The Dynamics of Knowledge Flows: Human Capital Mobility, Knowledge Retention and Change

The dynamics of
knowledge flows:
human capital mobility,
knowledge retention
and change
Tammy L. Madsen
Elaine Mosakowski and
Srilata Zaheer
The authors
Tammy L. Madsen is the Dean Witter Foundation Fellow
and Assistant Professor of Strategy, Management
Department, Leavey School of Business, Santa Clara
University, Santa Clara, California, USA.
Elaine Mosakowski is based at Krannert School, Purdue
University, West Lafayette, Indiana, USA.
Srilata Zaheer is Carlson School Term Professor of
International Management at Carlson School of
Management, University of Minnesota, Minneapolis,
Minnesota, USA.
Keywords
Human capital theory, Personnel, Job mobility,
Knowledge, Learning
Abstract
This empirical paper investigates the relationships
between the amount of human capital that flows into a
firm and two activities underlying a firms knowledge
production, variation or change and knowledge retention.
We track the flow of human capital within and across
organizational and geographic space for all multi-unit
banks operating in the world foreign exchange trade
industry from 1973 to 1993. The findings indicate that an
increased reliance on past experience reduces how much
human capital a firm imports in the future. This effect is
moderated by a self-reinforcing cycle of human capital
inflow. Inflows of human capital also decline when a firm
has recently adopted novel changes in its operations. The
paper uses evolutionary thinking to define a model for
intrafirm knowledge production.
Electronic access
The current issue and full text archive of this journal is
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http://www.emeraldinsight.com/1367-3270.htm
Journal of Knowledge Management
Volume 6 . Number 2 . 2002 . pp. 164176
# MCB UP Limited . ISSN 1367-3270
DOI 10.1108/13673270210424684
Variation or change and knowledge retention

affect a firm s knowledge production.
Tradeoffs in the amount of resources
dedicated to these activities influences the
development and distribution of knowledge
within firms across time (March, 1991). For
instance, a firm that preserves the past via
retention may dedicate less resources to
creating knowledge through variation activity
and to acquiring tacit knowledge and skills, or
human capital. On the other hand, a firm may
import more knowledge via inflows of human
capital when it trades off exploiting the past
for increasing knowledge creation or variation
activity. As a consequence, a general concern
of studies examining learning and adaptation
is the balance between a firm s variation and
retention activities (Madsen and McKelvey,
1996). How do variation and knowledge
retention affect the development and
distribution of knowledge within firms? More
specifically, how do these activities affect the
flow of tacit knowledge and skills, or human
capital, into a firm?
The movement of personnel is widely
recognized as a mechanism for distributing
tacit knowledge and skills, or human capital,
across space and time (Almeida and Kogut,
1999; Cooper, 2001; Gruenfeld et al., 2000).
Moreover, research suggests that variations in
firms knowledge bases are facilitated by
individuals (Argote and Ingram, 2000). The
tacit knowledge and skills held by a firm s
members, whether the members are
established or newcomers, are therefore
crucial to a firm s knowledge production. Few
longitudinal empirical studies, however,
explore the links between knowledge flows
within or across a firm s boundaries and
activities underlying a firm s knowledge
production, such as variation and retention.
This is surprising because knowledge inflows
might stimulate a firm s variation or
knowledge creation activity whereas
knowledge retained from a firm s past
experience might attenuate future knowledge
inflows. We address these dynamics by
examining how a firm s variation intensity and
knowledge retention intensity affect the
This paper s development benefited from
discussions between the first author and Jacques
Delacroix. The first author gratefully acknowledges
the Dean Witter Foundation for their financial
support. All errors are the responsibility of the
authors.
164
Tammy L. Madsen, Elaine Mosakowski and Srilata Zaheer
The dynamics of knowledge flows

Volume 6 . Number 2 . 2002 . 164176
amount of knowledge it imports via inflows of

human capital.
The classic evolutionary process of
variation, selection, and retention (VSR) is
viewed as a mechanism for developing and
organizing knowledge within a firm (see
Campbell, 1969; Weick, 1969, 1979).
Research suggests that, given a context of
competitive pressures, VSR interact inside a
firm to form a machine or engine for
producing knowledge (Plotkin, 1994). Our
model of a firm s knowledge-production
engine builds on this work. We first define the
engine s variation and retention components;
ensuing sections describe the engine.
Variation involves the creation of knowledge
that generates novel or wholesale-type
changes in a firm s ways of operating.
Variation intensity refers to the amount of
novel changes that a firm adopts at a point in
time. Retention explains the preservation and
refinement of changes or variations in the
behaviors adopted by a firm and the
subsequent dispersion of these changes across
the firm s subunits. Through dispersion, a
firm leverages its new and past knowledge
across space and time. Retention intensity
indicates how much retention a firm pursues
annually. The content that is retained by a
firm represents knowledge about its existing
and past behaviors and is stored in different
retention bins that form the firm s memory
(Walsh and Ungson, 1991). The state of each
retention bin partially reflects the outcomes of
past human capital inflow. A retention bin s
content also feeds back to a firm s variation
activity, affecting its future stock of human
capital inflow. In this process, a firm s
retained knowledge may be combined with
new knowledge to generate a novel change or
variation. The relationship between variation
and retention is thereby recursive rather than
opposing. However, firms engage in variation
and retention simultaneously. These activities
consequently compete for resources within a
firm. Examining variation and retention
simultaneously controls for these effects.
The context for this longitudinal study is
the world population of multi-unit banks
operating in foreign exchange (FX) trading.
The data span multiple levels of analysis and
allow us to track the movement of over
150,000 currency traders (individuals) across
47 countries and 2,300 trading rooms
(subunits) of 431 parent banks (firms) from
1973 to 1993. We examine variation in and
retention of one critical organizing pattern,

