Towards the Social Reconstruction of an Interdisciplinary Turf War

by Ezra W. Zuckerman
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Towards the Social Reconstruction of an Interdisciplinary Turf War
Author:
Ezra W. Zuckerman
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2004
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American Sociological Review
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69
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3
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458
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465
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English
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COMMENT

AND REPLY

Comment on Zajac and Westphal,ASR, June2004

Towards the Social Reconstruction of an Interdisciplinary Turf' War

Ezra W. Zuckerman MITSloan School of Management

. . . inspection and evaluation can uncover events and deviations that undermine legitimacy. (Meyer and Rowan 1977, p. 359)

Those who study markets tend to search for the one

explanation, or the single primary factor, that

describes some trend or activity. But it is clear

that there is no single dominant motive for firms

to repurchase stock.

(Grullon and Ikenberry 2000, p. 35)

erhaps more than in any other subfield of sociology, researchers in economic sociol- ogy tend to justify their work through opposi- tion to a rival discipline (Sarrensen 2003). Yet a fixation on the flaws in economics is dangerous for at least two reasons. First, if we focus exclu- sively on showing how sociological theories are superior to neoclassical models, we risk overlooking our theories' own limits, which often become clearer when applied to new domains. Thus, consider the motivation for the article by Zajac and Westphal(2004, hencefor- ward Z&W) in this issue of ASR. Z&W assert that their article is important because "little research has examined whether and how [neoin- stitutional] processes influence the perceptions of actors in financial markets, and. . . determine

Direct all correspondence to Ezra W. Zuckerman, MIT Sloan School of Management, E52-564, 50 Memorial Drive, Cambridge, MA 02 142 (ewzuck- er@mit.edu). This comment is offered in the hope that frank dialogue will help put economic sociology on surer footing. The author thanks the following peo- ple for their feedback and advice: Diane Burton, Roberto Fernandez, John Meyer, Damon Phillips, Ray Reagans, Jesper Ssrensen, Stoyan Sgourev, and Alan Zuckerman. The author is solely responsible for any remaining errors.

the market value of corporate policies (p.434)." The stated objective of their study is not to address a weakness or gap in neoinstitutional theory but to apply it to a new phenomenon. Yet how well does neoinstitutional theory, and the notion of institutional decoupling in particular, translate to financial markets? And can such an application help clarify the conditions under which neoinstitutional processes are more like- ly to operate?

Another potentially dysfunctional outcome of economic sociologists' oppositional posture towards economics is that, if we are too eager to find a neighboring discipline's faults, we are more likely to overlook valuable research by that discipline. Consider the topic of Z&W's article. I warrant that very few ASR readers are famil- iar with the financial economics literature on share repurchases. We thus are compelled to rely on Z&W to provide a thorough and accu- rate summary of such research. But if the ten- dency among economic sociologists is to assume that economists are hopelessly nayve, authors will be more likely to conduct a curso- ry literature review, and journal referees will be less motivated and able to hold authors account- able. These tendencies in turn increase the prob- ability that authors succeed only in dismantling straw men. Such considerations lead to addi- tional questions: Have Z&W accurately repre- sented the financial economics literature on share repurchases? How troubled would finan- cial economists be by Z&W's key finding- that reactions to buyback announcements after the mid- 1980s were positive even though many firms had not implemented such buybacks?

In this comment, I briefly address the ques- tions that Z&W's article raises. In the first sec- tion, I cast doubt on Z&W's application of neoinstitutionalism, and especially the idea of institutional decoupling, to the case of repur- chase announcements. In the second section, I question Z&W's representation of the relevant finance literature and, accordingly, the inter- pretation of their main finding as a surprise that undermines orthodox perspectives. The weaknesses on both these fronts are sympto- matic of economic sociologists' excessively confrontational posture towards neoclassical economics. I propose a more constructive engagement with economic theory and phe- nomena, from which our own theories should emerge strengthened.

