Reputation, diversification, and organizational explanations of performance in professional service firms

Growing interest in knowledge as a competitive asset suggests the benefit of studying professional service firms (PSFs). These firms are highly successful examples of organizations whose ability to manage knowledge is critical to their success. Furthermore, they are worthy of study because they constitute a significant sector of the economy, whether measured by their size, numbers, or influence. Despite their significance, little is known of the determinants of their performance. This paper proposes that the core tasks of PSFs raise unusual strategic and organizational challenges, the resolution of which affects organizational performance. We elaborate the effects of reputation and diversification and contrast them to theory for goods-producing industries. We also hypothesize that PSF managers face a choice in designing structures between the retention and motivation of the professional workforce and transferring knowledge from partners to other professionals. These predictions are tested and supported by data from the largest 100 US accounting firms for the period 1991–2000. The paper thus contributes to a theory of professional service firm management.