the mix of experience in a bank s trading
rooms.
A trading room s success is substantially
dependent on the mix of talent among its
traders (Cetina and Bruegger, 2001). This
talent is largely based on tacit knowledge
developed through experiential learning. A
recent study of a Swiss bank shows that the
bank typically monitors and adjusts the
experience mix in its trading rooms; one of
the bank s managers explained that each
room requires a particular mix of stars ,
talents and reliables (Cetina and
Bruegger, 2001, p. 189). Star traders hold
the room together and build the firm s
reputation, talents grow into and eventually
replace stars, and reliables fill out the mix
(Cetina and Bruegger, 2001, p. 189). Rooms
with too many stars might encounter
leadership conflicts whereas rooms with only
one star, and without a sufficient mix of
support, expose a bank to risk. A large gap in
traders experience might also harm a trading
room s performance. Firms consequently
attempt to assemble a mix of traders with
experience that is not too distant as well as a
mix that forms a solid team. Moreover, a
portion of each trader s experience is based on
their position in the trading room and on their
relationships with other traders. For instance,
inexperienced traders often work with
seasoned traders to gain experience before
entering the market on their own. A trading
room s experience mix therefore underlies a
set of roles and interrelationships that define
how the traders in a room interact and
coordinate their behaviors. As these roles and
interrelationships become embedded in a
firm, depicting task differentiation and
control, they form a set of higher-order
organizing patterns. Over time these patterns
are stored in a firm s memory, forming a
retention bin (Walsh and Ungson, 1991).
This experience mix, referenced as a bank s
organizing pattern, thus represents a way of
structuring the relationships among traders in
a room in response to external or internal
pressures on a firm.
Banks in the FX industry operate multiple
units dispersed in different national
environments and experience human capital
inflows from multiple sources. This allows us
to track human capital mobility within and
across organizational and geographic space
over time. The term inflow references the
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movement of human capital into a firm s

subunit. Prior research disaggregates the
inflows into types based on their spatial
origin, such as interfirm vs intrafirm or crossborder vs local (Madsen et al., 2001). For this
study, we define the aggregate amount of
human capital that flows into a firm annually
based on the subunits operated by the firm.
The next section presents the theory and
hypotheses. For brevity, we limit our
arguments to two main streams of research.
Theory and hypotheses

Variation and retention: parts of a
knowledge-production engine
Firms evolve through a cycle of VSR that
occurs at multiple hierarchical levels (e.g.
individual, subunit, firm, population,
community) (Aldrich, 1979; Baum and
Singh, 1994). This paper focuses on the
intrafirm level of analysis. We do not presume
that firms evolve in exactly the same way that
species do. Instead, we view evolutionary
thinking as a tool, such as a hammer; it is a
blunt tool but useful in many circumstances.
We also acknowledge that by considering only
two components of the VSR process that we
do not measure evolutionary learning.
Nevertheless, since we are interested in how
variation and retention affect a firm s stock of
human capital inflow it is useful to
understand the roles of variation and
retention in a firm s knowledge-production
engine.
Variation is primarily driven by a firm s
ability to create new ways of operating and
new opportunity sets via combinative learning
(Aldrich, 1999). Based on these subactivities,
firms develop a portfolio of variations from
which managers select. A firm s internal
selection process is guided by various
evaluation or control mechanisms that stem
from the firm s social norms and
administrative structures (McKelvey and
Aldrich, 1983; Burgelman, 1994; Miner,
1994). Variations selected by a firm are
retained in the firm s memory and dispersed
across the firm s subunits. The content that is
retained by a firm feeds back to the variation
and selection processes thereby actively
influencing subsequent knowledge creation
and evaluation activities. New ideas generated
in the variation phase are therefore,
conditioned by a firm s stock of experientially
developed knowledge and are subject to