THEORETICAL DECOUPLING

Z&W's article presents what appears to be a very puzzling phenomenon: From the mid- 1980s onward, the stock market reacted posi- tively to the announcement of share repurchase programs despite growing evidence that many firms did not follow through on their stated plans. Z&W argue that orthodox financial eco- nomics cannot explain this puzzle because its dominant framework, the efficient market hypothesis, holds that stock market participants should properly interpret such announcements or, at the very least, they should collectively learn the proper interpretation over time. Accordingly, market participants should dis- count such announcements as soon as they dis- cover that many announced buybacks are not implemented. But by continuing to react posi- tively to buyback announcements, the market participants seem to have learned nothing.

Z&W contend that sociological theory can solve this conundrum that contradicts financial economic theory. They use three theories as the pillars of this explanation. The principal pillar is Meyer and Rowan's (1977) notion of institu- tional decoupling. Z&W combine decoupling with a second neoinstitutional pillar, Zucker's (1977, 1983) model of institutionalization, to advance their main claim that "repurchase plans may accumulate symbolic value over time, despite repeated instances of decoupling [i.e., non-implementation] . . . [as they] become instilled with value and ultimately 'taken-for- granted' among external constituencies as nor- matively appropriate (p. 440, italics added)." Z&W further maintain that this process was supported by the rise of agency-theoretic logic

COMMENT ANDREPLY 459

of governance and by the emergence of a self- reinforcing feedback loop: "As this pattern is repeated, the connection between the policy and the . . . institutional logic tightens and may ultimately become taken-for-granted" (ibid., italics added). Finally, Z&W claim that institutional- ization of the positive view of buybacks was supported by the self-recursive nature of capi- tal markets-that is, the most proximate deter- minant of capital gains and losses are other speculators' (future) opinions (see Keynes 1960 [1936]:ch. 13). In such an environment, "the market value of repurchase plans can build over time through a self-perpetuating, social con- struction process despite the potential for decou- pling" because investors suspend their "individual beliefs" and go along with the pre- vailing, positive interpretation (p. 44 1, italics added).

The words I italicized in the previous three quotes are revealing. Throughout their article, Z&W hedge their claims in a manner that sug- gests that their theoretical edifice cannot real- ly be supported by the pillars they use. These strands of theory may help explain the buyback puzzle. But then again, they may not. It is hard to say either way because Z&W require these pillars to bear more analytic weight than they were originally meant (and can reasonably be expected) to hold.

Consider two notable ways in which Z&W deviate from Meyer and Rowan's (1977) origi- nal statement. First, Meyer and Rowan repeat- edly stress the distinction between "institutionalized organizations" and "produc- tion organizations" (p. 354). The first epigraph to this comment explains the importance of this distinction: Decoupling is difficult to sustain in market-like environments due to the threat that organizations are more llkely to be held account- able by external constituents who apply effi- ciency criteria. Accordingly, Meyer and Rowan argue that "institutionalized organizations seek to avoid inspection and evaluation by internal managers and external constituents" (p. 359). Thus, Z&W's application of decoupling to the stock market seems to violate Meyer and Rowan's scope conditions.

Second, Meyer and Rowan (1977) make clear that decoupling does not refer to situations where organizations deceive external con- stituencies, as Z&W imply. Rather, they liken decoupling to face work (Gohan 1967):

460 AMERICAN SOCIOLOGICAL REVIEW

Both internal participants and external con- stituencies .. . engage in informal coordination that, although formally inappropriate, keeps tech- nical activities running smoothly and avoids pub- lic embarrassments. In this sense, the confidence and good faith generated by ceremonial action is in no way fraudulent. (Meyer and Rowan 1977, pp. 358-359, italics added)'

That is, since all participants gain (at least in the short-term) from the preservation of the insti- tutional order, they will engage in "avoidance and discretion" and "overlook . . . anomalies" (ibid.) because they know that the achievement of technical ends often requires deviations from institutionalized scripts. Thus, Meyer and Rowan did not mean for decoupling to refer to cases of deception by the organization of its external constituencies, but as a device that both sides of such an interface use to manage the tensions among conflicting technical and institutional demands.

