Aqui No Se Habla Agencia. * An Examination of the Impact of Adverse Selection and Framing in...

Electronic copy available at: http://ssrn.com/abstract=546829

Aqui No Se Habla Agencia.1An Examination of

the Impact of Adverse Selection and Framing inDecision-Making: a US/Mexico Comparison

Stephen B. Salter

University of Cincinnati

Philip A. Lewis

Northern Kentucky University

Luis Felipe Juarez Valdes

Universidad de las Ameritas, Puebla, Mexico

Abstract

US companies seeking cheaper labor or extraordinary returns have often seen foreign directinvestment as a panacea. However, many of these companies founder on the horns of acontrol dilemma.While raw economic data such as labor rates prove to be true, productivityand decision-making styles are so different that companies fail tomaximize their investmentreturns. This situation is worsened as companies attempt to impose culturally inappropriatehome country controls on their foreign investment.This study examines one of the potential sources of failure, escalation of commitment,

which occurs when decision-makers over-commit incremental resources to failing invest-mentswithout reasonableprobability of recovery.Thisbehaviorhasbeenwidely documentedinUSdomestic literature (seeWhyte andHook, 1997, for a summary). However, there is alsosome evidence that such behavior is culturally bounded (Chow et al., 1997; Sharp and Salter,1997; Greer and Stephens, 2001). This study extends previous findings on cross-culturaldifferences in decision-making among managers by comparing the responses of managers inthe USA andMexico to an escalation of commitment exercise. The cross-cultural validity oftwo US based theories, agency (adverse selection) and framing (prospect theory), is tested.The results indicate that at base Mexican managers were more risk seeking. However

managers from the more individualistic USA were significantly more likely than Mexicanmanagers to escalate in the presence of agency (adverse selection) based incentives. Negativeframing among managers was universal in escalating commitment.

Introduction

There is an accumulating body of evidence that suggests decision-makers

over-commit incremental resources to failing investments (the so-called

We gratefully acknowledge the financial support of the CGA-Canada Research Foundation, theTexas A&M Center for International Business Studies and the University of Cincinnati Center forGlobal Competitiveness.We also acknowledge the helpful comments of participants at workshops atMacquarie University, and Loyola University New Orleans.

Journal of International Financial Management and Accounting 15:2 2004

r Blackwell Publishing Ltd. 2004, 9600 Garsington Road, Oxford OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA.

Electronic copy available at: http://ssrn.com/abstract=546829

escalation of commitment). The recent control failures at Allied Irish

Bank’s US subsidiary (Tran, 2002) provide a vivid example of activities

that were escalated long after they should have been abandoned. As in the

case of Daiwa bank and Barings (Cotter, 2002), escalation of losses from

derivatives went undetected for up to five years as traders attempted to

cover previous losses to avoid discovery. Small losses got larger and larger

as these traders tried to recover previous loses by taking larger and larger

gambles.

The escalation of commitment phenomenon has been widely studied

in the USA using many theoretical frameworks (Ross and Staw, 1986;

Staw, 1976, 1981; Staw andRoss, 1978; Arkes andBlumer, 1985;Harrison

and Harrell, 1993; Whyte, 1993; Whyte and Hook, 1997). Escalation

of commitment describes a scenario where managers ‘‘unreasonably’’

continue or add investment dollars to a project which, on the basis of

available data, should be abandoned. The extant literature presents this

phenomenonas a product of (1) a base riskpropensitywhichmay varywith

responsibility for the initial decision (self justification theory), (2) an

upward adjustment by incentives (agency theory), or (3) an upward

adjustment as a result of improper use of cues in information based on the

method of framing of the information (prospect theory).2

The research cited above was conducted and completed using US

managers. Suchmono-cultural studies take for granted the assumptions of

that culture. US studies, for example, assume that individuals will

make decisions that benefit themselves first and thus have to be control-

led from doing so (agency theory). Once one introduces the idea that there

are multiple value systems or cultures in the world (Hofstede, 2001;3

Schwartz 1999), the assumptions on which a particular control system is

built become a key limiting factor. Extending this to research, extant

mono-cultural US research results may be limited in their theoretical

generalizability across nations and in their practical use in control

system design outside the USA (see for example Boyacigiller and Adler

(1991), Chow et al., (1997) and Harrison and McKinnon (1999), for a

discussion).

The logical solution to the lack of non-US studies is to replicate these

studies outside the USA. This is assisted as certain patterns/groups of

cultures are proposed in Hofstede’s (2001) and previous work. These

patterns/groups of cultures allow the results from one country to be

generalized within the group of similar countries. The US is in a group

(with Canada and Australia) that is individualistic, lower on power

distance and relatively comfortable with uncertainty. By contrastMexico,

94 S. B. Salter, P. A. Lewis and L. F. Juarez Valdes

r Blackwell Publishing Ltd. 2004.