screening based on the firm s existing
structures and norms.
Retention encompasses the preservation,
dispersion and refinement of retained
variations. A behavioral pattern or routine
retained by a firm in one of its subunits may
subsequently be dispersed to a peer subunit.
Applying the pattern in this new context may
generate refinements in the pattern s
execution and performance. Other scholars
view this replication or dispersion process as
separate from retention (see Zollo and
Winter, forthcoming). But it is difficult to
define either process without invoking the
other. Moreover, in multi-unit firms, the
wider spread of a behavioral pattern
represents both preservation at the firm level
and subsequent dispersion of the pattern at
the subunit level. Finally, external forces
selectively discriminate against some firms
and favor others based on the variations
retained by those firms. Figure 1 lists some of
the general activities underlying each
component of the knowledge-production
engine. The figure also indicates that
pressures internal and external to a firm might
affect its knowledge production. Since
variation and retention have somewhat
competing roles in knowledge production,
they may affect the stock of knowledge that
flows into a firm in different ways.
Subsequent sections explore these
differences.
Variation intensity and human capital
inflow
Learning or knowledge-based arguments
suggest that firms that are more disposed to
variation or exploratory-type behavior may be
more receptive to inflows of knowledge.
Firms that have developed experience with
change tend to remain flexible and in turn, are
less reluctant to explore unfamiliar ways of
organizing (Hedberg et al., 1977). Their
search for knowledge is therefore, less likely to
be limited to their immediate neighborhoods
of expertise. Moreover, new personnel might
provide the knowledge diversity needed for
generating new ways of organizing. These
characteristics suggest that increases in
variation intensity will contribute to an
increase in the amount of human capital
flowing into a firm.
Research on organizational ecology also
suggests that increases in variation intensity
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Volume 6 . Number 2 . 2002 . 164176
Figure 1 Internal VSR as a knowledge-production engine
may stimulate increases in human capital

inflow. Change disrupts organizational
operations (Amburgey et al., 1993; Delacroix
and Swaminathan, 1991). Turnover, based
on the outflow and inflow of personnel, is
often a by-product of such disruptions (Baron
et al., 2001). One explanation is that
variations in a firm s organizing patterns may
affect communication and coordination
patterns among personnel. Because an
individual s attachment to a firm develops
over time as a function of their experiences
with the firm, changes to the firm s organizing
patterns may disrupt the individual s
traditional ways of operating and their
acquired legitimacy. These effects may lower
an individual s attachment to the firm and
increase the likelihood that the individual will
leave (Sorensen, 2000). These arguments
suggest that personnel departures may
increase among individuals who have
experienced novel or wholesale changes in
their teams, groups or subunits. In response,
firms seeking to replenish their human capital
may increase their stock of human capital
inflow. These arguments lead us to predict
that increases in a firm s variation intensity
will generate an increase in human capital
inflow.
H1. Increases in a firm s variation intensity
will generate an increase in human
capital inflow.
We are also interested in understanding if
variation attenuates or strengthens the
relationship between a firm s current stock of
human capital inflow and its future stock of
human capital inflow. If history matters, a
firm s propensity to import human capital
may be a function of the amount it imported
in the past. As a firm gains experience with

importing human capital, it may view inflows
as useful mechanisms for solving a broader
and more complex set of problems. If this
holds then one might expect a firm s stock of
human capital inflow to have positive path
dependence or to be self-reinforcing. Given
the prediction that variation intensity is also
positively related to future inflows of human
capital (H1), we expect that the interaction of
these two effects will yield a positive effect.
Stated another way, we hypothesize that
increases in a firm s variation intensity will
accentuate the positive relationship between a
firm s existing stock of human capital inflow
and its future stock of human capital inflow.
H2. Variation intensity will accentuate the
positive relationship between a firm s
existing stock of human capital inflow
and its future stock of human capital
inflow.
Retention intensity and human capital
inflow
Learning or knowledge-based arguments also
suggest that firms that adhere to their
traditional ways of operating may be less
receptive to importing knowledge via human
capital inflow. One explanation is that
individuals new to a firm may introduce
diversity that disrupts the firm s ways of
operating. For one, new personnel may carry
human capital that differs from the recipient
firm s human capital stock. These differences
may lead a firm s members to question or
challenge the efficacy of the firm s retained
organizing patterns. It is also possible that
new personnel bring human capital that
overlaps with a recipient firm s human capital
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stock or that new personnel are less

knowledgeable than a recipient s existing
members. In both instances, diversity may
still increase in the recipient firm because the
new personnel are less socialized to the
recipient s organizational context. Moreover,
frequent changes to the tenure distribution of
personnel disrupt the socialization process
because they affect the dynamics of
interaction among employees (March, 1991;
Sorensen, 2000). Changes to employee s
interaction patterns may, in turn, affect a
firm s organizing patterns. This effect may be
more prevalent in contexts such as the FX
industry where employees frequently interact
to accomplish their daily activities. Since
inflows of human capital might disrupt a
firm s traditional organizing patterns, firms
that increasingly rely on their past may
restrict, or at least reduce, the amount of
human capital they import.
The preceding arguments are consistent
with research in organizational ecology that
suggests that increasing retention intensity is
likely to promote a firm s resistance to change
or to factors that might stimulate change.
When firms repeat a pattern of behavior, their
competence at the behavior increases and the
behavior becomes institutionalized within the
firm. Increases in competence increase the
likelihood of rewards from the behavior and
the likelihood that the firm will retain the
behavior for future use. This self-reinforcing
cycle makes exposure to new personnel that
might disturb the status quo less attractive
(Levitt and March, 1988). Past learning,
through refinement of a behavioral pattern,
may therefore inhibit future opportunities for
knowledge development (March, 1991).
These arguments lead us to predict that
human capital inflow may decline with
increases in a firm s retention intensity.
H3. Increases in a firm s retention intensity
will generate a decrease in human
capital inflow.
If one considers the interaction of retention
intensity, which predicts a negative effect on
future human capital inflow, and human
capital inflow, which predicts a positive effect
on future human capital inflow, the net result
is ambiguous. Recall that the content of a
firm s retention bins is based on knowledge
that the firm has developed over time.
Exploiting knowledge developed in the past
increases a firm s accountability and
reliability. However, it also generates inertia,

