Wall Street Polices Itself: How Securities Firms Manage the Legal Hazards of Competitive Pressures. - Review - book reviews

Administrative Science Quarterly,  Sept, 1999  by Alfred Marcus

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David P. McCaffrey and David W. Hart. New York: Oxford University Press, 1998.211 pp. $35.00.

Though there are several variants of institutional theory, a common element that most variants of this theory share is that organizations must accommodate institutional expectations, which leads to isomorphism or convergence in organizational forms and templates (Greenwood and Hinings, 1996). Wall Street Polices Itself is a study of these institutional pressures as they apply to the securities industry. Because of major scandals, the firms in this industry have been subject to increasing legal and compliance pressures. McCaffrey and Hart very carefully describe and analyze the impact of these pressures.

Government regulation, self-regulation, and private litigation and arbitration have grown. Although the authors pay ample attention to government regulation, they maintain that government regulation by itself cannot control this industry. Self-regulation and arbitration play a major role. Taken together, these institutional pressures are profound, and the authors do a wonderful job of describing them. This book is the most precise and comprehensive discussion of these pressures available in the literature. It is based not only on a fresh gathering and analysis of publicly available information but also on in-depth, confidential interviews with major industry participants. The authors freely quote from these interviews to support their conclusions. Given institutional theory's emphasis on homogeneity in most industries (Greenwood and Hinings, 1996), the conclusions that McCaffrey and Hart reach are interesting. They find remarkable differences across firms in this industry.

McCaffrey and Hart show that all the firms have similar legal and compliance procedures in place because of external rules. In this sense, they conform to what institutional theorists call coercive isomorphism. Indeed, in firms with more legal and regulatory problems, these procedures seem to function quite effectively in providing warnings that something is amiss. But there is substantial autonomy even in this very constrained environment (Marcus, 1988), and some firms behave very differently.

The authors present data from 1990 to 1996 for 15 major broker-dealers, which include such widely recognized companies as Merrill Lynch, Shearson Lehman, Salomon, Inc., Goldman Sachs, and Morgan Stanley. The data show that there are substantial differences in the number of legal proceedings in which the firms are involved, the number of employees involved in disciplinary actions, the number of regulatory sanctions the firms face, and the amount of fines and penalties imposed. McCaffrey and Hart argue that these differences stem from the different ways that firms in this industry manage the fundamental tension that they face. On the one hand, firms in this industry have incentives to push to the limit the rules governing their operations. On the other hand, they have incentives to operate closely within the bounds of the law. Each firm manages this tension somewhat differently.

What explains the difference between firms that miss warnings and operate close to the brink (see Marcus and Nichols, 1999) and firms that pay attention and avoid inordinate fines, sanctions, and embarrassment? McCaffrey and Hart maintain that it is not just the technical and political skills of the legal and compliance personnel. This factor is a necessary but not sufficient cause for differences among firms. The most important reason for firm differences is how strongly top management communicates that complying with the rules is a critical task (p. 174). They quote an executive as saying, "There's a world of difference between firms where senior management really doesn't want to read their names in the papers, and . . . firms where management is more willing to take a risk of a lawsuit. . . . There's no question it varies from firm to firm" (p. 15). The chief executives in firms with better records "communicate clearly that going over the edge is bad for the firm and that those doing so will suffer for it" (p. 174). These findings are similar to those reached by Weaver, Trevino, and Cochran (1999) in their attempt to explain differences in corporate ethics programs. Factors impinging on firm behavior from the environment, such as government, self-regulation, and media attention, only go so far in explaining these differences. The single most important factor is top management commitment.

The conclusion one draws from these studies is that the normative embeddedness of an organization within its institutional context does not fully explain its responses. Individual organizational autonomy continues to play an important role. In similar institutional fields, idiosyncratic interpretations by top executives of the rules based on moral frames and values play a role. They introduce substantial variation. Though institutional theory primarily emphasizes coercive, normative, and mimetic factors coming from the external environment, which force conformity, it always has left some room for interpretive latitude and discretion. The study of this latitude and discretion, when it is exercised and why, should become an increasingly important topic. Why do some chief executives seem to care more than others, and why are they more effective in communicating this concern to their employees? The consequences as well as the motivations for the exercise of this type of latitude need to be better understood.