like Taiwan, Hong Kong, and Singapore is collectivist and favors high

power distance (the strong leader concept). It also appears from Hofstede

(2001) thatMexico like Taiwan, but unlike Singapore andHongKong, is a

culture relatively uncomfortable with uncertainty.4

In the cross-cultural escalation area the majority of studies have

compared North American countries (USA, Canada) with countries at

opposite extremes of the physical and cultural world (Hong Kong,

Singapore, and particularly Taiwan). These countries are convenient for

experimental design purposes as they have a very active academic research

community with close ties to existing US academics. Given our cultural

groupings this may provide some predictive value for Mexico as

individualism plays a major role in determining responsiveness to agency

based escalation theories. However, the Chinese regional concept of

‘‘face’’ has also been found to affect the propensity to escalate (Harrison

et al., 1999; Sharp and Salter, 1997) but does not apply in Mexico. In

addition, while these studies of ‘‘Greater China’’5 add an important

dimension tounderstanding escalationoutside theUSA, the importance of

Mexico and Latin America as a venue for US foreign direct investment

strongly suggests a replicationmaybe in orderwithin that region.US stock

of foreign direct investment (FDI) in Latin America significantly exceeds

that in Greater China (Mataloni, 2002). The stock of US FDI assets in

Mexico alone is approximately US $114.6 billion, which is 3 times the

amount invested byAmericans in Taiwan (US $40.6 billion) and over 30%

more than that invested by Americans in Hong Kong or Singapore

(Mataloni, 2002). Perhaps more important for management control

systems, only in the UK and Canada do US multinational national

enterprises (MNEs) employ more individuals than Mexico. Mexico’s

1,048,000 employees ofUS affiliates is approximately 3.5 times the number

employed in Taiwan, Singapore and Hong Kong combined. Thus, the

argument can be made that even though the cultures of Greater China are

somewhat similar toMexico, the sheer volume of US FDI investment and

employees indicates the need for further study.

Studies of escalation and control inMexico andLatinAmerica are rare.

After a reviewof themajor research indices in this particular area,we could

find only one study – Greer and Stephens (2001). This study is, however,

incomplete in thatwhile it presents an initial examination of the propensity

of Mexican managers to escalate, it focuses on base propensity to escalate

and can draw no conclusions on the impact of framing on escalation. In

addition it does not look at the adverse selection/agency framework,which

has been a core part of US/Canadian research and practice.

Adverse Selection and Framing in Decision-Making 95


In summary, we find that only a relatively small portion of the existing

cross-cultural literature covers Latin America, and that which looks at

Latin America provides only a partial examination of the escalation

question, bypassing a test of the theory that underpinsmuch of the control

system literature and practice. Accordingly, this study replicates and

retests the culture main effect for escalation found in Greer and Stephens

(2001) and extends the literature by testing the validity of a potentially

culturally bound theory of escalation (agency framework). It also assists in

preparing firms for designing management control systems in a country

where the US has significant foreign direct investment.

Literature Review

US and Canadian Literature and the Escalation Phenomenon

In a synthesis of previous literature Brockner (1992: 39) points out that

‘‘escalating commitment appears to be the result of numerous factors and

processes’’. As noted in the introduction, three main source theories have

been used to explain escalation: (1) a base risk propensity which may vary

with responsibility for the initial decision (self justification theory); (2) an

upward adjustment by incentives (adverse selection/agency theory); and

(3) anupward adjustment as a result of improper use of cues in information

based on the method of framing of the information (prospect theory).

Base risk simply says some persons in themost normal of circumstances

are willing to escalate due to:

1. A reluctance to appear weak by admitting mistake;

2. A perception of self responsibility and unwillingness to tolerate failure;

and

3. A willingness to take risk based on life experiences.

This type of willingness to take risk was the original explanation of

escalation described in Staw (1976). There is also a strong possibility that

base risk is at least partially determined by cultural and economic factors

which are discussed below.

Agency theory (Jensen andMeckling, 1976;Harrison andHarrell, 1993;

Harrell and Harrison, 1994) builds on classical expected utility economics

models by relaxing the assumption that the manager’s and the firm’s

interests are identical. It posits that under certain conditions individuals

makedecisions thatmaximize their personal utility andnot that of the firm.



The conditions that are necessary for this divergence in an escalation

context, known as adverse selection, are:

1. Information asymmetry, where the agent (manager) has more

information than the principal (firm owner), so that the principal is

not fully aware of the state of the project, and

2. Incentive to shirk, i.e., themanager’s reward for continuing (escalating)

the project is greater than that for discontinuing it.

Prospect theory (Hogarth, 1980; Bazerman, 1984; Kahneman and

Tversky, 1979) is a cognitive theory of individual decision choice under

conditions of risk. It explains a range of apparently irrational individual

choices and preference reversals. One prediction of prospect theory is that

the manner in which a decision is described (framed) systematically affects

decision choice. The framing effect arises because individuals over-weight

losses (relative to a purely economic rational valuation) when they are

described as being certain in contrast to situations where their likelihood is

described as beinguncertain. Thus,whenadecisionoutcome is described as

a loss (negative framing), managers are more willing to take risks to avoid

that certain loss outcome thanwhen exactly the same outcome is described

in terms of a gain (positive framing). The consequence of this framing is

that risky choices result in risk-seeking behavior for loss outcomes and

risk-averse behavior for gain outcomes. Using Canadian undergraduate

students,Whyte (1986, 1993) demonstrated that escalation of commitment

could be explained by prospect theory’s value function.Usingmanagers in

American executive MBA programs, Rutledge and Harrell (1993) and

Rutledge (1995) showed that the negative framing of decision outcomes

also increased escalation. Both of these results are consistent with prospect

theory.

While there is no consensus as to which of these theories dominates in

explaining escalation, a recent study of software projects by Keil et al.

(2000) identifies agency theory as the best predictor of escalation, with

prospect theory and base risk/self justification having less explanatory

power. Finally, in reviewing the North American literature, one needs to

consider that theremay be an interaction between the framing of a decision

(prospect theory) and the circumstances in which the decision maker finds

him or her self (agency theory).6 It is possible, for example, that prospect

theory canbe viewedas a specificationof the agent’s utility function. In this

case the agent who is making the decision is within a framework of

asymmetric information and incentive to shirk, but may also be editing or

prejudging the information based on their own frame. However, as



intuitively appealing as this may seem, to date, no study has found clear

results for the interaction of framing and agency in an escalation context.

As discussed above, the agency pre-conditions for escalation are

asymmetric information and incentive to shirk (Harrison and Harrell,

1993). There are a number of studies that manipulate a portion of this

equation in interaction with prospect theory. For example:

1. Johnson and Kaplan (1991), Simonson and Nye (1992) and Kennedy

(1993) find that accountability (lack of information asymmetry)

significantly reduced the sunk cost effect caused by framing.

