Date: 24 Aug 2013

Allowance for failure: reducing dysfunctional behavior by innovating accountability practices

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Abstract

A common theme in current corporate governance is to increase managers’ accountability. In contrast, this paper emphasizes the need for less accountability in certain situations and consequently introduces the concept of “allowance for failure”. This concept refers to the style in which the decision maker’s environment—such as capital market, corporate governance, and management control system—deals with potential failures (e.g., project or investment failures). The argument that allowance for failure is important is illustrated by the example of failing projects, drawing on the escalation of commitment literature. It is hypothesized that allowance for failure indirectly reduces project escalation, i.e., the continuation of a failing project. The relationship is mediated by managers’ perceived threat in case of project failure. In addition, the paper suggests that capital market orientation increases managers’ perceived threat in the case of project failure and thus indirectly increases project escalation. Cross-sectional survey data were collected to test these hypotheses. The results from 320 failed projects under the responsibility of top-level managers support the hypothesized effects. Cross-validation with 109 projects terminated by lower-level managers and 133 projects terminated by company owners shows consistent results. The study’s findings highlight the importance of carefully analyzing potential consequences of promoting capital market orientation. More important, the study indicates a need for innovative accountability practices that expand allowance for failure to avoid dysfunctional consequences for decision-making, especially if strong capital market orientation is prevalent.