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Article Excerpt
1. Introduction
One of the most significant questions in global strategy is how multinational firms should navigate multiple and often conflicting institutional environments (Ghoshal and Westney 1992, Morgan et al. 2001). Although most foreign direct investment (FDI) is still conducted by companies whose profitability is derived largely from labor productivity, we still know surprisingly little about whether and how much labor market institutions (defined as formal and informal rules governing the labor market) matter for the profitability of FDI. Despite earlier calls for research in this area (Rosenzweig and Singh 1991), there has been little work done on the effect of labor market institutions on multinational firms' strategic choice and performance, and key questions remain understudied. Under what conditions should multinational firms simply avoid institutionally incompatible environments, and what makes an environment institutionally incompatible? How much should multinationals adapt to different institutional environments? Past studies have examined the likelihood of organizational practice transfer abroad, but few have examined the effect of adaptation on multinational performance. Adaptation is a critical international business strategy (Ghemawat 2007), yet a recent literature review shows that little is known about the optimal level of adaptation by multinationals to any local market institutions (Dow 2006). (1)
To shed more light on these questions, we leverage a unique quasi-natural experiment. Lincoln Electric long ago decided to be present in nearly all of the world's largest welding markets, regardless of each market's labor institutions. We show that summary statistics of key labor market measures for the countries in which Lincoln Electric operates closely resemble the same statistics for the wider universe of countries. And although Lincoln Electric is unusual for its broad global footprint, it is representative of a wider universe of horizontal U.S. multinational enterprises (those producing and selling in foreign markets to foreign consumers). (2) Lincoln Electric (hereafter referred to as "Lincoln" or "Lincoln Electric") is a much-studied company operating in a representative manufacturing industry where profits have historically been derived largely from labor productivity. Furthermore, Lincoln Electric pioneered many incentive practices--particularly the discretionary bonus--that have been widely adopted by other firms.
One of the reasons for the lack of studies of multinational firms and conflicting labor market institutions is that it is costly to measure each country's labor market institutions, and difficult to interview managers from every host country for even a single multinational firm. Over a two-year period, we interviewed Lincoln Electric managers and local labor market experts around the globe, and studied local labor laws and regulations, which allowed us to implement what we believe is the first quasi-natural experiment on the effect of diverse labor market institutions on a global firm's strategic choices and performance. We find that Lincoln Electric performed significantly better in countries with labor laws and regulations supporting manufacturers' interests and allowing unconstrained use of incentive pay-for-performance. In countries with less friendly labor market institutions, Lincoln was still able to enhance its performance significantly by what we term flexible intermediate adaptation.
Together, these findings suggest that the theory of strategic complementarity (Milgrom and Roberts 1995, Ichniowski and Shaw 2003) needs to be made more institutionally contingent. A bundle of managerial practices may be complementary (with payoffs for each increasing in the presence of the others), but complementarity may be predicated on the host country's institutional characteristics, such as a pro-labor or a pro-capitalist orientation. Practices that complement each other in the United States may not do so in a different institutional environment. The multinational should be aware of the effect of labor market institutions on performance, and may need to consider moving its resources to friendlier institutional environments if the effect is large enough. If a firm needs to be in a given market for other reasons (such as market size), the optimal mix of labor market practices needs to be customized in a flexible, intermediate form of adaptation. The optimal mix of labor practices for Lincoln Electric is typically different across countries, and successful adaptations emerge from managers' optimizing between the practices employed in Lincoln's flagship U.S. operation and host-country customary practices.
We proceed as follows. First, we discuss why some societies restrict incentive pay-for-performance, and then we introduce Lincoln Electric and its business strategy, including caselets illustrating Lincoln Electric managers' flexible adaptation to institutional environments. We then discuss our method for the quasi-experiment, followed by description of the data, our results, and conclusions.