2. Rutledge (1994) and Rutledge andHarrell (1994) studying groups, find

that positive framing moderates risk taking among those groups with

prior responsibility (incentive to shirk). These papers make no clear

statement about the impact of the more powerful negative framing in

their papers.

3. Rutledge and Harrell (1993), in a study of individuals, found no

interaction of framing and prior responsibility (a variable that may

proxy for incentive to shirk in the agency explanations of escalation of

commitment).

The reader should be cautious however. None of these papers is a

complete test of the agency*framing interaction. An intensive search of

the major literature databases7 reveals only one article, Sharp and Salter

(1997), that formally tests the agency*framing interactions in full i.e.,

manipulating both asymmetric information and incentive to shirk as well

as the presence of framing. Sharp and Salter (1997), find that framing and

agency together moderate the propensity to escalate but the results are not

statistically significant. Taken togetherwith the incomplete nature of other

tests we conclude, with regret, that there is neither clear evidence that there

is an impact for an agency*framing interaction norwhat direction such an

interactive effect might take. Since the emphasis of this paper is on cultural

effects we do include the agency*framing interaction solely as a control

variable, without hypotheses or expectations.We now turn to that cultural

dimension.

Culture and Escalation

Culture – a Primer

Culture represents the deepest values held by a society which affect all

personswithin the society and all its structures. For this studywe primarily



use Hofstede (1980, 1991, and 2001) as it focuses on work related values.

The Hofstede values that are relevant to this study are:

1. Uncertainty Avoidance, which measures ‘‘the extent to which the

members of a culture feel threatened by uncertain or unknown

situations’’ (Hofstede, 1991: 113).

2. Individualism, which ‘‘pertains to societies in which the ties between

individuals are loose: everyone is expected to look after himself or

herself and his or her immediate family’’ (Hofstede, 1991: 51).

3. Power Distance, which is ‘‘the extent to which the less powerful

members of institutions and organisations within a country expect and

accept that power is distributed unequally’’ (Hofstede, 1991: 28).

For the purpose of analyzing most of the cross-cultural literature, we

add the regional sub value of ‘‘face’’ (Ho, 1976). Ho (1976: 867) describes

‘‘face’’ as being ‘‘lost when the individual fails to meet essential

requirements placeduponhimby virtue of the social positionheoccupies’’.

Persons disappointing either a superior or a group may lose face.

A Review of the Changing Mexican Culture

Using Hofstede’s (1980, 2001) terminology, Mexico can be seen as

a culture that is high in uncertainty avoidance and power distance, but

low on individualism. The work of Fernandez (1997), Hoppe (1998),

Trompenaars and Hampden-Turner (1998) and Ehrlich (2001) provide:

(1) substantial support for the ongoing construct validity of three of

Hofstede’s four original cultural value dimensions; and (2) evidence of

systematic andmeaningful differences betweenMexican andUSmanagers

on all major cultural value dimensions. These papers suggest that:

1. Power distance continues to be greater in Mexico than in the USA.

Morris and Pavett (1992) find thatMexicans, as a whole, accept a more

patrimonial society which translates in the work setting to a culture of

loyalty to the supervisor and the assumption that all accountability and

authority rest at a higher level.

2. While scores for individualism in Mexico have increased substantially,

the USA remains far more individualistic. Comparing similar plants of

US companies on both sides of the US/Mexico border, Morris and

Pavett (1992) find the US culture teaches independence and individu-

alism, whereas the Mexican culture focuses more on the group and

respecting authority.



3. While historically,Mexicans have been relatively uncertainty avoidant,

it is no longer clear this is true. Fernandez (1997) argues that scores for

uncertainty avoidance inMexico and the USAmay have been reversed

as Mexico’s elite have faced the challenges of restoring its failing

economy, withMexico becoming amuch less uncertainty avoidant and

more risk taking society. A more recent study of 2600 US andMexican

executives byEhrlich (2001) confirms the originalHofstede (1980) view.

Ehrlich (2001) finds that the average Mexican executive score is 56

(down from 82) while the average US executive score is 42 (down from

46). This indicates a significantly lower need for certainty and structure

among Mexican managers today. However, US managers continue to

have a better cultural capacity to deal with risk and ambiguity.

Whichever of these findings is correct, it should be embedded in the base

propensity to take risk. If Fernandez (1997) is correct, there will be a

higher base propensity amongMexicans to escalate. If Hofstede (1980)

and Ehrlich (2001) are correct, the Mexicans will escalate less at base.

4. Masculinity scores in Mexico appear to have increased only a small

amountwhile the score for theUSAshowsa substantial shift toward the

femininity side of this dimension, leaving it significantly below that of

Mexico.

National Culture, Decision Making and Escalation of Commitment

Drawing on the work of Kluckhorn and Strodbeck (1961) and Hofstede

(1980, 1991, 2001), Abramson et al. (1996), Boyacigiller (1990) andKogut

and Singh (1988), among others, have demonstrated the strong expl-

anatory power of cultural differences in patterns of decision-making. In

preparing our hypotheses we examine both theoretical links between

culture and escalation and findings in the extant literature.

Theoretical Links between Culture and Escalation

Theoretically, usingHofstede’s (1980, 1991, 2001) dimension plus the sub-

cultural variable of face, culture should impact on escalation as follows:

1. Base risk increases in communitarian (low individualism), high power

distance and high face cultures. Communitarian culturesmaybewilling

to seek risk as the group protects them from the consequences. In

escalation situations avoiding the loss of face from the failure of

previous investments may also encourage risky behavior. The effect of



uncertainty avoidance is unclear. While it should retard risk taking, in

an escalation situation continuing a project may be the least uncertain

of the options.