Perhaps it does not matter that Z&W use the notion of institutional decoupling differently from the manner intended by Meyer and Rowan. The acceptance of Z&W's article for publication in ASR suggests that their interpretation of decoupling has significant currency among con- temporary economic sociologists, and it is unsurprising that this interpretation is hard to square with the original (cf., Mizruchi and Fein 1999). Moreover, perhaps the violation of Meyer and Rowan's scope conditions should not con- cern us, especially since neoinstitutionalists have recently become more willing to apply their predictions to market environments (DiMaggio and Powell 1991:32-33; Scott 2001:133-35). And there is good reason to think that the stock market participants' powers of inspection and evaluation are limited, as Z&W

Z&W (p. 441) use the same quote but somehow interpret Meyer and Rowan to mean that organiza- tions can acquire confidence and good faith in a fraudulent way. In a personal communication (October 15, 2003), John Meyer agreed with my interpretation (of decoupling and of Meyer and Rowan more generally) and put the matter thus: "Our argument was that decoupling routinely happens in good faith. And in general, this is often so extreme that participants are not really very conscious of the decoupling-let alone manipulative about it."

suggest (e.g., Zuckerman 1999: 1409-12; Zuckerman 2004; cf., Brav and Heaton 2002).

Thus, we have the real question, How rea- sonable is it to extend the notion of institution- al decoupling to include deception of market participants by executives of public companies? Meyer and Rowan themselves imply the chief difficulty with this extension: Even if market participants are limited in their ability to inspect and evaluate, they certainly has a significant col- lective capacity for oversight. And given such powers of inspection and evaluation and enough time for inquiry, it is hard to construct a theo- ry-economic, sociological, or otherwise-that would not expect market participants to at least make progress in discerning whether public companies are really doing what they claim, especially when: (a) that practice violates the interests of market participants; (b) such viola- tions, while camouflaged, are increasingly like- ly to become known by market participants; and (c) market participants have very strong incentives to uncover violations. Indeed, con- sider Zucker's classic experiment on the auto- kinetic effect (Zucker 1977). Zucker's key finding is that institutionalized standards of interpretation are less sensitive to the autokinetic stimulus. Yet at the same time, all interpretations eventually converge to the baseline interpreta- tion through repeated exposure to the stimulus. And imagine if subjects were to be rewarded for judging the autokinetic effect based on the rel- ative accuracy of their judgment-a situation that more nearly approximates valuation in the stock market. Convergence towards the baseline (and beyond-to the recognition that the light is stationary) should then be even quicker. The general point is that neoinstitutionalists should be as puzzled as financial economists that the positive view of buybacks persisted despite widespread, non-implementation over a decade.

Nor is this puzzle solved by the final pillar of Z&W's argument, the principle of self-recur- sion. The problem is that, while this principle is crucial for understanding why market prices sometimes deviate from "fundamental" values (see e.g., Zuckerman 1999, 2004), it provides essentially no guidance for anticipating when a practice or event will become more or less val- ued over time. As Z&W stress, self-recursion likely hinders market participants' collective capacity for learning since many speculators attend more to one another and to past market conditions than they do to economic news. Yet the more general implication of self-recursion is that it hinders any change in prevailing inter- pretations. Indeed, if all market participants merely watch one another, it is unclear how any information--even if interpreted via histori- cally-contingent theories of value (Zuckerman 2000)-affects prices. So something else must be going on. Moreover, market prices are clear- ly constrained, at least to some extent and espe- cially over time, by fundamental value^.^ The challenge is to understand how information about economic events is filtered through self- recursive dynamics to generate prices (Zuckerman 2004). Simply saying that learning may not occur due to self-recursion is unhelp- ful because self-recursion thereby becomes a convenient,post-hoc, device for explaining away any puzzling market valuation.

MUCHADO ABOUT AGENCY THEORY?

Although Z&W have raised an interesting puz- zle, they have yet to build a theory that can solve it. Fortunately, the puzzle may be solved simply by taking a closer look at previous work on the subject. Z&W assert that, in "explaining [why the stock market typically reacts posi- tively to an announcement that a firm intends to repurchase its shares], financial economists have typically invoked an agency logic" (p. 437). According to Z&W, "financial gurus" such as Warren Buffett and "members of the business press" have also offered "similar interpreta- tions" (ibid.). That is, the standard explanation for these well-received buybacks is that, by returning wealth to shareholders that might oth- erwise have been squandered, managers signal that they are the faithful stewards of shareholder interests. This gloss is the basis for the puzzle. After all, if market participants react positive- ly to buyback announcement because they believe that the firm will be returning excess

For instance, if a stock trades at such a low price that every dollar spent on a share gains rights to an income stream with the present value of two dollars, it becomes likely that a large-pocketed investor will buy the company and gain ownership of that income stream. This at least places afloor below which prices cannot go and, more generally, suggests how infor- mation about fundamental values enters the price calculus.