which impedes a firm s ability to break from
tradition. Given these effects, we predict that
a firm s retention intensity will attenuate the
positive relationship between existing and
future stocks of human capital inflow.
H4. A firm s retention intensity will
attenuate the positive relationship
between a firm s stock of human
capital inflow and its future stock of
human capital inflow.
Data
Data sources
The data stem from annual publications of
the Foreign Exchange and Bullion Dealers
Directory (Hambros Bank, London, 19731993). Data collection occurred in two
phases. Phase one documented all the
market-making trading rooms in the FX
industry (approximately 26,763 rooms held
by over 1,500 parent banks worldwide) from
1973-1993, their parent bank affiliations, the
number of hierarchical levels in a room, and
the trading rooms locations (city and
country). In 1993, trading rooms were
located in 47 countries and parent banks were
headquartered in 65 different countries.
Interviews were also conducted in over 40
trading rooms. Phase two documented the
names and positions of the traders operating
in the industry during the 21-year period
(approximately 150,000 names) and the
number of traders operating in each trading
room. The number of names documented per
directory-year ranges from 2,965 in 1973 to
11,522 in 1993. In addition, 25 telephone
interviews were conducted with US traders to
understand the attributes that are critical to a
trading room s performance. The interviews
were semi-structured and all respondents
were asked the same set of questions. In the
interviews conducted in phase one and two,
all traders indicated that two dimensions are
critical to performance: the experience of
traders in a trading room; and how a room is
organized.
The archival data is restricted to marketmaking trading banks, which are banks
committed to buying or selling any amount of
currency in the interbank market. The data
were cleaned to ensure that listing lapses were
not counted as room exits. One concern is
that the directory only prints the names and
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Volume 6 . Number 2 . 2002 . 164176
positions of 12 traders per room. Therefore,

in 11 percent of all trading rooms on average
over time, we do not know if the 12 traders
listed represent the complete trader roster. In
all other cases, however, we expect the trader
information to be relatively complete. No
incentive exists to omit traders as inclusion in
the directory facilitates contact by other
traders and each trader listed receives a
complimentary copy of the directory. We
acknowledge that this characteristic may
understate trader mobility for large trading
rooms. The archival data are also left
censored since many rooms existed prior to
1973. We recognize that beginning the
observation period in 1973 may introduce
errors due to left censoring (Tuma and
Hannan, 1984, pp. 128-35). Although data
are available prior to 1973, the introduction
of floating exchange rates in 1973 represented
an institutional event that significantly
affected currency trading. In addition,
Reuters introduced a computerized foreign
exchange system in 1973 that facilitated the
development of an electronic market. Even
though the computerized system initially
provided only general news and price
information, it eventually made market
information more explicit and more readily
accessible worldwide. This event, and the
more significant institutional change, suggest
that 1973 provides an effective demarcation
point for beginning our analysis. A detailed
industry description is available from the first
author on request.
Sample and unit of analysis
Our sample includes all banks operating
multiple trading rooms (N = 431). The focal
unit of analysis is the parent bank. Data
collection spanned three levels of analysis
the parent firm or bank, the trading room or
subunit and the individual trader. In all cases,
we aggregate data at lower levels to the parent
firm level of analysis. Theoretical and
empirical issues motivate this approach. First,
from a theoretical standpoint, multi-unit
firms, especially multinational ones, are
complex organizations. Subunits within the
same parent firm are more tightly linked with
each other than with subunits operated by a
competing parent firm. These strong ties
coupled with common firm-specific
knowledge and language enhance the efficacy
of intrafirm knowledge diffusion (Kogut and
Zander, 1996; Zander and Kogut, 1995). As
a consequence, a change in behavior adopted

by one subunit will be shared with and
communicated more readily to a sibling
subunit than to a rival s subunit. Through this
systematic process of inheritance, subunits
benefit from the knowledge production of
other subunits operated by their parent firm
in addition to their own knowledge
production.
Turning to empirical issues, our interest lies
in testing the effects of the amount of
retention and variation on human capital
inflow. Measuring a multi-unit firm s amount
of retention activity at one point in time
requires examining whether the firm disperses
behaviors across its multiple subunits. Firms
operating only one subunit may preserve
behaviors over time but, by definition, cannot
affect wider dispersion of behaviors across
multiple subunits. Conducting the analysis at
the subunit level would thereby not allow us
to capture both of the activities that underlie
retention, preservation and dispersion.
Conducting the study at the subunit level
would also limit our research scope to
investigating whether or not a variation event
occurred rather than how shifts in a firm s
amount of variation activity affect its future
stock of human capital inflow.
Measures
Human capital inflow
A human capital inflow event occurs when a
trader moves into a trading room from
another trading room operated by its parent
bank, locally or across borders, or from a
trading room operated by a rival parent bank,
locally or across borders. For each event, we
define the amount of experience that a trader
brings into a recipient room. These amounts
are summed at the room level and weighted
by a room s size (the number of traders
operating in a room). The weighted averages
are aggregated to the parent bank level. This
aggregate value is weighted by a parent bank s
size (the number of rooms operated by a
parent bank). The resulting bank level
variable represents the annual stock of human
capital inflow to a bank.
Retention intensity
Retention involves the preservation and
subsequent dispersion of organizing patterns,
previously adopted by a bank in certain
subunits, across a bank s other subunits. To
begin, we classify a trading room s behavior in
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Volume 6 . Number 2 . 2002 . 164176
a given year into three mutually exclusive