2. In analyzing the impact of culture on framing there are two potential

options. First, in a high power distance society, since lower level

managers have little responsibility they may be indifferent to the

framing. On the other hand, Face enhances the poignancy of any loss

and may exacerbate the value of small loses beyond the normal

enhancement discussed in prospect theory.

3. Agency conditions, where the individual is seeking his/her own interest

over that of the company, are much less likely in communitarian (low

individualism) societies as these societies discourage the individual

from seeking their own interest. Similarly, in high power distance

societies employees accept the superiority of their boss’s interest over

their own and will choose to follow the wishes of their boss whether or

not they are present, hence removing the power of asymmetric

information conditions to encourage escalation. In Greater China the

loss of face implied in not continuing a project may be so powerful that

it vitiates the communitarian and power distance instincts.

Extant Findings Linking between Culture and Escalation

In the area of escalation of commitment, most of the extant studies have

focused on Greater China and find mixed results. These results are

summarized below.

In termsof base risk,Chow et al. (1997), using a sample ofAmerican and

Taiwanese managers, found as a main effect that managers in Taiwan are

more likely to escalate than Americans. Chow et al. (1997) explain their

results by arguing that loss of face (a sub-cultural dimension) places

Taiwanese managers in a position of having to take more risk in a failing

project rather than fail. Harrison et al. (1999), also using a Taiwanese

sample, find less risk taking at base (the opposite of Chow et al., 1997).

However, they argue, in contrast to what the theory would seem to

indicate, that it is a communitarian response. Using managers fromHong

Kong, Singapore, Canada, and the USA, Sharp and Salter (1997)

hypothesize that ‘‘Asian’’ managers will escalate more at base for face

reasons but find no clear main cultural difference in willingness to escalate

between ‘‘Asian’’ andNorthAmericanmanagers. Since these results using

Greater China managers are largely contradictory or based on a regional

cultural value (face), they tell us little of what we can expect at the base risk



level from non-Asian countries such as Mexico. The only available base

risk study outside of Greater China is Greer and Stephens (2001). Greer

and Stephens (2001) find that for two out of three measures, Mexicans

managers are, at base, more risk seeking than USmanagers. This is in line

with Mexico as a communitarian society but implies that Hofstede’s view

of them as uncertainty avoidant is no longer correct, and is in line with

Fernandez’s (1997) view that Mexicans are now risk seeking. It may also

reflect Frucot and Shearon’s (1991) view that Mexican executives such

as those used in Greer and Stephens (2001) may be closer to their US

counterparts than to other Mexicans. Even so, it leaves open for

reconfirmation and retest the question as to the base risk profile of

Mexicans.

In terms of the potential for framing to be affected by culture, Chow

et al. (1997) found that managers in Taiwan are not responsive to specific

framing manipulations. Sharp and Salter’s (1997) LOGIT results indicate

that negative framing appears to increase the likelihood of escalation of a

project regardless of the cultural base, i.e., there is no difference between

North Americans and ‘‘Asians’’ in their response to framing. Keil et al.

(2000) find inter-Greater China differences in response to framing, with

Singaporeans being closer to a US profile than Taiwanese. The only study

examining framingoutside ofAsia isGreer andStephens (2001).Greer and

Stephens (2001) find that in only one of the three measures of escalation

is there evidence of differences between US and Mexican responses to

framing. In this situation, when Mexicans were faced with negative

framing, they responded in the opposite direction to that expected and

becamemore cautious.While confusing at first, this decisionmakes sense if

one examines it in a high power distance context. The Mexican managers

are leaving the decision for a superior, or are avoidinghurting a superior by

being cautious. ThisGreer and Stephens (2001) finding, unlike theGreater

China studies, leaves open the intriguing possibility that culture and

framing do interact. However, given that the effect appears in only one

measure of escalation out of three, the finding is suspect and should be

retested.

As previously discussed, the third and final explanation of potential

causes for framing is the agency/adverse selection dimension of escalation.

This is particularly important given the centrality of agency theory tomost

of the control systems literature and the resulting management practices.

Cross-cultural agency/adverse selection research is not addressed byGreer

and Stephens (2001) and has been limited solely to Greater China. Sharp

and Salter (1997) find that the agency/adverse selection explanation of



framing to agency conditions is insignificant for their ‘‘Asian’’ dyad of

Hong Kong and Singapore, yet highly significant for the North American

sample.Harrison et al. (1999) find similar resultswithTaiwanesemanagers

but argue that the response is relative rather than absolute. As discussed in

the preceding section, theory would lead us to believe that in cultures like

Mexico which are relatively low in Individualism and high in Power

Distance, the likelihoodof responding to adverse selection (agency stimuli)

isminimal. In fact given Sharp and Salter (1997) it is possible thatMexican

managers would not be responsive at all to agency manipulations.

However, there is no test of these priors in the existing literature.

Hypotheses and Model

The Escalation Phenomenon

All hypotheses are in the alternate form and are developed as follows.

The theory literature and extant research on culture and base risk

(Chow et al., 1997; Sharp and Salter, 1997; Greer and Stephens, 2001)

suggests that cultureswith greater communitarian values aremore likely at

base to take risk to avoid the disruption that a project termination will

cause. Mexico is a communitarian culture and should exhibit higher

propensities to escalate. We therefore hypothesize that:

HA1:The base willingness to escalate is higher amongMexican decision-

makers than US decision-makers.

The hypothesis for a framing*culture interaction ismore of a challenge.

Perhaps theoretically, as there is no face dimension,Mexicans, asmembers

of a high power distance culture ought to view the frame as irrelevant.