COMMENT ANDREPLY 461

cash to shareholders, discovery that buybacks are often not implemented should cause market participants to become skeptical of future such announcements. It thus seems surprising that stock prices continue to react positively to buy- back announcements.

Yet what if the agency-theoretic rationale were not the only justification for buybacks? And what if the alternative reasons entailed that, under certain circumstances, the firm need not, or should not, conduct an announced buy- back? These questions are not idle speculation. Indeed, these have already been carefully addressed in the very financial economics lit- erature that Z& Wclaim to summarize. The large financial economics literature on buybacks can- not be adequately outlined in the space allotted for this co~nrnent.~Yet

even the few articles that Z&W reference provide reason to doubt their gloss and how they use it to construct their argument. Consider the second epigraph to this comment, which is the opening of a review essay that is cited by Z&W and published in a journal that Z&W describe as a vehicle for "translat[ing] agency-based research . . . for senior executives and policy makers" (p. 45 1). Not only do Grullon and Ikenberry (2000) resist identifying a single motive for buybacks, but they state that "the explanation most widely discussed by financial economists is that cor- porate managers use repurchases to 'signal' their optimism about the firm's prospects to the market" (p. 35). Grullon and Ikenberry's state- ment does not mean that the agency-theoretic explanation for buybacks has no currency among financial economists. Rather, it is one of a set of possible motives discussed in that lit- erature. For example, Grullon and Ikenberry (2000) discuss seven classes of motivation for buybacks. Another recent article (Dittmar 2000) discusses five such motive^.^

It may not matter that Z&W have exaggerat- ed financial economists' use of the agency-the-

In October of 2003, I conducted a search in the JSTOR database for articles in finance with "repur- chase" in their abstracts. This search produced twen- ty-five articles, only one of which is cited in Z&W.

Of the twenty-five JSTOR articles mentioned in the previous footnote, only ten had the word "agency" anywhere in them. By contrast, thirteen had the word "takeover" in them and fifteen had the word "valu-

462 AMERICAN SOCIOLOGICAL REVIEW

oretic explanation. After all, it still seems puz- zling that market participants would react pos- itively to buyback announcements even after numerous firms had failed to carry them outs5 But it is not very surprising when one consid- ers the explanation that is most commonly given by financial economists, according to Grullon and Ikenberry: Managers repurchase shares to signal that the stock is undervalued by market participants. There are two versions of this hypothesis (see Grullon and Ikenberry 2000:3 1). Z&W obliquely mention the first (Z&W p. 449, fn. 4): While market participants have proper- ly valued the firm with the information at their disposal, corporate management has addition- al positive information, the existence of which is signaled by the buyback. But consider the pos- sibility that some managers think they know their firm's true value better than do market participants-this is the second version of the undervaluation hypothesis (to which I refer as

perceived undervaluation) and it demands atten- tion for several reasons.

First, it is basic to any sociological account of financial markets that the interpretation of material information is problematic, and that market participants do not converge on a single, best interpretation, as assumed by the efficient market hypothesis (e.g., Zuckerman 2004). Indeed, the heterodox view that price reflects a balance among competing interpretations of the same information is increasingly prevalent among financial economists as well (e.g., Harris and Raviv 1993; Kandel and Pearson 1995). Therefore, it is to be expected that managers will sometimes think their stock is undervalued.

Second, there is considerable evidence that perceived undervaluation is a common motive for buybacks. For example, survey data from the late 1980s indicate that management's feeling that its firm's "stock was undervalued" was the most important reason (of seventeen reasons) for initiating a buyback (Wansley, Lane, and Sarkar 1989).6 Consider as well the very newspaper

ation." See later note for discussion of the motives that are associated with these words.

The real surprise is that the market reacts to buy- back announcements so skeptically (see Grullon and Ikenberry 2000:38).

