to share information about economic opportunities motivates
firms to expand boundaries
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do some people in human-capital-intensive industries, such
as law and medicine, decide to work together in firms? When
do firms "extend their boundaries" by including
a wider range of work and people with a broader variety of
expertise? Research published by Kellogg Professor of Management
and Strategy Thomas Hubbard finds that the answers are shaped
in part by the value of sharing economic information.
and Luis Garicano (University of Chicago) investigated factors
that determine firm boundaries in human-capital-intensive
industries. They used confidential law office data collected
by the U.S. Bureau of the Census and examined information
that indicates how lawyers specialize and are organized into
firms. Using this data, the researchers examined central issues
in the organization of human capital.
findings suggest that organizing lawyers into firms facilitates
the exchange of information about economic opportunities.
"Firms essentially weaken individuals' incentives to
withhold information from each other," Hubbard explains.
Since lawyers in the firm share revenues, they know that giving
one another useful information that benefits the firm also
will benefit them individually.
the evidence for the value of referrals, the researchers found
that lawyers who work in litigation-intensive fields tend
to work in field-specialized firms while lawyers in transactional
fields tend to work in firms with multiple kinds of specialists.
Hubbard and Garicano explain this pattern by the relative
referral value in each of these kinds of law. "If you're
a litigator, clients can self-refer pretty easily," Hubbard
says. "If I'm being sued for negligence, it's pretty
obvious that I need a negligence lawyer, and I don't need
an environmental lawyer." Thus, there is not much value
in having these two types of lawyers in a firm, because the
referral patterns between them are so low.
for lawyers engaged in transactional work, the referral opportunity
is greater. For example, if a client is buying a facility
in the next county, the client may wonder about both the deal's
tax and the environmental implications. In this case, the
client cannot easily identify the need and match the need
to the appropriate expert. This results in the original lawyer
having knowledge of a potential economic opportunity. Expanding
the firms' boundaries by affiliating the tax, environmental
and contract lawyers, breaks down barriers to sharing information.
explains that risk sharing offers a popular theory about why
lawyers join firms. In fact, this explains why any firm diversifies:
to insulate from demand fluctuations. However, the researchers
found little evidence to support risk sharing as a motivator
for collaboration in the context of law firms. "If you're
a corporate lawyer, you are usually working with someone in
a related specialty, such as a tax lawyer," Hubbard says,
adding that these demands are positively correlated. "If
law firms' boundaries were all about hedging their bets, corporate
lawyers would never work with tax lawyers. They would work
with lawyers in areas of the law where demands are not positively
correlated, such as divorce lawyers."
says that just because an industry is human-capital-intensive
does not mean that large projects lead to large firms with
many kinds of specialists. In the construction industry, it
takes a variety of skills to build a house. If a house-building
firm expanded its boundaries, it might result in a firm that
consists of a carpenter, a plumber, a drywall installer and
an electrician. This is rarely the case. "Just because
you need various specialists to produce something doesn't
mean that all these specialists will work within the same
firm," Hubbard says.
the nature of referrals enables the researchers to apply their
findings to other industries. Hubbard describes a referral
as an exchange of information about an economic opportunity;
this collaboration transcends the realm of law and can be
applied in other firms, such as a pharmaceutical company.
Researchers in one division might make discoveries that could
be more valuable in another part of the organization. If these
were separate entities, the discovery's value might be minimized
due to difficulties in sharing the information. When the researchers
are in separate divisions of the same firm, this facilitates
information exchange, and the entire firm benefits.
broad principles of what we found could apply generally to
all human-capital-intensive firms," Hubbard says.
Caley is a freelance writer based in Corvallis, Ore.