The limited empirical evidence suggests that any reaction to this inter-

action will be to moderate the propensity to escalate. While this obliges a

retest, it is not convincing to us in terms of direction. Therefore, we

hypothesize that:

HA2: When faced with negative framing, Mexican decision-makers will

not be significantly different in their propensity to escalate commitment

than US decision-makers.

Finally, for adverse selection (agency) there is a strong theoretical

argument that Mexicans, as members of both a communitarian and high

power distance society, should be unmoved by or relatively unresponsive

to agency manipulations. There is no Mexican or South American data,



but Asian research (Sharp and Salter, 1997; Harrison et al., 1999) provides

some supporting evidence for this proposition. Therefore, we hypothesize

that:

HA3: Mexican managers are less likely to be swayed by the effect of

information asymmetry and incentive to shirk than US managers.

Methodology

Sample

In choosing the sample we attempted to meet the following objectives.

First, it should contain managers who are familiar with the manager

material. Managers should have some business decision-making experi-

ence (undergraduate students were excluded), and we used realistic

situations/decisions. Second, the sample should contain awide diversity of

management experience in order to properly test the experience item found

to be significant in both Sharp and Salter (1997) and Greer and Stephens

(2001). Therefore, the questionnaire was administered to managers

participating in MBA, Executive MBA, and executive development

programs in business schools in two countries – the USA and Mexico.

Of the 286 respondents, 201 were US and 85 wereMexican. The managers

had a medium level of experience with an average of 5.55 years, ranging

from less than one year tomore than 30. TheMexicanmanagersweremore

experienced with a mean experience level of 7.15 years while the US

managers averaged 4.88 years.

Instrument

Each manager was presented with four different escalation decisions

(following Sharp and Salter, 1997). To enhance the realism of the case

situation, managers were first asked to express their choice as a go/no go

decision.Managerswere then asked to indicate their preference formaking

a further investment on a ten-point scale. Following Greer and Stephens

(2001) and Harrison and Harrell (1993), a scalar test of confidence in

the decision was used. The scale was anchored at one end by ‘definitely

preferred not to make the investment’ (score5 1) and the other end by

‘definitely preferred tomake the investment’ (score5 10).

In all cases, the activities (projects) to date had incurred non-

recoverable losses and their future outcome was in some doubt.



Furthermore, the additional investment was break-even (the expected

value of its outcomes exactly equaled the incremental amount to be

invested), and, if successful, the net proceeds would exactly recover the

previously invested (sunk) cost. Two of the cases were operating decisions

(market research and software development projects), which potentially

included long-run intangible benefits, and two were short-term financial

decisions with no possible long-term consequences for the firm (currency

speculation and a risky bank loan). The monetary amounts in the decision

were realistic amounts for which respondents would likely be responsible

in the course of their own work.

Agency was manipulated by including, in two of the four cases, a

description of the decision-making situation in which both conditions for

adverse selection (information asymmetry and a personal incentive to take

the risk)were present, and in the other two a description inwhich theywere

absent. Framingwasmanipulated by describing the outcome of not taking

the decision either in neutral terms (in two cases), or in away that described

the already-incurred (sunk cost) loss as certain, and described the

escalation choice as an opportunity to avoid the loss already incurred

(two cases). The Appendix provides an illustrative example of the

manipulation of the bank loan case. Each manager received each of the

possible combinations of agency and framing manipulation spread across

the four cases, and the distribution of an equal number of each version of

the instrument resulted in approximately equal numbers of managers

receiving each combination of experimental treatment. Four versions of

each case were created (for each agency and framing manipulation),

resulting in 16 different combinations of case, agency and framing

manipulation.

The cases were reviewed for external validity and pre-tested in classes in

both countries. To control for possible order or fatigue effects, two orders

of cases were used (the second being the reverse of the first), resulting in a

total of eight versions of the instrument booklet. Thus each participant

received all four cases, each with a different combination of agency and

framing manipulations. However, in spite of pre-testing, initial analysis

identified a significant order of cases (fatigue) effect in the software

development case. Consequently, findings from this case were not

included.8

Managers were also asked to report a variety of demographic data.

Managerswhosemanipulations check responses did notmatch their scalar

response or who were not country natives were eliminated from the

sample.



Measurement of Variables

Two dependent variables were used. The first, DECISION, is the simple

1/0 invest not invest variable. The second, Strength,was scored on the 1–10

willingness to escalate scale.

The independent variables were agency and framing. The agency

manipulation (AGENCY) was a binary variable, coded 1 for the presence

of information symmetry and incentive to shirk, and 0 otherwise.

Similarly, negative framing of the outcomes of escalating (NEGFRAM)

was coded 1, and the neutral framing was coded 0. Culture (MXUS) was

measured as a binary variable, coded 1 for Mexico and 0 for USA. In

addition, interaction variables for agency*culture and framing*culture

and agency*framing were utilized.

Drawing on the results of Sharp and Salter (1997) that work experience

affected the overall propensity to escalate, a work experience control

variable (years employed full time) was included.9 In addition a set of

control dummy variables was included for the cases.

Statistical Method

Apreliminary test of base risk was conducted using both a parametric and

non-parametric t-test. Thus, each hypothesis was tested twice. In the first

iteration, using the 1/0 invest/non-invest decision variable, Multinomial

Logistic regression was used. In the second iteration, the scalar variable

was used and the hypotheseswere tested usingOLS regression. Themodels

were:

I. Decision5 a01b1 (agency effect)1b2 (framing effect)1b3 (culture)1b4(work experience)1b5 (agency effect*framing effect)1b6 (agency

effect*culture)1b7 (framing effect*culture)1b8 (currency trader

dummy)1b9 (bank loan dummy)1e.

II. Confidence in Decision5 a01b1 (agency effect)1b2 (framing ef-

fect)1b3 (culture)1b4 (work experience)1b5 (agency effect*framing

effect)1b6 (agency effect*culture)1b7 (framing effect*culture)1b8(currency trader dummy)1b9 (bank loan dummy)1e.

