The Lemons Problem in Markets for Strategy

Abstract

An agency perspective has emerged as a prominent view of the path to increased firm value in strategy research. In this view, increasing firm value requires resolving a ‘fundamental agency problem’ between shareholders and managers, specifically a ‘moral hazard’ or shirking problem that reflects managers’ weak incentives to increase the value of the firm. Correspondingly, research has focused on governance mechanisms that mitigate this agency problem. We focus on an alternative agency problem--an explanation for poor strategy choices that emphasizes well-intentioned managers making strategic choices that they believe will increase firm value, but facing difficulty in informing capital market participants about the value of these choices. We propose that the most valuable strategies are likely to be the most difficult for market participants and intermediaries to evaluate, and that pressures on managers to adopt strategies that are more easily assessed can lead to an adverse selection or ‘lemons’ problem. We examine the implications of governance mechanisms designed to mitigate moral hazard problems in the context of adverse selection. We further propose that firms with more valuable strategies may migrate to private equity, such that many of the strategies in private equity markets will be more valuable.