The Importance of Being Consulted

Fedele, Alessand o; Man o ani, And ea Wo king Pape The Impo ance o Being Consul ed Quade ni - Wo king Pape DSE, No. 712 P o ided in Coope a ion wi h: Uni e si y o Bologna, Depa men o Economics Sugges ed Ci a ion: Fedele, Alessand o; Man o ani, And ea (2010) : The Impo ance o Being Consul ed, Quade ni - Wo king Pape DSE, No. 712, Alma Ma e S udio um - Uni e si à di Bologna, Dipa imen o di Scienze Economiche (DSE), Bologna, h ps://doi.o g/10.6092/unibo/amsac a/4530 This Ve sion is a ailable a : h ps://hdl.handle.ne /10419/159553 S anda d-Nu zungsbedingungen: Die Dokumen e au EconS o dü en zu eigenen wissenscha lichen Zwecken und zum P i a geb auch gespeiche und kopie we den. Sie dü en die Dokumen e nich ü ö en liche ode komme zielle Zwecke e iel äl igen, ö en lich auss ellen, ö en lich zugänglich machen, e eiben ode ande wei ig nu zen. 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I he documen s ha e been made a ailable unde an Open Con en Licence (especially C ea i e Commons Licences), you may exe cise u he usage igh s as speci ied in he indica ed licence. h ps://c ea i ecommons.o g/licenses/by-nc/3.0/ T Q T he Impo a Al e A n Q uade ni - Wo        a nce o Bei n e ssand o Fe d n d ea Man o Wo king Pape        n g Consul e d ele ani s DSE N° 7 ed 7 12         T I  B C ∗ Alessand o Fedele † And ea Man o ani ‡ Abs ac Does managemen consul ing acili a e he access o c edi o s a -ups? This pape ies o answe he ques ion by de eloping a heo e ical amewo k whe e a i m applies o a bank loan o implemen a isky p ojec . The p obabili y o success inc eases i he i m exe s a cos ly manage ial ex a-e o , bu he bank is unable o obse e such an e o : a mo al haza d p oblem may he e o e occu . Du ing an economic down u n he p ojec ’s expec ed p o i abili y is likely o be low ela i ely o he e o cos . In his case we ind ha c edi is g an ed only i he bank hi es a managemen consul an , e en when he la e does no imp o e he business p ac ice. Keywo ds: managemen consul ancy, mo al haza d, bank c edi , economic down- u n. JEL Classi ica ion: M11, M13, D82 ∗ We hank Ca lo Sca pa o use ul commen s and sugges ions. The usual disclaime applies. † Depa men o Economics, Uni e si y o B escia, Via S. Faus ino 74/b, 25122, B escia, I aly, Tel: +39 0302988827, Fax: +39 0302988837; email: [email protected] . ‡ Depa men o Economics, Uni e si y o Bologna, S ada Maggio e 45, 40125, Bologna, I aly, Tel: +39 0512092602, Fax: +39 0512092664; email: a.man o [email protected] . 1 1 In oduc ion The managemen consul ancy indus y expe ienced spec acula g ow h in he las decades and much deba e poin ed o he easons o his boom (see Kipping and En- gwall, 2002, in e alii). A equen ly discussed explana ion is based on a “ma ke knowledge” a gumen and e e s o he posi i e ole o consul an s in supplying ex- pe ise and skill. The apid p og ess o in o ma ion echnology inc eased he in e nal complexi y o he i m and o ced manage s o seek p o essional ad ice ou side he i m i sel . Consul ancies a e hen hi ed o deli e up- o-da e managemen p ac ices and ma ke in o ma ion. On hese g ounds, hey p o ide a se ice ha clien s canno pe o m on hei own (Doche y e al., 1997; We , 1999; A mb us e and Kipping, 2002). A second explana ion o he g ow h o consul ancies is based on a “legi imacy” a - gumen . Acco ding o his pe spec i e, e en when consul an s do no imp o e he busi- ness p ojec , hey can be hi ed o con i m he alidi y o new en ep eneu ial p ojec s o he necessi y o adop ing some d as ic measu es (E ns and Kiese , 2002; Gluckle and A mb us e , 2003). In o he wo ds, e en when i ms do no eally need he ex- pe ise o a consul an o concei e a mo e e icien managemen p ac ice, consul an s may gain impo ance i , o example, hey alida e he decisions aken by he manage s a he eyes o he sha eholde s, o i hey jus i y unpopula changes, such as layo s and downsizing. O he explana ions ha e been added, as he p o ision o empo a y managemen skills in di icul pe iods, o he abili y o consul an s hemsel es o c ea e a “consul ing ashion”, i.e. o de elop a se ies o e ho ical echniques and s a egic images o cap u e he clien ’s a en ion (Ab ahamson, 1996, and Kiese , 1997). 