event categories: retention, variation (change)
and no change. Although the no change
category is not included in our analysis, it
serves two critical purposes: first, to capture
cases where a retention or variation event
does not occur and, second, to allow that
retention and variation are not simply
opposite constructs. As mentioned, we focus
on the retention of one critical organizing
pattern, the mix of trader experience in a
trading room.
The experience mix captures the diversity
of the knowledge base among traders in a
room. A shift in the experience mix, such as
moving a trader with 20 years of experience or
introducing a set of rookie traders, influences
the knowledge base of a trading room and
impacts its day to day operations. Junior
traders may be less responsive to rapid market
changes whereas more experienced traders
may be more sensitive to rate movements and
market liquidity. Moreover, traders in a room
often work as a team, with experienced
traders assuming a mentor role. For instance,
senior traders might assist junior traders in
covering positions prior to market closing.
Rookie traders thereby benefit from
experienced traders expertise.
A room s experience mix also represents a
set of roles and interrelationships that define
acceptable behaviors. Over time, these
behaviors become embedded in a firm and
reflect codes that define how a firm responds
to external forces (Walsh and Ungson, 1991).
The shared codes among a firm s members
guide organizing patterns, such as
coordination and communication patterns.
Nevertheless, there is a downside to
experience. The fast-paced nature of currency
trading wears on traders over time and as a
result, traders often burn out after just a few
years of trading. Traders do not necessarily
burn out from expertise they have developed
but from the pace of practical experience that
helped them to develop expertise. As a result,
firms experiment with a balance between
youth and experience in their trading rooms.
Extensive interviews with over 65 trading
room managers indicated that some
combination of senior, mid-level and junior
traders must exist in a room more
experience is not necessarily an advantage. In
their continual search for an optimal
experience mix, managers decide whether to
retain the status quo in their rooms or to try a

different mix.
Defining a trading room s experience mix
required developing an algorithm that
calculated each trader s cumulative
experience (the number of years a trader
worked in the industry) from 1973 to 1993.
The algorithm compares a trader s last name,
first initial and second initial across years.
When a match occurs (all three parts at time t
match all three parts at time t 1), a trader s
experience count is incremented. Whenever
possible, the experience measures were
constructed using unique trader names. In
cases where a match is ambiguous, data on
the bank and country assignments are used to
identify a trader s history[1]. The algorithm
calculates a trader s cumulative experience in
the industry; the experience counter is not
reset to zero when a trader moves to a new
location or works for a different parent bank.
For example, consider a trader who works for
Citibank for three years and then works for
Fuji Bank for two years. Based on the
matching algorithm, the trader s total
experience is equal to five years.
A room s experience mix is the sum of the
experience of the traders in that room.
Because the experience mix might vary with
changes in the number of traders in a room,
the construct is normalized by the number of
traders in a room (e.g. a room s size). This
ratio, referred to as a room s experience ratio,
equals the total amount of trader experience
in a room divided by the number of traders in
a room. We calculate each parent bank s
average room experience ratio annually based
on all the trading rooms operated by a parent
bank. A bank s average experience ratio
reflects a pattern of acceptable organizing
behaviors that a bank has implemented in its
rooms. This baseline pattern, or common
code, defines how a parent bank responds to
external pressures and serves as a template for
replicating the organizing pattern across the
bank s rooms. The baseline pattern becomes
institutionalized as the number of a parent
bank s trading rooms adopting the organizing
pattern increases (Tolbert and Zucker, 1983).
We do not presume that any pattern adopted
is effective. We do suggest, however, that a
bank s wider dispersion of a pattern across its
rooms signals that the bank may value the
pattern.
Retention at the room level is then defined
as a change in a room s experience ratio that
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Volume 6 . Number 2 . 2002 . 164176
moves a room to a position that is less than

