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Faculty Viewpoints

Balancing the Letter and the Spirit

Should organizations favor the dependable efficiency of rules and standards or a less calculated but more flexible operation that bends to accommodate individual situations? How about both?

By Dylan Walsh

“Those are my principles, and if you don't like them ... well, I have others.”
— Groucho Marx

All organizations face the same conundrum: On the one hand, they have a need for rules, to promote efficiency, 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 actions—though they mean diverging from rules—can sometimes allow for organizational learning and lead to a competitive advantage.

“Organizations are thus left with a seemingly impossible decision,” Yale SOM’s Rodrigo Canales wrote in a 2014 article for 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?

The best practice, he concluded, is to keep the two approaches in constant tension.

For five months, Canales interviewed and observed both managers and field officers in three 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 precisely, were deemed to exhibit a “hybrid” style. He then gathered proprietary data on approximately 450,000 microfinance loans made by one of the organizations between 2004 and 2008; the data provided a detailed picture of each loan and loan recipient, as well as of how well the loans performed over time. He also gathered a smaller amount of data from two additional microfinance organizations to mitigate the possibility of bias in the original data. The question Canales was hoping to answer: is there a particular composition of employees that is organizationally optimal?

He discovered that branches of the organizations that employed a mix of employees who followed the spirit of the law and the letter of the law were most successful, on average. “Branches that contain ‘discretionary diversity’—that is, a balanced distribution of agents with opposing styles—perform best,” Canales wrote. (Interestingly, branches with the highest concentration of “hybrid” employees were least successful.)

However, this result was not simply a byproduct of a diversity of approaches, Canales determined, but 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 explained in the article. “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.” In other words, a branch full of those who follow the spirit of the law may extend too many helping hands at the expense of solvency, while a branch filled with those who follow the letter of the law may adhere to the rules blindly without recognizing downsides or lost opportunities.

The implication was that these two contradictory styles enhance one another when there are structures in place—such as credit committees, in the case of microfinance organizations—that foster open discussion and debate. (Two examples of how this tension plays out are presented below.) This effect may be especially evident, Canales posited, in service-oriented occupations like teaching or social work.

Interestingly, other types of diversity—such as gender, age, or education—had no impact on loan outcomes. Nor were outcomes affected when there was diversity across the regional or zonal level—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.

Achieving this kind of diversity within an organization, Canales acknowledged, creates certain challenges. For instance, designing a compensation system to equitably reward both styles is a complex matter. And meetings among individuals with diverse styles tend to run longer and be more contentious. “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,” wrote Canales.

But these quandaries merely open space for future research and on-the-ground experimentation. For instance, is there a minimum degree of diversity and tension that is productive but also uncostly? In industries other than microfinance, at what organizational level should this kind of diversity be established? And what leads to such diversity in the first place? Can training be tilted one way or the other to balance teams out? It is only fitting to assume that no single answer will perfectly suit every situation.

Example Exchanges

Two examples of conversations that took place at branch-level credit committee meetings that Canales studied. SL = a “spirit of the law” loan officer; LL = a “letter of the law” loan officer.

Letter of the Law Balances Spirit

SL1: This client had a clean record in all the previous loans, but she was having a bad sales month and now part of her merchandise was stolen, so she fell behind... I want to restructure the loan, with this new payment schedule. [Shows slide, removes within seconds.] She really needs the help, her kid is still not well, and...

LL1 [interrupts]: Wait, go back to the payment schedule. That doesn’t seem right. Show me the ratios again. Why aren’t you including the recurring medical costs in the expenses there? That liquidity index is not going to work. She cannot make those payments.

SL1: What are you talking about? This is a solid client; of course she will repay! [To LO3] You know her, right? She recommended other clients to you...

LL1: She can be a saint for all I care; those numbers are not going to work. [Discussion continues for 10 minutes.] I hear you [on wanting to help her], but I am telling you that your cash flow does not work, so you need to negotiate a different schedule with her; otherwise, you will be presenting her case again in two months.

Outcome: The manager intervened and sided with LL1 after more discussion. SL1 was instructed to calculate more conservative financials, draw up a new repayment schedule, and negotiate it with the client.

Spirit of the Law Balances Letter

LL1: The client has missed three consecutive payments and told me that he is not doing well, so he cannot make a payment right now. Here is the list of assets he has on this loan; so following policy I want to offer to take the fridge, which should cover the remainder of the loan.

SL1: How many loans has he had with us?

LL1: [Goes to paper file, takes some time.] This is his seventh loan.

SL1: So two years?

SL2: You can’t do that, man. Don’t take the fridge! How is he going to sell dairy if you do that?

SL1: He has been a good client for two years! Why don’t you give him a hand?

LL1: He missed three payments; I told him that the next step was to take an asset, collect from his references, or send in the collector. That’s the policy.

SL1: I know what the policy says! But this is a good client who knows other good clients. You do that and he is going to be in even more trouble and others are going to hear about it. No, no. You need to help this guy out, trust me on this one.

Outcome: The discussion goes on for 20 minutes. The manager agrees to accompany LL1 to visit the client and pursue potential alternatives

Read more:

Rodrigo Canales on managing the tradeoffs between profitability and social impact in microfinance.

Rodrigo Canales and two Yale colleagues discuss the promise—and problems—of microfinance.

Department: Faculty Viewpoints