1 We belie e ha some hing is missing. Casual obse a ion sugges s ha consul an s can be hi ed o mi iga e in o ma ional ic ions be ween lende s and bo owe s, he eby acili a ing he access o c edi : banks o en eso o consul an s p io o g an ing loans o applican i ms. To he bes o ou knowledge, his aspec has been a he neglec ed bu may p o ide new insigh s on he ole o consul ing companies. Re iewing mains eam li e a u e, he bene icial ole o gene ic media o s has been ini ially s udied by Mye son (1986) and Fo ges (1986) in communica ion games. Na - owing down he a ea o esea ch, only Mi usch and S ausz (1999) and Demougin and Fabel (2007) p o ide heo e ical scena ios in which consul an s educe in o ma ional asymme ies: he o me conside an ad e se selec ion model wi hin a i m and de i e 1 Bloom ield and Danieli (1995) sugges ha consul an s aim a cha ac e izing hei ela ionship wi h he clien as be ween ‘ he indispensable and he dependen ’ (p. 27). 2 condi ions unde which he consul ancy’s media ion is help ul; he la e in es iga e a ipa i e incen i e con ac be ween an inno a o supplying a new idea, a p o essional con e ing he idea in o a p oduc i e p ojec , and a consul ing ma ching he wo pa - ies. The ocus o hese con ibu ions is no on he isk o c edi c unch. The ecen inancial c isis, howe e , showed ha his is p obably he key aspec o en ep eneu s who wan o s a up a business. 2 The aim o his pape is o ill his lacuna. In pa icula , we will show how managemen consul ing can alle ia e a mo al haza d p oblem in ol ing a s a -up i m which applies o a bank loan. We belie e ha his is a ele an issue as he inc eased in e nal complexi y o i ms no only equi es ex e nal p o essional ad ice, bu may also exace ba e in o ma ional p oblems be ween i ms and ex e nal inancie s. This is especially ue when he in e ac ion be ween he i m and he bank is one-sho . I , in addi ion, he bank expec s low e u ns om inancing a p oduc i e p ojec because o a global economic and inancial c isis, hen he issue a s ake u ns ou o be e en mo e ele an , as in o ma ional asymme y becomes ( ela i ely) cos ly and may de ac o gi e ise o c edi a ioning. Ou model hinges upon a s a -up i m un by an owne -manage which applies o a bank loan o implemen a business p ojec . We hink o a (one-sho ) “a m’s lengh ” ansac ion wi hou moni o ing a he han a ( epea ed) ela ionship one. This ocus can be asc ibed o nume ous easons. On he one hand, he owne -manage migh need money only in he ini ial phase o he business, and hen plan o inance he con inua ion o he ac i i y h ough he acc ued e u ns o eso o he capi al ma ke and look o al e na i e and cheape o ms o inance, like bond issues. 3 On he o he hand, Boo and Thako (2000) show ha banks in es mo e in a m’s lengh ansac ions a e acing an inc easing capi al ma ke compe i ion, e en i de eloping close ela ionships wi h bo owe s o e ime can acili a e moni o ing and sc eening asks. The p oduc i e p ojec has a posi i e expec ed alue, i.e. i is c edi wo hy, only i he owne -manage exe s an addi ional and cos ly manage ial e o in he imple- men a ion phase. A plan o ac ion is likely o ail unless i is p ope ly designed, and his equi es ull commi men by he manage . In al e na i e, he bank can hi e a consul an who p o ides empo a y managemen skills, i.e. analyses he exis ing busi- 2 Fedele and Man o ani (2008) demons a e ha , in p esence o p oduc i e p ojec s based on com- plemen a y ac i i ies, delega ion o hidden asks o an in e nal employee can acili a e he access o c edi o a i m. 3 When he bank-bo owe ela ionship is no epea ed, Hauswald and Ma quez (2006) a gue ha he aquisi ion o in o ma ion ia moni o ing implies a e y cos ly sc eening and o he losses in e ms o ime, e o and esou ces employed by he bank; Ra id and Spiegel (1997) sugges ha moni o ing s a -ups may no be cos e ec i e o banks, because he loans a e complex o con ol. 3 ness p ojec and de elops a plan o ope a ional imp o emen , ins ead o elying on he owne -manage ’s abili y o do so. We will conside he e o e wo di e en scena ios, depending on which