one standard deviation away from its parent
bank s average experience ratio in the
previous year. This measure is similar to a
distance measure; that is, we examine how
close or how far a room is to its past behavior
and to its parent bank s baseline behavior.
The retention construct is adjusted for the
effect that total room experience evolves with
cumulative trader experience. We sum the
retention event counts across each parent
bank for each year. The construct is weighted
by a parent bank s size since a firm s retention
amount will vary by firm size. The final
construct thus captures a firm s retention
intensity.
Variation intensity
Variation represents a meaningful alteration
in a firm s state, form or function. Since only
the variations selected and retained by a firm
are subject to external market pressures
(Nelson and Winter, 1982), we focus on
actual variations in a trading room or subunit.
A variation event occurs when a change in a
room s experience ratio moves the room to an
experience ratio that is greater than one
standard deviation away from the parent
bank s average experience ratio. This design is
intended to capture only meaningful or novel
changes in a room s organizing pattern rather
than cosmetic or incremental deviations from
a room s organizing pattern. A variation event
is therefore not simply any type of change.
The design is distinguished from existing
studies because we define a variation event by
relating a change in a room s organizing
pattern to its parent firm s past baseline
pattern. The variation event counts are
summed across each parent bank annually
and the measures are normalized for the
number of rooms a bank operates. This
approach allows us to identify the annual
amount of variation that a bank is engaging in
rather than simply whether or not a variation
event occurred.
Control variables
Other firm effects
The model specifications include a measure
for a parent bank s size. Large firms may
operate a higher number of trading rooms and
in turn, employ more traders than small firms.
Large firms chances of experiencing human
capital inflow and outflow may therefore be
greater than small firms chances. Research
also suggests that large firms are susceptible

to inertial effects (Barron et al., 1994). If this
holds then large firms may be less receptive to
human capital inflow than small firms. To
address these issues, the model specifications
include a measure of a parent bank s size,
defined as the number of rooms a parent bank
operates in a given year. We use the log
transformation of a parent bank s size to
reduce skewness in the distribution. We also
measure the total amount of human capital
outflow from a parent bank s trading rooms.
A firm may increase its stock of human capital
inflow to replace human capital lost via
personnel departures. A human capital
outflow event occurs when a trader exits a
trading room and the trader is absent from the
room for at least two years. The human
capital outflow events are summed across
each parent bank annually. The ages of a
bank s trading rooms may also affect its future
stock of human capital inflow. In the simplest
sense, a bank with new or young trading
rooms might source more human capital than
a bank with a set of established rooms. As a
trading room ages, the relationships and the
patterns of coordination and communication
among its members become more
institutionalized. Older trading rooms may
therefore engage in lower amounts of human
capital inflow than younger trading rooms. To
control for these effects, we include a variable
that captures the average age of a bank s
trading rooms after institutional change. We
use the log transformation of a room s age to
adjust for skewness in the distribution.
Industry effects
The analysis also includes measures for
industry characteristics that might affect
human capital inflow. Density captures the
number of competitors in the industry and
represents a proxy for the number of jobs
available in the worldwide currency exchange
market (see Sorensen (2000) for a similar
approach). The density measure assumes that
each firm presents an equal competitive
threat. Variation in firm size, however,
contributes to variance in firms competitive
strengths (Barnett and Amburgey, 1990).
Including a mass variable, defined as the sum
of the log(size) of all the firms minus the
log(size) of the firm under observation,
partially captures this heterogeneity in ability
(Barnett and Amburgey, 1990). Both
measures are calculated annually. We also
171

Volume 6 . Number 2 . 2002 . 164176
include a dummy variable for each year

observed to control for time period effects.
Model specification and estimation

Model specifications
The two models used to test the hypotheses
are specified as follows:
HCIit 1 HCIit1 1 Retentionit1
2 Variationit1 3 Variationit1
HCIit1 1 zit1 1 vi
it1 "1it
HCIit 2 HCIit1 4 Retentionit1

5 Variationit1 6 Variationit1
HCIit1 2 zit1 2 vi
it1 "2it
and
"nit "nit1 unit
Where subscript i references the firm,

subscript t indexes the time period, is the
coefficient on the lag dependent variable, z is
a vector containing a set of control variables
capturing firm and industry effects, v indexes
a set of dummy variables that capture the time
period effects, and represents a selection
parameter. The error term, ", includes an
influence from error in the prior time period,
"nit-1, and a disturbance associated with the
current time period, unit (Greene, 1993).
Parameter determines the magnitude of
carryover in error from the prior time period.
In equation (1), H1 predicts that 2 > 0 and
H2 predicts that 3 > 0, conditional on
1 > 0. In equation (2), H3 predicts that
4 < 0 and H4 predicts that 6 < 0,
conditional on 2 > 0.
Pooling observations over time for each
firm increases the chance that OLS
requirements of independence are violated.
This may bias parameter estimates. To
address this issue, we estimate fixed effects
models by subtracting the mean for each
variable across all observations of a firm over
time from the value of each variable and
surpressing the intercept. We also use a
proportionality variable to correct for
heteroscedasticity effects. Lag lengths were
identified by evaluating Akaike s
Information Criteria and the correlograms
for each variable.
The use of time series data mandates a test

for autocorrelation of the error terms in each
equation. The standard Durbin-Watson test
is inappropriate for models with lag
dependent variables (Greene, 1993). Instead
we use a modified Breusch-Godfrey test
(Greene, 1993, p. 428). The test does not
reject the null hypothesis of zero
autocorrelation in each equation s error
terms. When a model includes a lag
dependent variable and the error terms are
autocorrelated, the OLS estimator is
inconsistent and the residuals on which is
based are also inconsistent. The traditional
GLS estimators are therefore not usable.
Estimation can be achieved, however, using
an alternative instrumental variables method
following Hatanaka (1976) (see also Greene,
1993). This method decomposes the error
term into both random noise and an estimate
of serial correlation, therefore, we can be
fairly confident that our dependent variable s
measure is not confounded by persistent
unobserved effects.
Finally, sample selection bias may result
when parameters that influence the inflow of
human capital also cause firms to be selected
out of the sample (Heckman, 1979). The
models include a parameter to control for the
impact of selection processes on a firms stock
of human capital inflow. Using a
generalization of Heckman s (1979) two stage
sample selection model according to Lee
(1983), the selection parameter, , is
calculated as follows:
1 Ft
1 Ft
where is the probability density function,