Results

The mean responses for the different manager groups before the

introduction of any manipulations are shown in Table 1. The results from

this table show that prior to the manipulation, Mexican managers were



significantlymore willing to invest additional funds (Strength5 5.78) than

USmanagers (Strength5 4.56). This result appears to add credence to the

views of Fernandez (1997) and Greer and Stephens (2001) that Mexicans

have become less uncertainty avoidant, and, contrary to the view of

Hofstede (2001), are now more comfortable with risk than their US

counterparts. This observation is confirmed with a Mann Whitney U test

of the 1/0 willingness to escalate (decision) and a parametric test t-test for

confidence (strength) both significant at p�.003 with unequal variances.

Hypothesis 1 is, therefore, rejected in favor of the alternative that the base

willingness to escalate is higher among Mexican decision-makers rather

than the US decision-makers.

Table 2 presents evidence that US managers can be manipulated to

significantly increase their commitment to a project under adverse

selection conditions. Starting from no agency/no framing, US managers

increase their strength of commitment from 4.56 to 5.91 where agency is


Table 1. T-test of propensity to escalate(Without framing or agency present)

Country N Mean Stddeviation

Std errormean

Mexico 85 5.78 3.111 3.37USA 145 4.56 2.652 0.220

Independent sample test

F Sig. t df Sig.(2-tailed)

Meandiffer-ence

St. errordiffer-ence

(95%Confidenceintervalof the

differenceLower Upper

Equalvarianceassumed

7.858 0.005 3.159 228 0.002 1.22 0.387 0.460 1.983

Equalvariancenotassumed

3.031 154.5 0.003 1.22 0.403 0.425 2.017

Notes:Dependent variable: STRENGTH (1–10) prefer not to invest to prefer to invest.


present.Mexicanmanagers by contrast become significantly less willing to

escalate commitment when placed in a position where there is no clear

management direction, decreasing from 5.78 where there is no agency/no

framing to 4.82 where agency is present. In many ways the Mexican

managers viewed this situation as almost a breach of trust to senior

management and became more conservative as a loyalty reaction.

Table 3 provides initial data comparing pre and post framing scenarios

by nationality. Starting from no agency/no framing, managers in both the

USA and Mexico are affected by how the expected outcome is framed. In

cases where negative framing is present, managers are more likely to

commit additional resources to the project than if the expected result is

framed neutrally. The percentage increase in willingness to escalate is

higher in Mexico than in the US, but nationals of both countries react as

framing is shifted from neutral to negative by increasing commitment.

Table 4 shows the results of theMultinomialLOGITmodel using a joint

sample of US andMexican managers. The model is significant with an X2

of 126.062, which is significant at the a� .000. All of the main effects are

significant and positive.

As expected the agency and framing main effects are significant for the

whole sample. Further, the MXUS variable shows that Mexicans overall

have higher base propensity to take risk. This supports the findings of

Greer and Stephens (2001) in two of the three cases. However, the key

findings in Table 4 are the interactions.


Table 2. Willingness to escalate scores by country under agency conditions

Agency conditions

Mexico USA

Mean Standard deviation Mean Standard deviation

Absent 5.78 3.11 4.56 2.56Present 4.82 3.29 5.91 2.76

Notes:Dependent variable: STRENGTH (1–10) prefer not to invest to prefer to invest.

Table 3. Willingness to escalate scores by country under framing conditions

Framing conditions

Mexico USA

Mean Standard deviation Mean Standard deviation

Absent 5.78 3.11 4.56 2.56Present 7.27 2.87 5.69 2.66

Notes:Dependent Variable: STRENGTH (1–10) prefer not to invest to prefer to invest.


TheMXAGENCY interaction of culture by agency is highly significant

and negative. Given that the MXAGENCY variable is scored 1 when the

agency manipulation is applied to the Mexican managers and zero

otherwise, the result shows that theMexican managers ignore the attempt

to induce escalation by removing supervisory support and creating a

personal incentive to shirk. They seem to be repelled by the prospect of

betraying the supervisor when incentives offered are insufficient to

overwhelm such scruples. We see this as a joint effect with the patrimonial

culture encouraging loyalty and the collectivist culture reducing the value

of individual incentive to shirk. Thus, we reject the null hypothesis for H3

in favor of the alternative that Mexican managers are less likely to be

swayed by the effect of information asymmetry and incentive to shirk than

US managers.

Unfortunately and contrary to what Table 3 seems to indicate, the

framing effect*culture interaction is insignificant,mirroring theGreer and

Stephens (2001) findings in two of three cases. Framing effects are not

significantly different in the Mexican culture than the US. Therefore, we

fail to find support for Hypothesis 2. This would also seem to provide


Table 4. Multinomial logit results

B Std. error Df Sig.

INTERCEPT � 0.427 0.346 1 0.217AGENCY 1.160 0.233 1 0.000NEFGRAM 1.042 0.234 1 0.000MXUS 0.714 0.269 1 0.008YREMPFT 0.051 0.015 1 0.001AGENCY*NEGFRAM � 0.723 0.303 1 0.016MXAGENCY � 1.089 0.383 1 0.004MXFRAM � 0.055 0.333 1 0.870Bank loan case � 0.883 0.206 1 0.000Currency trader case 0.515 0.186 1 0.006

Notes:Dependent variable is DECISION 1(Yes)/2(No).1. Nagelkerke R^25 0.184.2. X25 126.062 which is significant at a�0.000.3. Legend:a. AGENCY: Presence (1) or Absence (0) of the conditions for adverse selection, i.e.,

asymmetric information and incentive to shirk.b. NEGFRAM: Presence (1) or Absence (0) of negative framing.c. MXUS: Subjects’ country of birth. Mexico5 1; US5 0.d. YREMPFT: A work experience control variable (years employed full time).e. MXAGENCY: is 1 if the agency manipulation is applied to Mexican subjects, 0 if

otherwise.f. MXFRAM: is 1 if the negative framing manipulation is applied to Mexican subjects, 0 if

otherwise.


support for previous findings in Greater China that framing effects are

universal (Sharp and Salter, 1997; and Chow et al., 1997).

