Learning from Performance: Banks, Collateralized Debt Obligations, and the Credit Crisis

• In Event: 342 - Regular Session. Organizations: Network Comparisons and Economic Outcomes

Abstract

This study investigates the organizational processes that drive the rise and spread of repeatable innovations, focusing on the case of collateralized debt obligation (CDO) underwriting among U.S. investment and commercial banks, 1996-2007. I investigate how banks integrated evidence from their own experience with this activity and the observed experiences of other activity users. Contrary to the predictions of conventional diffusion theories, I do not find that banks blindly mimicked the CDO underwriting activity of others. Nor did they learn vicariously from the true performance effects of activity use elsewhere, since these effects were not observable. Instead, I find that banks learned superstitiously from the general performance of other CDO underwriters. Banks continued to respond to this loosely linked performance feedback even after they obtained direct experience with CDO underwriting, and they became even more attentive to confirmatory evidence on this dimension as CDO underwriting became more popular. I discuss implications for institutional theory and accounts of the credit crisis.

Author

• Kim Pernell-Gallagher, Harvard University