of human capital enhances benefits and reduces costs of decentralization of decision-making at the firms. In the empirical part authors show complimentarity between organizational changes at the firms and qualification of employees, and demonstrate that organizational changes lead to larger productivity growth for firms with higher quality of human capital. Bresnahan et al. (2002) exploit data on large US firm to confirm complimentarity between decentralization, quality of human capital and economic results of the firms.

Bertrand and Choar (2003) demonstrate the important effect that individual top-managers have on firm corporate behavior and performance. Authors track the top-managers across different firms over time. Empirical analysis reveals significance of top-manager fixed effects that explain important share of heterogeneity in investment, financial and organizational practices at the firms. These results make authors conclude that top-managers bring their own, individual style of management to the firm, which plays important role for firm performance.

Perez-Gonzalez (2006) and Bennedsen et al. (2007) demonstrate importance of professional talent and qualification of CEOs for economic results of the firms. The papers show that firms which hire CEOs on a competitive basis at the market demonstrate better economic results compared to firms which choose CEOs based on family connections. Perez-Gonzaless (2007) emphasizes the importance of competitive hiring for top managerial positions. Using Warren Buffet’s analogy, the author says that “those firms that pick executives from the small pool of family heirs would be “choosing the 2020 Olympic team by picking the eldest sons of the gold-medal winners of 2000 Olympics”. Bennedsen et al. (2007) point that choosing CEOs by family ties limits the “pool of managerial talent”.

In post-communist economies the problem of choosing people for top managerial positions is especially acute. Bloom et al (2012b) point that before the beginning of transition firms in such countries did not have an objective of profit maximization, problems that firms solved were very different from problems of firms in market economies. Therefore, in the post-communist countries many managers still lack relevant knowledge and qualification. Authors demonstrate that post-communist countries still have on average lower quality of management than developed ones, while variation in the quality of management in post-communist countries is high. According to the results of the study quality of management at Russian firms is on average low.


  1. Data

The paper uses data of the survey “Russian Firms in a Global Economy” (RuFIGE). The survey was run by the Higher School of Economics Institute for Industrial and Market Studies in summer and autumn of 2014. In the framework of the survey top managers of 1950 manufacturing firms from 60 Russian regions were interviewed. The survey includes questions about different aspects of firms’ internal organization and performance, in particular, question about organization of decision-making at the firms and question about strategies of hiring for top managerial positions.

The question about organization of decision-making is formulated as follows: “With reference to strategic decisions which of the following statements better describe your firm situation?



  1. Decisions in your firm are centralized: the CEO/owner takes most decisions in every area

  2. Decisions in your firm are decentralized: managers can take autonomous decisions in some business areas”

The wording of this question replicates the wording from the earlier survey
“European Firms in a Global Economy” (EFIGE) run in 2010 in 7 countries of Europe.

The question about hiring policies is formulated in a following way: “What are the most important factors the owners/CEO of your firm take into account primarily when they appoint employees to the key managerial positions?



  1. Level and quality of education

  2. Previous professional experience at your firm

  3. Professional experience at other firms (organizations)

  4. References from acquaintances or people whom owners /CEO of your firm trust to

  5. References from former employers or recruitment agencies

  6. Personal acquaintance with the candidate

  7. Interview results

This question does not have analogs in the survey “European Firms in a Global Economy”. It was formulated specially for the Russian survey in order to allow study the interplay between organization of decision-making and hiring policies at the firm.

Factors which firm owners/CEO take into account primarily when appointing employees to the key managerial positions, listed in the question, can be divided into two categories: factors that do not contain restrictions for the pool of people from which employees for key managerial positions can be selected, and factors that contain such restrictions. Factors that do not contain restrictions for the pool of eligible candidates are: level and quality of candidates, professional experience at other firms (organizations), references from former employers or recruitment agencies, interview results. Factors that contain restrictions for the pool of eligible candidates are: previous professional experience at the firm considered, references from acquaintances or people whom owners/CEO of the firm considered trust to, personal acquaintance with the candidate.

Based on this division, for the purposes of the analysis of this paper I construct a binary variable for the hiring policy for top positions at the firm: hiring policy is ‘competitive’ if neither one of the factors chosen in the answer to the questions contains restriction for the pool of eligible candidates; hiring policy is ‘restricted’ if at least one of the factors chosen in the answer to the question contains such restrictions.

I also use data on corruption and quality of courts in Russian regions from Business Environment and Enterprise Performance Survey (BEEPS) 2012, and Russian Federal State Statistics Service (Rosstat) data on GRP per capita in Russian regions.

The average employment at the firm from RuFIGE sample is about 100 employees. Competitive hiring policies are used only at 41% of firms from the sample. 17% of firms have decentralized strategic decision-making. Table 1 illustrates the interaction between organization of decision-making and hiring policies for key managerial positions at the firms.
Table 1. Decentralization and hiring for key positions

 

 

Hiring for key positions

 

 

Restricted

Competitive

Organization of decision-making

Centralized

49%

34%

Decentralized

10%

7%

Only at 7% of firms from the sample decentralization of decision-making is accompanied with competitive hiring policies.




  1. Is It Indeed Important to Decentralize Decision-Making to Professionals?

Is it indeed important to accompany decentralization of decision-making with competitive hiring, or, in other words, to decentralize decision-making to competitively selected professionals? The RuFIGE survey data indicate that it is. I will illustrate this by the example of firm investments.

Table 2 shows shares of firms that implemented investments in 2011-2013 for firms with different modes of organization of decision-making and different policies of hiring for key managerial positions. It can be seen from the Table, that there are almost no differences in the share of firms that invested between centralized firms with restricted hiring policies, centralized firms with competitive hiring policies and decentralized firms with restricted hiring policies. However, in the group of decentralized firms with competitive hiring policies share of investing firms is much higher. The difference is impressing: decentralized firms with competitive hiring policies are about 1.5 times more likely to invest than all other firms.
Table 2. Share of firms that implemented investments

 

 

Hiring for key positions

 

 

Restricted

Competitive

Organization of decision-making

Centralized

39%

41%

Decentralized

41%

59%

Table 3 presents similar data for large investment. The Table shows shares of firms that invested 10% of their annual turnover or more in 2011-2013. It is seen from the Table, that for large investment tendency is quite the same: while there is no significant differences in the share of firms that implement large investments between centralized firms with restricted hiring policies, centralized firms with competitive hiring policies and decentralized firms with restricted hiring policies, share of firms that implement large investments among decentralized firms with competitive hiring policies turns out to be much higher (about 1.5 times higher than among other firms).


Table 3. Share of firms that invested 10% of annual turnover or more

 

 

Hiring for key positions

 

 

Restricted

Competitive

Organization of decision-making

Centralized

30%

30%

Decentralized

33%

48%
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