is the cumulative distribution function and
F(t) is the cumulative hazard function. The
selection parameter, , is calculated for every
firm-year.
Results
Table I summarizes the results of the
hypotheses tests. The results of equations (1)
and (2) are presented in Table II. Prior to
discussing the results in detail, we briefly
summarize some of the patterns observed in
the main variables of interest. For brevity, we
do not report the correlation matrix here.
However, it is important to note that the
correlation between variation intensity and
172

Volume 6 . Number 2 . 2002 . 164176
Table I Summary of results
Table II The effects of variation intensity and retention intensity on

human capital inflow for multi-unit banks in the foreign exchange trade
industry, 1973-1993
Results
H1.
H2.
H3.
H4.
Increases in a firms variation intensity will generate

an increase in human capital inflow
Variation intensity will accentuate the positive
relationship between a firms existing stock of human
capital inflow and its future stock of human capital
inflow
Increases in a firms retention intensity will generate a
decrease in human capital inflow
Retention intensity will attenuate the positive
relationship between a firms existing stock of human
capital inflow and its future stock of human capital
inflow
Rejected
Independent variables
Human capital inflowt-1
Rejected
Variation intensity
Supported
Retention intensity
Variation intensity human capital Inflowt-1
Rejected
retention intensity is only 0.28; the

correlations between human capital inflow
and a firm s variation intensity and retention
intensity, respectively, are less than the
absolute value of 0.1. Figure 2 shows that
during the initial years following institutional
change, firms in the FX industry on average
pursued more variation activity than retention
activity. After 1977, the data indicate that the
firms engaged in approximately twice as much
retention activity than variation activity.
Figure 3 shows that the average amount of
experience that a trader brings to a firm
follows an upward trend until 1987. For the
remaining years observed, the average
experience carried into a firm ranges from five
years to approximately 6.5 years.
Table II reports the parameter estimates for
equations (1) and (2). The coefficients on the
lag dependent variable are positive and
significant in both models. This finding
suggests that a firm s stock of human capital
inflow is self-reinforcing. This is consistent
with our conjecture that the more experience
a firm has with importing human capital, the
more likely the firm may look to human
capital inflow as a mechanism for solving a
broader set of problems. Models 1 and 2 show
that the coefficient for variation intensity is
negative and significant. This finding
counters our prediction that increases in
variation intensity will generate an increase in
a firm s stock of human capital inflow.
Instead, it appears that, in the FX industry,
firms that increase their variation intensity
resist additional inflows of human capital in
the immediate future. Model 1 shows that the
coefficient for the interaction of variation
intensity and human capital inflow is also
negative and significant, accentuating the
Retention intensity human capital inflowt-1

Firm effects
Human capital outflow
Log(size)
Banks average subunit log(age)
Industry effects
Density
Mass
Adj R2
Number of firms
Dependent variable
Human capital inflowt
1
2
0.23 ***
(0.02)
0.21 ***
(0.06)
0.06
(0.04)
0.26) ****
(0.02)
0.13 ****
(0.02)
0.26****
(0.02)
0.33****
(0.06)
0.13**
(0.04)
0.02 ****
(0.004)
0.28 *
(0.12)
0.11
(0.10)
0.02****
(0.004)
0.28*
(0.12)
0.07
(0.10)
0.004
0.006
(0.004)
(0.004)
0.03 ****
0.03****
(0.008)
(0.008)
0.03 **
0.03***
(0.009)
(0.009)
****
0.007
0.007 ****
(0.0002)
(0.0002)
0.71
0.71
431
431
Notes:
*
p B 0.05, **p B 0.01, *** p B 0.001, **** p B 0.0001
All variables are lagged one time period, standard errors are in
parentheses
The models are fixed effects using a mean-centering approach according
to Greene (1993)
Models were estimated using Hatanaka correction for autoregression with
lag dependent variables. Weighted least squares estimation was used to
correct for heteroskedasti c errors
is the adjustment for sample selection bias (Lee, 1983)
main negative effect of variation intensity on

human capital inflow. This finding is counter
to H2. These results suggest that increases in
variation intensity may have stronger effects
on firms that have engaged in high amounts of
human capital inflow than on firms that have
imported lower amounts of human capital.
Consistent with H3, model 2 indicates that
increases in retention intensity generate a
decrease in the amount of human capital that
flows into a firm. The coefficient for retention
intensity is negative and significant in model 2.
173