Among the control variables, experience is significant and negative.

More experienced managers appear to be able to counter the judgment

biasing impact of culture and information processing. In addition,

managers are less willing to take risk in the bank loan case and more so

in the currency trader case. This is not surprising given that currency

trading is inherently risky and hence may be seen as something one may

legitimately gamble in. The AGENCY*FRAMING interaction is

surprisingly both significant and negative. This interaction is 1 when both

conditions apply and zero otherwise. While it is not the main purpose of

this paper to explore such an interaction, it does indicate for the first time in

a statistically significant way that agency and framing effects may interact

and that the one moderates the other, essentially placing a cap on how

much escalation takes place. However, regrettably, further analyses of the

raw numbers using t-tests indicate that it is only among the Mexican

sample that that the interaction produces significant differences.

Finally, a review of Table 5, the Regression Results, using the strength

variable (confidence in the decision), reveals that they are identical to those

of the Multinomial Logistic Regression.10

Conclusions and Implications

The most interesting finding is the strong effect of cultural differences on

managers’ response to agency manipulations. It would appear that in the

presence of information asymmetry and incentive to shirk, American

managers are more likely than Mexicans managers to escalate commit-

ment. This supports the previous work of Sharp and Salter (1997) that the

more individualist the country, themore likely it is that escalationwill take

place.

There are also base country differences with the Americans being less

likely to escalate. This confirms theworkofGreer andStephens (2001) that

culture influences risk propensity. The question is why? If one believes that

Mexicans are like Taiwanese in their desire to avoid uncertainty, the

question is why take the risk? Our view is that uncertainty avoidance

encourages sticking with what is rather than what could be. Hence, in

highly uncertainty avoidant countries such as Mexico and Taiwan,

participants continue with current projects rather than risk change. This

would dovetail with Sharp and Salter’s (1997) findings that Hong Kong

and Singapore, which are relatively low in uncertainty avoidance, do not



adopt a particularly aggressive stance in initial decisions. Whatever the

cultural conclusions, Mexico can now be added to a list of countries with

high risk profiles. The control implications of our findings are that US

companies entering into joint ventures or investments in Mexico should

provide for either clan control (a non-Mexican check point for project

evaluation) or remote expert system checks.

These findings further suggest that the effect of adverse selection

conditions in an escalation of commitment situation may be highly

country-specific. It also supports the view of Boyacigiller andAdler (1991)

regarding the global generalizability of American theories of managerial

decision-making. Despite concerns about the regional variable of face, it

appears, simply put, that individualism drives agency. Therefore it is time

to reexamine the validity of agency theory in non-US settings.

For the practicing manager, the results suggest that the design of a

management control and decision support system for project evaluation


Table 5. Regression results

Unstandardizedcoefficients beta

Std.error

Standardizedcoefficients beta

t Sig. VIF

(CONSTANT) 5.099 0.268 – 19.038 0.000 –AGENCY 1.554 0.291 0.265 5.342 0.000 2.449NEGFRAM 1.370 0.293 0.234 4.683 0.000 2.496MXUS 1.121 0.346 0.175 3.237 0.001 2.921YREMPFT � 7.198E–02 0.018 � 0.128 � 3.953 0.000 1.045AGENCY*NEGFRAM

� 0.853 0.377 � 0.123 � 2.262 0.024 2.923

MXAGENCY � 1.439 0.489 � 0.147 � 2.946 0.003 2.485MXFRAME � 0.181 0.411 � 0.022 � 0.442 0.659 2.548BL case � 1.355 0.261 � 0.219 � 5.200 0.000 1.761CT case 0.448 0.227 0.072 1.975 0.049 1.336

Notes:1. Dependent variable: STRENGTH (1–10) prefer not to invest, prefer to invest.2. Adjusted R2 – 0.140 which is significant at a � .000.3. Dependent variable is DECISION 1(Yes)/2(No).4. Nagelkerke R^25 .184.5. X25 126.062 which is significant at a� .000.6. Legend:

a. AGENCY: Presence (1) or Absence (0) of the conditions for adverse selection, i.e.,asymmetric information and incentive to shirk.

b. NEGFRAM: Presence (1) or Absence (0) of negative framing.c. MXUS: Subjects’ country of birth. Mexico5 1; US5 0d. YREMPFT: A work experience control variable (years employed full time).e. MXAGENCY: is 1 if the agency manipulation is applied to Mexican subjects, 0 if

otherwise.MXFRAM: is 1 if the negative framing manipulation is applied to Mexican subjects; 0 ifotherwise.


should address not only the incentive to shirk and ability to hide

information, but also the base risk profile of a country. Thus, the relative

emphasis that should be placed on agency theory’s incentive to shirk and

ability to hide information in the design of control systems needs to be

adjusted for each culture. This is particularly relevant toUSmultinationals

because the US has the highest score of any country on Hofstede’s

individualism measure and US based control systems are likely to

overemphasize the need for control of shirking and malfeasance in more

communitarian cultures. At the same time, the USmultinationals’ control

system may not accurately reflect the willingness to take risk in other

cultures. Organizational practices can and should be modified to adapt to

the culture’s value structure.