2. Labor Power and Why Some Countries Place Constraints on the Use of Incentive Pay
Incentive pay-for-performance can be a highly effective form of compensation benefiting both employer (via increased productivity) and worker (via increased pay) simultaneously (Lazear 2000). Yet, organized labor has traditionally often opposed the unconstrained use of incentive pay-for-performance (Kennedy 1945), both lobbying for formal legal restrictions on specific practices and opposing the unconstrained application of incentive pay inside companies. In this section, we describe the fundamental challenge of pay-for-performance, and organized labor's traditional objections to certain incentive practices. We then use the theory of egalitarianism (Siegel et al. 2008), drawn from political economy and social psychology, to explain why countries vary in their adoption of restrictions on pay-for-performance.
Pay-for-performance can create a prisoner's dilemma between employer and worker (Leibenstein 1987), requiring the worker to reveal information on the best way to do a job and the employer to set and maintain an appropriate incentive rate. The worker should exert effort; the employer should pay the promised incentive and resist the temptation to renegotiate a lower rate once the worker has divulged all information (unless the very nature of the task changes). The semiskilled or skilled worker has superior knowledge about the best way to do a task, resulting in power over the employer during the establishment of the incentive. However, the employer has power to subsequently reset pay (Baldamus 1957). To reach the optimal outcome, worker and employer have to cooperate so that neither takes advantage of the other at the point where each has power. Yet, historically, trust often broke down, with information not fully shared by employees and incentives reduced at the employer's whim (Roy 1952; Dawson 1999, p. 39). Misapplication of incentive pay was a major factor in the rise of labor unions and demands for formal laws limiting the use of these structures (Kennedy 1945, p. 50). (3)
Unions expect higher transaction costs and increased risk of holdup when firms use incentive pay-for-performance (Kennedy 1945, Leibenstein 1987). Kennedy (1945) notes that unions negotiating time-based compensation know that most issues are settled at contract signing, but with incentive pay, unions must work with many more variables defining and measuring a multitude of tasks within the firm. In the terms of transaction cost economics (Williamson 1975, 1985), unions fear that the use of incentive pay-for-performance puts them in a context in which there is asset specificity (specifically, their members' investment in firm-specific human capital, though this investment is somewhat offset by the firm's need for specially trained workers), uncertainty over future events that could result in the need for renegotiation of incentives, and the potential for managerial opportunism in seeking renegotiation.
Incentive pay structures also often conflict with union leaders' interest in maximizing equity across members with varying productivity levels, as incentive pay is associated with higher average pay but also higher dispersion of pay within a firm (Seiler 1984). Another concern may be cohesion of the union itself, because leaders might expect some workers to adopt a more individualistic mindset (Kennedy 1945, p. 65). Unions may also worry about the health and welfare of the worker, with concern that pay-for-performance incentives could lead the worker to overwork himself (Kennedy 1945, Vezina et al. 1989). Finally, the cooperation required to implement incentive-pay practices may simply run counter to the traditionally adversarial position of unions vis-a-vis the firm. Kennedy (1945, p. 149) notes, "Just as soon as they begin to share responsibility for rates and standards, a union committee and officers expose themselves to almost inevitable suspicion, criticism, and disagreement from the membership."
Due to union opposition, some countries have legislation restricting the use of piecework and other incentive pay. However, legislation varies considerably by country, and we argue that this variation is not random. In previous work, Siegel et al. (2008) provided a historically motivated institutional theory of egalitarianism, explaining why some countries give greater priority to the rights of labor than others. As put forward in Siegel et al. (2008), cultural egalitarianism stands for a shared societal view of all people as moral equals, and also relates to a society's intolerance for abuses of market and political power inequality. The authors show how historical shocks such as the nature of wars of state formation dating back to the 19th century, along with societal fractionalization and the content of religious belief at the turn of the 20th century, explain more than half of today's cross-country variation in surveyed levels of egalitarianism. Cultural beliefs about egalitarianism then form the foundation for a society's balance between worker protection and employer operating freedom. Countries higher in egalitarianism are much more likely to select policies enforcing the rights of labor and limiting the prerogative of employers in setting incentives and compensation.