Wansley et al. (1989) concentrate on repurchase by tender-offer as opposed to open-market repur- chases, which are the focus of the article by Z&W.

article (Sinton 1995) that Z&W cite as evidence for the dominance of the agency-theoretic zeit- geist behind buybacks. In that article, Lewis Coleman, the CFO of Bank ofAmerica, is quot- ed as follows:

Companies look at buybacks in two ways. They feel the price of their stock is cheap. Or, if there's not as good a use for excess capital they want to give it back to shareholders. Both reasons are valid but we believe strongly in the second. And there's the added benefit that buybacks make your stock less susceptible to price fluctuations. (Sinton 1995, San Francisco Chronicle July 3 1 : B1)

This quote certainly testifies to the importance of the agency-theoretic motive. But it also sug- gests a more complex picture and indicates the importance of perceived undervaluation as a common motive. Indeed, given his status as the foremost advocate of value investing (which focuses on identifying undervalued stocks), it is unsurprising that Warren Buffett prominent- ly mentions the perceived undervaluation motive alongside the agency-theoretic motive. In par- ticular, Buffet argues that repurchases are rec- ommended when "companies . . . find their shares selling far below intrinsic value in the marketplace" (Buffett 1985:par. 14; see also Buffett 2000:par. 107).

Yet perhaps the most important reason that the perceived undervaluation motive must be con- sidered is that it provides a straightforward explanation why firms sometimes announce, in all sincerity both expost and ex ante, that they are planning on repurchasing their shares in the open market but then not actually do so. In par- ticular, if subsequent (and perhaps in response) to the buyback announcement, a firm's shares were to rise to the point that management no longer regards the stock as undervalued, there would be no reason or obligation to proceed with the buybackprogram. Let us call this the "price-correction" explanation. Z&W refer to no research on the failure to carry out buyback programs and seem to imply that they are the first to discover that nonimplementation is com- mon. In fact, the media (e.g., Bryan-Low 2001) and the financial economics literature have raised this issue, and price-correction is a fie-

However, even respondents who had not conducted a buyback of any type cited undervaluation as the principal reason to consider a buyback.

COMMENT ANDREPLY 463

quently mentioned explanation. Indeed, Grullon and Ikenberry's (2000) review essay describes Ikenberry, Lakonishok, andvermaelen's (2000) carehl analysis of the price-correction hypoth- esis among 1,060 Canadian firms that announced repurchase programs from 1989 to 1997.7 Their key findings are that the stocks of firms that did not repurchase their stock expe- rienced high returns in the first year subsequent to the announcement (mean return of 11.6%); and the firms that bought at least 30% of the shares they had initially authorized for repur- chase experienced a much smaller mean return in the first year (2.6%) but higher returns in the subsequent years (6.8% vs. 0.6% for the firms that did not repurchase shares). The implications are clear:

While it is always possible that managers in some cases may consider using repurchases to mislead the market, the evidence does not show this to be prevalent. A more plausible interpretation would appear to be that managers simply choose not to buy their stock when prices rise and the under- valuation problems that may have prompted the share repurchase authorization in the fit place are resolved (Grullon and Ikenberry 2000, p. 45).

Given the various motives that could lead managers to announce a buyback and given that one of the most commonly cited motives entails that there will be situations where man- agers do not actually carry out the repurchase program, it is questionable whether the failure to follow through on a repurchase program is an example of institutional decoupling even as defined by Z&W. Similarly, the failure of mar- ket participants to recognize that they are being deceived is not evidence that the stock market does not facilitate learning. Such a claim requires a demonstration that there is some- thing that market participants should have learned and did not. However, because it is

'The study was not conducted on U.S. firms since ascertaining the "track record on completion . . . [of buybacks] in the U.S. firms . . .is difficult. . . because mandatory disclosure about actual repurchases is limited to a few pieces of information scattered throughout the firm's financial statements" (Grullon and Ikenberry 2000:44; cf., Stephens and Weisbach 1998).This issue raises questions about how Z&W measure the implementation of buybacks, which they imply is not problematic.

unclear what, if anything, market participants should deduce from the gap between announced buyback plans and actual repurchases, it is impossible to say what they should have learnede8

CONCLUSION

I comment on Z&W's article to highlight the unhealthy habits that researchers in economic sociology should avoid. Indeed, the publication of any article says as much about the referees and the field they represent as it is does about the authors. While economic sociology had sig- nificant success in its early years, Z&W's arti- cle is typical of disturbing tendencies seen in the subfield more recently (see Fernandez, Castilla, and Moore 2000: 1352; S~rensen 2003). In par- ticular, we sociologists tend to be self-congrat- ulatory rather than self-critical and to attack economic research without seriously engaging it. Sociologists rightly deride other disciplines' ideologically driven, imperialistic forays into sociological temtory. But people who live in glass houses should not throw stones.