agen he bank “employs” o ob ain he ealiza ion o he manage ial e o . In he i s case, absen he consul an , he bank designs a s anda d deb con ac , aking in o accoun ha he e o le el canno be obse ed. The owne -manage ’s commi men o exe he e o is c edible only when he bank pays an in o ma ional en , o he wise he o me e ades he p o ision o he e o (i.e. he shi ks) and, acco ding o agency heo y, a mo al haza d p oblem a ises (Holms om, 1979). In he second scena io, on he con a y, he bank equi es he se ice o he managemen consul an in he ealiza ion o he p ojec , whose expec ed alue is posi i e only i he la e p o ides he manage ial ex a-e o . The in e en ion o he consul an equi es addi ional speci ica ions. Since man- agemen consul ing is gene ally no subjec o p o essional s anda ds, he pe o mance e alua ion is no an easy ask, as se e al pape s poin ed ou (Al esson, 2000; Cla k and Mangham, 2004; Gluckle and A mb us e , 2003). 4 We ely on his li e a u e o assume ha he consul an ’s e o is unobse able, ei he by he bank and he i m. On one hand, his elimina es he possibili y o collusion be ween he consul an and he clien i m, hus simpli ying he heo e ical amewo k o ou pape . 5 On he o he hand, as consul ancy i ms a e gene ally paid in a “cos plus” ashion, a mo al haza d p oblem may e-eme ge, in his case be ween he bank and he consul ing i m. A way o p e en he occu ence o such an oppo unis ic beha iou is o ely on ma ke signals such as b and name and epu a ion. Indeed, in many cases he ela ionship be ween consul an and bank is an on-going one. The loss o epu a ion associa ed wi h deli e ing bad quali y se ices implies a subs an ial educ ion o u u e p o i s o he consul an ha , when su icien ly o wa d-looking, may be disciplined o exe he addi ional manage ial e o . This mechanism wo ks inso a as he quali y o he consul ing se ice can be di ec ly obse ed ex pos ,i.e. i such se ices a e concei ed as expe ience goods (Nelson, 1970). Ye , o en clien s a e unable o do so, gi en ha consul an s p o ide bo h he “diagnosis” and he “ he apy”. This is why A mb us e (2004) conside s he se ice p o ided by he consul an as a combina ion be ween an 4 Cla k (1995) a gues ha consul an s a e capable o exploi ing p ecisely hose a eas in which he clien a e no able o e alua e ex an e he quali y o he se ice. 5 See Fincham (1999) o an in e es ing s udy o he consul an -clien ela ionship. As in o he con ibu ions on he ield, howe e , he ocus is on he consul an ’s ole in he managemen o o gani- za ional change a he han on he po en ial collusion be ween he wo pa ies. We belie e he la e migh ep esen an in e es ing ex ension o he cu en analysis. 4 expe ience and a c edence good. 6 We ollow his app oach by supposing ha he ex pos low quali y (shi king by he consul an ) canno be asce ained wi h ce ain y by he bank. 7 None heless, Gluckle and A mb us e (2003) coined he exp ession “ne wo ked epu a ion”, i.e. epu a ion media ed h ough business o p i a e ne wo k, o deno e he peculia combina ion o pas pe o mance and public ecogni ion ha ensu es he success o a consul ing i m. Repu a ional conce ns do no apply o he i m because (i) business s a -ups, lacking p io his o y and inancial/ope a ing eco d, ha e no (o no ye ) epu a ion (Huyghenbae and Van Guch , 2007); (ii) he in e ac ion wi h he bank is one-sho . We will sol e he model unde he wo al e na i e scena ios and in each o hem we will de i e he condi ions unde which he bank g an s he loan. As bo h he owne - manage and he consul an ha e o be compensa ed o he addi ional e o , he bank designs he app op ia e incen i e scheme o he agen a s ake and hen decides whe he i is wo hy o no o concede he loan. A equilib ium he bank compa es he wo scena ios and decides which agen o employ. The emainde o he pape is as ollows. The basic model is laid ou in Sec ion 2. Sec ions 3 and 4 conside s he wo scena ios, espec i ely wi hou and wi h he in e en ion o he consul an . Sec ion 5 de i es he bank’s decision and s esses on he wel a e imp o ing e ec o he consul an se ice. Sec ion 6 concludes. 