Limitations and Future Research

First, the study did not include personality variables, such as self-efficacy

(Whyte et al., 1997), or locus of control (Brownell, 1981) that might have

accounted for part of the very large unexplained variation in risk

preferences between individuals in this context. Second, although

respondents should have been approximately indifferent between escala-

tion and abandonment (by virtue of the experimental design) there were

notable differences between the three cases in terms of willingness to

escalate commitment. We have a very limited understanding of the case-

specific factors that make economically similar escalation decisions so

much more attractive than others. Third, while we hypothesized that

individualism/power distance were the cultural basis for the culture-

agency interaction, it may be attributable to some other cultural factor not

included in the Hofstede taxonomy. In addition, given the controversy

over Mexican culture, a retest should be included in a future study as

should a larger number of other Latin countries, particularly Brazil the

next largest US trade partner. Finally, given the growth in Mexican

individualism we see potential to split the symmetric information and

incentive to shirk manipulations.

Notes

1. Aqui no se habla agencia literally means ‘we don’t speak agency here’, i.e. agency isirrelevant here. This refers to our findings in Mexico.2. At the suggestion of a reviewer we conducted an extensive search of the accounting and

management literature and could find no published studies suggesting that these effectsinteract.Therefore,we assume they are atmost additive andprobably independent.However,at the request of a reviewer we did add the interaction to our study as a control variable.



3. Hofstede first published his theories and data in Hofstede (1980). The 2001 book is thesecond edition and the data for all the countries involved here is identical to the originalHofstede (1980) scores.4. This concept of Mexico as a relatively uncertainty avoidant country has been

challenged by Fernandez (1997) as we shall discuss later.5. Greater China includes countries dominated by Chinese and the Chinese diasporas,

and includes at a minimum the PRC, Hong Kong, Taiwan, and Singapore.6. Our thanks to one of our reviewers for bringing this to our attention as it is not a

commonly known aspect of the theory.7. ABI Inform, Academic Press Journals/Elsevier, EBSCO and UMI.8. The software case was placed either second (following the market research case)

or third (following the currency trader) in sequence. The order effect may have arisen froman unforeseen interaction effect with previous cases. This case was also the only case thatused a family owned enterprise and a new technology. Looking back these may haveimpacted on the decision, with the new technology encouraging risk while the familyencouraged caution.9. Themodel was also tested with the square root of number of years of work experience,

since saturation effects may eventually set in. No difference in results was found.10. At the suggestion of a participant at a research seminarwhere an earlier version of this

paper was presented we retested the model coding the Mexico/US dummy as 1/� 1 andagency and framing as 2 present and 1 not present to create 4 distinct categories with scoresfrom2 (Mexicanmanager to theAgencymanipulation) to � 2 (USwith agency). The resultswere identical to those described above.

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Appendix – Sample Case

The Bank Loan

Background. You are a senior corporate loan officer in the London,

England, subsidiary of an international bank. It is 7 August 1995, and it

looks like today will be interesting. (No adverse selection condition) You

have to reach a decision on a $500,000 loan to The Industrial Fastenings

Company, a medium-sized company listed on the local stock exchange,

whichmanufactures nuts and bolts for a variety of industrial and domestic

applications. You have full authority tomake the loan, but like all loans, a

copy will be included in the daily loan report to head office. Details of the

loan are in the briefing note below.

(Adverse selection condition) First, you have to reach a decision on a

$500,000 loan to the Industrial Fastenings Company, a medium-sized

company listedon the local stock exchange thatmanufactures nuts andbolts

for a variety of industrial anddomestic applications.Youhave full authority



to make the loan, but like all loans, a copy will be included in the daily loan

report to head office. Details of the loan are in the briefing note below.

Second, you have just received a phone call from a director of a private,

very prestigious successful but conservative Swiss bank. He has indicated

that he is very impressed with your record as a profitable but prudent

banker with no client bankruptcies, and would like you to be a candidate

for their Managing Director and CEO position when the current CEO

retires onDecember 31 1995.The prestige, location andopportunity are all

very attractive to you.

Briefing Note on Industrial Fastenings Company

Some years ago, you approved a loan to The Industrial Fastenings

Company, $1 million of which is still outstanding and overdue. However,

in accordance with bank’s conservative accounting policy, all of this

amount has alreadybeenwrittenoff internally over the last three years, and

had no significant impact on the bank’s profitability. Because of various

tax credits, the bank pays no income taxes at the present time, so loan

write-offs have no tax effect.

The Industrial Fastenings Company is now in a very precarious financial

position and if you do not make the loan will cease trading before the year-

end. The company’s present precarious financial position is caused by a lack

of up-to-date machinery in one important process, which has caused the

company to become uncompetitive. If you lend the $500,000 to purchase the

new machine, provided that the economy does not decline, The Industrial

Fastenings Company will very quickly generate cash flow in excess of $1.5

million, allowing the repayment of both of the loans and interest in full. If,

however, the economydeclines, the companywill likely survive into1996, but

will inevitably be bankrupt and unable to repay any loans, and since the

machine is highly customized, the bank will recover nothing. The bank’s

economic forecasting section estimates a 2/3probability of economic decline.

Alternatives

Based on the above, you summarize your choices as follows:

(Neutral Framing)1. If you do not grant the loan, you will save $500,000.

2. If you grant the loan, there is a 2/3 probability that no money will be

saved (recovered) and a 1/3 probability that $1.5 million will be saved

(recovered).



(Negative Framing)1. If you do not grant the loan, the loss will definitely be $1 million.

2. If you grant the loan, there is a 2/3 probability that the loss will be $1.5

million, and a 1/3 probability that the loss will be zero.

Decision:Please choose one of the following: 1. Do not grant the loan ____

2. Grant the loan ____

Please indicate the strength of your of your preference for the choice youmade

by marking an ‘X’ at the appropriate point on the scale:

I definitely I definitelypreferred 1 |__|__|__|__|__|__|__|__|__|__| preferred 2



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