Indeed, the obvious weakness of Z&W's arti- cle is its failure to engage the relevant eco- nomic literature seriously. And because Z&W do not address the alternative explanations to their thesis (which are prominently featured in the very articles they cite), their implicit rejec- tion of such alternatives is insupportable. Consider also Z&W's conclusion (p. 449) that a "sociological perspective on stock market reactions" is supported but "a market learning perspective" is not supported. Rather than pat- ting ourselves on the back, we should worry about such a conclusion. There are, after all, good reasons to think that market participants have some collective capacity for learning.9

Another common motive for buybacks (see Dittmar 2000:335-36) that complicates Z&W's argu- ment is the attempt to thwart an unwanted takeover by increasing the firm's debt-load and increasing its stock price. If the takeover threat disappeared (per- haps in response to the repurchase announcement), it would be unsurprising that the firm has not fol- lowed through on its repurchase program.

The same goes for arbitrage, the second of the twin mechanisms that underlie orthodox financial economics (Brav and Heaton 2002).

464 AMERICAN SOCIOLOGICAL REVIEW

While it is nayve to think that markets work perfectly, it is also naive to suppose that they are environments where anything goes.1° More gen- erally, while economic sociologists tend to dis- miss orthodox economic research as hopelessly simplistic, there is an upside as well as a down- side to the simplicity of economic models: They often tap a compelling intuition, which any rea- sonable explanation of the phenomenon in ques- tion would do well to consider and incorporate in some way. Indeed, economic models must be compelling to merit our attention. Otherwise, we should just ignore them. Straw men are just not that interesting.

I conclude with a note on the project of apply- ing sociological theory, and neoinstitutional principles in particular, to (financial) markets. This is a worthwhile pursuit not despite, but precisely because, market participants' collec- tive powers of inspection and evaluation delim- it the space available for social construction. The key is to realize that such powers are significant but are limited in characteristic ways (Zuckerman 2004). Thus, when these limits are juxtaposed with the premise that firms do engage in institutional decoupling (in the sense meant by Meyer and Rowan), the recognition of such limits raises interesting research questions that could truly advance neoinstitutional theo- ryan4 more generally, shed light on how prac- tices diffuse through systems. For example, it would be instructive to investigate such ques- tions as: (a) How long does it take for partici- pants in a tight selection regime, such as the stock market, to learn that an institutionalized practice is actually inefficient? (b) What con- ditions hinder and foster such learning process- es? Recent work at the intersection of interorganizational learning theory and neoin- stitutionalism (e.g., Beckman and Haunschild 2002; Denrell 2003; Strang and Macy 2001) provide helpful hints in this direction. But there is much more work to be done. Rather than

lo Gothan (1974) nicely stated that there are lim- its to social construction in any arena: "All the world is not a stage-at least the theater isn't entirely. (Whether you organize a theater or an aircraft factory, you need to find places for cars to park and coats to be checked, and these had better be real places, which, incidentally had better carry real insurance against theft)" (p. 1).

seeing financial markets as an additional domain to which sociological theories can be applied, we should see them as an opportunity to probe for the proper scope for our theories as they apply to any domain (Zuckerman and Rao 2004).

Ezra W!Zuckerman is associate professor of strate- gic management at the MIT Sloan School of Management. His main research program focuses on the relational structures that emerge as "crude functionalist" solutions to basic problems faced by marketparticipants. In addition to work on classifi- cation systems in the market, this research includes work with Stoyan Sgourev on industrypeer networks, which are exclusive groups of noncompeting peer jrms from the same industry that gather on a regu- lar basis to learn from one anotherk experiences and to motivate one another to achieve higher per-

formance.

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