2 The Model A i m un by an owne -manage applies o a bank loan o implemen a isky p oduc i e p ojec . The bank, once ecei ing he i m’s applica ion, decides whe he o (i) p oceed alone o hi e a managemen consul an ; (ii) g an he loan o no . I he loan is g an ed, he p ojec s a s up and, in case o success, he i m epays he bank. One can hink o a decision p ocess in which ac ions (i) and (ii) a e simul aneous, o sequen ial. A he end wha ma e s o he bank is he e alua ion o he p o i abili y o he p ojec in he wo scena ios. The p oduc i e p ojec can ei he succeed o ail, and only in he o me case e u ns a e posi i e. The success p obabili y inc eases i he agen (ei he he owne -manage o he consul an ) exe s a cos ly manage ial (ex a) e o . The bank may he e o e be in e es ed in inancing he p ojec , bu i canno obse e whe he he agen beha es o 6 See Da by and Ka ni (1973) o a p ecise de ini ion o c edence goods and o a discussion o how epu a ion a ec s he amoun o aud in ma ke s wi h his ype o goods. 7 Quali y o c edence goods can be disco e ed, o example, h ough he obse a ion o a signal sen by independen and c edible diagnosing expe s (Emons, 1997). 5 shi ks, hus i canno con ac upon he e o choice. Acco ding o he agency heo y, he e is a po en ial mo al haza d p oblem be ween he pa ies and he p oblem a ises when he agen does no beha e, as i will become clea sho ly. The desc ip ion o he model p oceeds by conside ing sepa a ely he wo scena ios. I he bank chooses o p oceed alone, i designs a s anda d deb con ac and hen he owne -manage selec s he e o ’s in ensi y. I , on he con a y, he bank hi es he consul an , a con ac is signed be ween he pa ies wi h a speci ic emune a ion o e ed o he consul an ; a e ha , he consul an selec s he le el o e o . In bo h si ua ions, i he loan is g an ed, p ojec e u ns acc ue in case o success and he i m epays he bank. Th oughou he pape we e e o he bank as “i ”, o he consul an as “she” and o he owne -manage as “he”; in addi ion, hey a e all supposed o be isk-neu al. 3 The Access o C edi Wi hou Consul ancy We conside i s he si ua ion whe e he bank does no eso o he consul an . The p ojec ’s alue is assumed o be Πwi h p obabili y pand 0wi h p obabili y 1−p. I he owne -manage exe s an ex a-e o , he success p obabili y inc eases o P > p. Ye , he addi ional deploymen o esou ces implies o he owne -manage a disu ili y, whose mone a y equi alen is cap u ed by e o cos E. The alue Π he e o e deno es he p ojec ’s ea nings (be o e in e es s and axes) in case o success, ne o he manage ial e o ’s mone a y disu ili y. Implemen ing he p ojec equi es one uni o unding, which is p o ided by he bank h ough a s anda d deb con ac : a epaymen Ris due by he i m only when he p ojec succeeds, in which case he epaymen canno exceed he p ojec ’s p o i : R⩽Π. The i m is hus p o ec ed by limi ed liabili y. The ou side op ion o he bank is o in es he uni o capi al in an al e na i e sa e asse e u ning ρpe uni in es ed. When he i m beha es and exe s he e o , he expec ed alue o he p ojec is EV ≡PΠ + (1 −P)×0−E−ρ, whe e ρ ep esen s he oppo uni y cos o capi al in es ed by he bank. Acco ding o he design o he deb con ac , such a alue is di ided in he ollowing way: U≡ P(Π −R)−Eis he i m’s expec ed sha e whe eas V≡PR −ρis he bank’s one. When he i m does no exe he e o , disu ili y Eis nough and he p ojec alue amoun s o EV ≡pΠ + (1 −p)×0−ρ. 6 The i m’s expec ed sha e is u≡p(Π −R), while ha o he bank is ≡pR −ρ. We suppose ha he p ojec has a posi i e expec ed alue only i he cos ly e o is exe ed. As a consequence, he bank is no willing o g an he loan i he owne - manage shi ks, being he p ojec no c edi wo hy. This can be o mally exp essed in: Assump ion 1 EV ⩾0> EV . On he one hand, he p obabili y o success pis supposed o be su icien ly low o he p ojec o be nonc edi wo hy when he e is misconduc . On he o he hand, he e o disu ili y mus be low ela i ely o he expec ed p o i PΠwhen he e o is p o ided. Indeed, sol ing by Einequali y EV ⩾0, we ge E⩽E≡PΠ−ρ, which is he ele an in e al egion o pa ame e E. The bank se s epaymen R o maximize i s expec ed sha e, which, ne o he in es men oppo uni y cos ρ, is ei he PR o pR. The p obabili y o ob aining he epaymen depends on