Volume 6 . Number 2 . 2002 . 164176
Figure 2 Average variation and retention intensity for multi-unit banks in the foreign exchange trade industry,
1975-1993
human capital outflow is negative and

significant in both models. In sum, the
findings are consistent with H3 but oppose
H1, H2 and H4.
Figure 3 Average amount of experience a trader carries into a firm,

multi-unit banks, foreign exchange industry, 1974-1993
Discussion
The coefficient for retention intensity in

model 1 is also negative but not significant.
The coefficient for the interaction of retention
intensity and human capital inflow is
significant but positive rather than negative.
This finding suggests that the indirect effects
of retention on future human capital inflow
are lower for firms that have a high stock of
human capital inflow. One interpretation of
this finding is that a continuous inflow of
human capital might assist firms with high
retention intensity in breaking from tradition.
The results for the firm and industry level
effects are consistent across models. As
expected, the findings show that human
capital inflow increases with increases in a
firm s size and with increases in rivals
competitive strengths. The coefficients for the
log of firm size and for mass are positive and
significant in both models. We were surprised
to find that inflow decreases with increases in
human capital outflow; the coefficient for
Firms are increasingly interested in factors

that facilitate or constrain their abilities to
produce, leverage and transfer knowledge.
Moving tacit knowledge and skills is
particularly challenging given that it is largely
embedded in individuals. Tracking human
capital mobility within an industry over 21
years offers one way to systematically explore
the dynamics of one type of knowledge flow.
Furthermore, relating a firm s variation and
retention activity to human capital inflow
provides a way of understanding how
activities underlying knowledge production
might affect a firm s future stock of tacit
knowledge and skills. Limitations
notwithstanding, the findings provide strong
support for the idea that knowledge retained
in the past may restrict how much human
capital a firm imports in the future.
Nevertheless, the self-reinforcing cycle of
human capital inflow appears to moderate
this effect. Surprisingly, inflows of human
capital also tend to decline with recent
experience with change. This negative effect
appears stronger for firms that have imported
large amounts of human capital than for
firms that have imported less human capital.
We highlight a few implications of this
study below.
174

Volume 6 . Number 2 . 2002 . 164176
Human capital inflow: a way to break

from tradition?
In some regions, such as Silicon Valley,
human capital mobility among firms is
rampant. Increasing competitive and
economic pressures also drive firms to
continuously change routines and capabilities
in order to maintain their competitive
positions. But balancing variation and
knowledge retention and understanding how
these activities affect human capital mobility
is difficult. Our findings suggest that firms
that rely more on their past may benefit from
engaging in continuous inflows of human
capital. New personnel may introduce
sufficient diversity, either to a firm s
knowledge stock or a firm s social context, to
help these firms avoid competence traps. The
idea of bringing in new personnel to introduce
diversity, or shake things up, is not new. The
results suggest however, that a one-time
inflow event is insufficient to attenuate the
potential adverse effects of a firm s retention
intensity. A continuous inflow of human
capital is necessary over time.
Experience with change may inhibit
human capital inflow
We were somewhat surprised to find that
human capital inflows decrease when a firm
increases its change activity. One
interpretation of this finding is that firms may
delay importing additional human capital
until they have digested changes they have
adopted in the past. This suggests that
experience with novel change, or similar
exploration-type behavior, may inhibit future
inflows of tacit knowledge and skills. Recent
experience with change may therefore limit
future opportunities for learning. Moreover,
the negative effect between variation intensity
and human capital inflow is likely to be more
pronounced for firms that have experienced
high amounts of human capital inflow than
for firms with low amounts.
The dynamics of human capital inflow
The findings show a self-reinforcing cycle of
human capital inflow. This may have positive
or negative implications for a firm. On the
positive side, the cycle provides a continuous
flow of human capital to a firm and in turn,
creates opportunities for knowledge
development and combinative learning. On
the negative side, the self-reinforcing cycle
could generate a path of random drift rather
than a path of development that satisfies or

exceeds environmental needs. Moreover, a
threshold may exist beyond which the number
of new personnel entering a firm is more
disruptive than productive. Increasing inflows
may not necessarily stimulate useful
knowledge development. Firms should
therefore be sensitive to the path dependence
associated with inflows of human capital.
Developing organizational systems that
enable a firm to simultaneously leverage new
employees knowledge and integrate new
employees into a firm with the least amount of
disruption might be one way to address this
issue.
In conclusion, this study shows that time
matters for research investigating knowledge
flows. Examining flows at a cross-section in
time tells us little about their dynamic
relationships and their responses to other
factors related to knowledge production. In
fact, it is difficult to explore knowledge
development or learning at all without some
sense of time. Prior research shows that
examining mobility across different spatial
boundaries also matters (Madsen et al.,
2001). Combined these findings suggest that
future research investigating knowledge flows
should control for time and space dimensions.
Note
1 When a tie exists for a name, first initial and second
initial, such as two Browns, A.T. (referenced as
Brown, A.T.1 and Brown, A.T.2), we examine the
location and parent bank affiliation for the traders
over time. A match between time t and time t + 1 is
defined, for example, for Brown, A.T.1, when the
trader is located in the same country and affiliated
with the same parent bank at time t and time t + 1.
Duplicate names are identified within years, tracked
across years and assigned a unique identifier based
on the above logic. Duplicate names account for
less than 2.3 per cent of the total trader population.
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The dynamics of

Variation or change and knowledge retention

Tammy L. Madsen, Elaine Mosakowski and Srilata Zaheer