Why Do Firms Hire Management Consultants?
| Peter Klein |
Academic economists and management scholars are often skeptical of management consulting firms. Their advice seems fluffy, ad hoc, unscientific. But consulting firms continue to prosper. Are their clients irrational?
I always assumed signaling plays a role. One can imagine a Spence-style separating equilibrium in which high-quality firms signal their unobservable characteristics to customers, suppliers, rivals, etc. by hiring an expensive consulting firm, while low-quality firms find this prohibitively costly. Of course, all consulting firms are not alike, and there are many different types of consulting services (e.g., strategy — more fluffy; IT implementation — less fluffy).
An article in the new JMS by Donald Bergh and Patrick Gibbons looks at the signaling value of consulting, measuring the stock-market reactions to firms’ announcements of hiring a consulting firm. Excess returns are positive and significant, and increasing in the client’s prior performance — the market likes it when “good” firms hire consultants. (The effects don’t seem to depend on the reputation of the consulting firm, though.) This is consistent with my story above, though we’d need to know something about firms that could have hired a consultant but didn’t to say more.