Yale School of Management

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Balancing the Letter and the Spirit

Should organizations favor the calculated efficiency of rules and standards, or a more flexible operation that bends to accommodate individual customers? How about both.

June 16, 2014

Those are my principles, and if you don't like them, well, I have others.

            - Groucho Marx

Every organization faces the same conundrum: on the one hand, there is a need for rules, which promote efficiency and standardization. Rules create order and demonstrate commitment to explicit norms. On the other hand, rules cannot capture the full complexity of the world, making their static application occasionally counterproductive, even unfair. Personal relationships and customized action—though it means diverging from rules—can open space for organizational learning and competitive advantage.

“Organizations are thus left with a seemingly impossible decision,” Yale’s Rodrigo Canales writes in Organization Science. “Should they pursue the efficiency, accountability, and order of a bureaucracy, or should they choose the flexibility, innovation, and learning” of relational ties?

Keep both in constant tension, he concludes.

For five months, Canales interviewed and observed both managers and field officers in Mexican microfinance organizations. With managerial input, he divided loan officers into three groups: those who followed the “letter of the law,” those who followed the “spirit of the law,” and those who, because they fit neither classification, seemed more a hybrid of the two camps. He then gathered proprietary data on approximately 450,000 microfinance loans made by a single organization between 2004 and 2008; the data provided a detailed picture of the loan and the loan recipient, as well as how well the loan performed over time. The question behind all of this data collection: is there a particular composition of employees that is organizationally optimal?

He discovered that organizations with a mix of employees who follow the spirit of the law and the letter of the law were the most successful lenders. “Branches that contain ‘discretionary diversity’—that is, a balanced distribution of agents with opposing styles—perform best,” Canales writes. (Branches with “hybrid” employees were least successful.)

The implication is that these two contradictory philosophies, in fact, enhance one another when there are structures in place.

These results were not a necessary byproduct of the diversity observed, but they stemmed from the fact that each microfinance branch has a credit committee to discuss loan decisions. “When committees contain significant discretionary diversity, it creates a productive tension that pushes loan officers to justify their decisions according to broader organizational goals,” Canales says. “Branches that are homogeneous, in contrast, degenerate to extreme versions of each organizational model, reaping the model’s benefits but being blind to its limitations.” A branch full of those who follow the spirit of the law may extend too many helping hands at the expense of solvency; a branch filled with those who follow the letter of the law may follow rules blindly without recognizing the downsides or lost opportunities.

The implication is that these two contradictory philosophies, in fact, enhance one another when there are structures in place—credit committees in the case of microfinance—that generate open discussion and debate. This may be especially true, Canales posits, in “service-oriented” positions like teaching, labor, or social work. (Two examples of how this tension plays out are presented at the end of this article.)

Interestingly, other types of diversity—gender, age, education—had no impact on loan outcomes. Nor were outcomes affected when there was diversity across the regional or zonal level, but only at the branch level. Discretionary diversity, to be productive, must therefore exist where operational decisions are made. In this case, credit committees made decisions at the branch level.

Adopting this kind of diversity within an institution, Canales recognizes, creates certain challenges. For instance, designing a compensation system to equitably reward both styles is a complex problem. And credit meetings with diverse groups are time consuming. “Even managers who can see the benefits of thorough committees are often torn about the time they require: a lack of discretionary diversity might be less effective, but it is certainly more efficient,” notes Canales.

But these quandaries merely open space for future research and on-the-ground experimentation. For instance, are there minimum degrees of diversity and tension that are productive, but also uncostly? For businesses besides microfinance, at what organizational level should they seek this kind of diversity? And what leads to this diversity in the first place? Can training cater one way or another to balance teams out? No single answer—it is only fitting to assume—will cleanly suit every case.

Below are two examples of conversations that took place in branch-level credit committees. SL = spirit of the law; LL = letter of the law.

Contributed by:
Dylan Walsh
Freelance journalist, New Haven, CT