Because of this historical role of culture and accompanying formal legal institutions, today's multinational finds a wide range of policies constraining or enabling pay-for-performance across countries. Williamson (1975, pp. 36-37) discussed how differences in "atmosphere,"--cultural beliefs and sociopolitical institutions--could lead firms to make different optimal transactional choices across locations and noted, "The social context in which transactions are embedded--the customs, mores, habits, and so on--have a bearing, and therefore need to be taken into account, when moving from one culture to another" (Williamson 1985, p. 22). In the present context, differences in egalitarianism that were largely formed a century or more ago led societies to choose regulations on incentive pay-for-performance that often have also been in place for decades, sometimes 50 years or more. (4) In the current era of globalization, many firms like Lincoln Electric have encountered these multiple, oftentimes conflicting labor market constraints. As previous research has examined the alignment of firm-level transactional choices to variation in the economic environment (Masten et al. 1989, 1991; Masten 1993), we seek to study how the multinational firm should make incentive choices given cross-country differences in labor power and local labor market institutions. (5)
3. Lincoln Electric and Flexible Intermediate Adaptation
Lincoln Electric is a welding manufacturer based in Cleveland, Ohio with a broad global footprint. Founded in 1895, Lincoln Electric produces both welding machines and consumable products for those machines. Over the 20th century, Lincoln Electric outlasted a series of significant competitors in its industry, including General Electric and Westinghouse, and by 2006 the company had $1.97 billion in annual revenue. Over the past 60 years, the company has gained recognition for its use of incentives and pay-for-performance, practices that have been widely copied by other U.S. manufacturers (Hay Group 2004, Mercer Human Resource Consulting 2006, Watson Wyatt Data Services 2006).
The company's industry-leading productivity has been attributed largely to its management system, which consists of four main components: (a) piecework wages, (b) a discretionary annual bonus based on individual and company performance, (c) an individual merit rating used to determine the annual bonus, and (d) a voluntary employee advisory board that works to generate productivity-enhancing innovations. (6) Additionally, Lincoln Electric uses a number of complementary management practices, such as minimizing the number of supervisors on the plant floor and assigning a great deal of autonomy to factory employees. In Cleveland, the company sets tens of thousands of piece rates, and workers have been trusted for decades to record their output accurately.
Lincoln began expanding abroad in the 1940s, but its first major foreign investments, made in the late 1980s, initially failed. There were several potential reasons for this initial failure. The company wanted its new subsidiaries to operate in Lincoln USA's image; international managers were expected to introduce piecework, a bonus system, and an advisory board (Dawson 1999, p. 41). Many workers in Western Europe in particular did not want to adopt the company's practices (Hastings 1999). The European acquisitions were also made just prior to an economic downturn. Past case histories of Lincoln Electric during this time period hypothesize that its international results were tied to the level of pro-capitalist/promanufacturer institutions in each host country (Chilton 1993a, b; Dawson 1999; Hastings 1999; Maciariello 2000). Still, none of the studies test this hypothesis more than anecdotally.
Lincoln renewed its global expansion in the mid-1990s, moving into nearly every large welding market in the world, regardless of limits on incentive pay-for-performance. As CEO John Stropki noted, "We're taking the fight to the competition in all regions of the globe" (Lewis 2007). This company decision rule is what gives us a unique quasi-natural experiment. During the sample time period, Lincoln Electric operated in 16 of the 20 largest welding markets: the United States, Canada, Mexico, Venezuela, Brazil, the United Kingdom, France, Germany, Italy, Spain, The Netherlands, Poland, Turkey, Australia, Indonesia, and China. Although there are no published estimates of the welding market by country, internal estimates closely match an ordered ranking of country gross domestic product (GDP). Differences in these orderings arise from intensive spending on infrastructure (the lifeblood of welding companies) in large emerging markets such as Venezuela. (7) The few cases in which Lincoln Electric has not entered a large market have involved idiosyncratic constraints. Japan has a dual electronic standard for welding equipment that made the cost of entry prohibitive (Siegel...
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