he e o le el exe ed by owne -manage , whose choice is in u n a ec ed by he epaymen le el. Indeed, he ge s Uwhen exe ing he e o and u o he wise. Sol ing in R he inequali y U⩾uyields R⩽R≡Π−E P−p, which ep esen s he owne -manage ’s incen i e compa ibili y condi ion: he exe s he e o only o ela i ely low alues o he epaymen R,i.e. when he posi i e e ec on his expec ed u ili y b ough by an inc ease in he p obabili y o success ou does han he nega i e e ec due o he cos ly e o . As a consequence, he bank aces a ade-o : i s sha e is inc easing in R, bu when R > R he owne -manage p e e s o shi k, hus educing by P−p he p obabili y Ris epaid. When se ing R=R, he maximum epaymen ha induces he owne -manage o beha e, he bank ge s V ∗ =PΠ−E P−p−ρ and he i m U ∗ =p P−pE. No ice ha U ∗ is highe han ze o and inc eases along wi h Ebecause i ep esen s a compensa ion o he e o disu ili y: he i m ecei es a so-called in o ma ional en . 7 induced o beha e. This educes he bank’s cos o issuing he loan and u ns ou o be he only way o he c edi wo hy p oduc i e p ojec o ge access o inancing. We summa ize he abo e easoning in he ollowing Rema k 1 Du ing an economic c isis, he i m has access o c edi only i he bank has he op ion o hi ing a consul an who ca es abou epu a ion, e en when she does no imp o e he business p ac ice. An impo an lesson om Rema k 1 is ha he epu a ion o he consul an u ns ou o be a powe ul de ice o mi iga e he mo al haza d p oblem be ween he bank and he owne -manage . E en when no p o iding new solu ions o exis ing p oblems ( his aspec is cap u ed by se ing eequal o E), he e y p esence o a consul ing company can educe he possibili y ha a lending ins i u ion is no willing o inance a c edi wo hy p ojec . 6 Conclusion In his pape we ha e analyzed he in es men p oblem o a s a -up i m. The i m applies o a bank loan o implemen a p ojec which p omises a posi i e expec ed e u n only i a manage ial e o is exe ed in he implemen a ion phase. We ha e conside ed wo al e na i e scena ios: in he i s one only he bank and he i m a e in ol ed, while in he second a consul ing company can be hi ed. In bo h si ua ions he e exis s a mo al haza d p oblem, as he e o o he agen s, ei he he manage o he consul an , is hidden. We ha e he e o e compu ed he compensa ion ha has o be p o ided o each agen in o de o beha e, and concluded ha he loan would ha e been conceded by he bank only below some speci ic h eshold alues o he e o cos s. Finally, we ha e compa ed he espec i e en o he wo agen s o e alua e he decision o he bank a equilib ium. A c ucial poin is ha , while he ela ionship be ween he bank and he s a -up i m is supposed o ake place only once, ha be ween he bank and he consul an is epea ed: he bank (o o he banks) can p opose new con ac s o he consul an i sa is ied by p e ious pe o mance. We ha e concluded ha he bank decides o hi e he consul an when he la e ca es abou epu a ion in e ms o o egoing u u e p o i s, hus equi ing a lowe compensa ion han he owne - manage . When his is he case, hen he e exis s an in e al egion whe e c edi is g an ed only unde he p esence o he consul ing se ice. The epu a ion o he 14 consul an becomes he e o e a powe ul ool o educe in o ma ion ic ions be ween he bank and he owne -manage . Wi h espec o he exis ing li e a u e, we ha e ied o ill a heo e ical gap: we ha e p o ided a mo al haza d amewo k ha demons a es he abili y o consul an s, e en when no p oposing mo e e icien solu ion o exis ing managemen and o ganiza ional p oblems, o acili a e he access o c edi o s a -ups. We ha e shown ha his issue is ele an due o he ecen inancial c isis. We belie e ha a leas wo impo an and somewha na u al ex ensions o he cu en analysis should be included in ou u u e esea ch agenda. Fi s , as he ou come o a consul ancy p ocess depends on a s ic in e ac ion be ween he consul an and he i m, he consequences o collusion has o be s udied. Second, he ole o en u e capi al i ms is wo h in es iga ing, since hei ac i i y mainly consis s in p o iding en ep eneu ial i ms wi h inancing, o en in conjunc ion wi h manage ial expe ise. 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